Preparing for a Joint Venture (Part 1)

By Joe Parisi and Ed Underhill

What is a Joint Venture? A joint venture is a business entity formed between two or more unrelated companies, usually for the purpose of taking advantage of each company's existing assets or markets. The expectation is that by combining their differing strengths in a joint venture, two companies working together can more quickly penetrate a particular market than either company could through independent efforts. A joint venture (or "JV," as it is often called) can be an excellent way for a foreign company to enter the North American market without devoting the personnel or making the capital investment that is usually necessary to form a wholly-owned U.S. subsidiary. A joint venture can be an even more attractive business opportunity to a foreign corporation in difficult economic times when capital and personnel are limited.

A joint venture can be operated through a limited liability company ("LLC"), a corporation, or a partnership. The rights and the obligations of parties to a joint venture are primarily controlled by the Joint Venture Agreement (the "JVA"). But before the JVA is signed, participants to a joint venture should take several preliminary steps to reduce the risks and disadvantages that are inherent in a joint venture.

Part of I of this article on Preparing for a Joint Venture provides a brief overview of how a joint venture is formed, and discusses the need to protect technical "know-how," confidential information and intellectual property ("IP") during the earliest joint-venture discussions. The goal of this article is to remind foreign companies looking to participate in a joint venture under U.S. law that they need to take certain steps before they reveal their confidential information and IP to a potential JV partner.

Why a Joint Venture? Participants in a joint venture are often "friendly" competitors in certain markets or they would be competitors if they sold their products in the same geographical territory or to the same customer market. Instead of competing with each other, two companies form a joint venture to produce a new product or a new service for sale to a specific market. For example, many JVs formed in the United States involve a foreign corporation that has new or exclusive technology. The foreign manufacturer is looking for an established market for its cutting-edge products.

But the foreign manufacturer has decided that it needs more than just an American distributor to sell its products in North America – it needs a "partner" that will help modify existing products to satisfy American standards, or help develop new products based on technology that each company possesses. In addition, the joint venture participants sometimes determine that it will be better if the JV products are manufactured, at least in part, by the American partner in the United States, or by the business entity established under the JVA.

The American joint-venture partner, on the other hand, usually has an established distribution network or customer base that is ready or anxious to obtain the cutting-edge products or services. Often, the American company also manufacturers its own products that are similar to the cutting-edge product that will be the subject of the JV. But the American company is unable to develop or manufacture a cutting-edge component of its own, either because it does not have the technology, personnel, or capital to develop new products.

Under these circumstances, a foreign manufacturer and an American manufacturer will decide that a joint venture is the best business practice for developing and introducing a new product to a ready market. But, even during the earliest discussions, both potential joint-venture partners will need to share confidential information or other IP -- such disclosures might have to be freely made and will need to demonstrate a level of trust if the joint venture is to succeed. Even so, it must be recalled that the information and IP to be disclosed will be given to a company that might eventually be a potential competitor. Therefore, special care must be taken before any information is disclosed to a third-party. How the foreign corporation identifies, protects, and divulges its confidential information and IP to its potential JV partner will have important consequences for the foreign corporation regardless of whether the joint venture is eventually formed.

The Joint Venture Agreement and Other Important Documents. The rights and obligations of a joint venture are primarily controlled by the JVA, which should consist of a written document that contains all of the representations and terms of the joint venture. Every promise, expectation, or obligation of the JV that is important to the foreign company should be included in the JVA. This should be done no matter what reasons are given by the American partner for leaving information or terms out of the JVA. Sometimes, an American JV partner will tell a foreign company that "we don't need to say it in the JVA; you already said it in an e-mail. So, just consider the e-mail to be a term of the contract." Such a statement is nearly always wrong. Relying on information or promises contained in e-mails is especially dangerous for the foreign company. In most cases, the U.S. Courts will not consider the contents of an e-mail exchanged before or at the time the JVA is signed to be included as terms of the JVA.

The foreign company should not look to its American JV partner to explain the meaning of contract terms. Even if the American company is well-intentioned in its explanation of contract terms, the American JV partner might still misunderstand the legal significance of terms contained in the JVA.

It is especially important that the foreign company work closely with its accountants and American lawyers in the preparation of the JVA. The Agreement and the formation of the JV may have important tax and accounting consequences for the foreign company. In addition, the JVA may contain legal terms that are not familiar to the foreign corporation. At a minimum, the foreign company must make certain its U.S. attorneys review the JVA before it is signed.

Protecting information before the Joint Venture is formed. While the JVA is typically the controlling document in a joint venture, the parties should first sign an initial Non-Disclosure Agreement at the first stages of the JV discussions. It is common to see companies sign the initial Non-Disclosure Agreement (or "NDA," as it is usually called) prior to any serious discussions regarding a possible joint venture. If the JV discussions are productive, the companies will sign a Memorandum of Understanding (or "MOU" as it is sometimes called).

The MOU typically is a preliminary statement of the goals of the JV, and it sets forth in a general manner, the parties' expected roles and responsibilities. The MOU should also contain a legal promise by the JV participants that neither will divulge nor use confidential information or IP that is obtained from the other party during the preliminary JV discussions.

Although such contract provisions are typically called "non-disclosure" provisions, such paragraphs must also state that the parties are prohibited from using confidential information or IP obtained from the other party. It is vital that a foreign corporation not provide any confidential information, technical "know-how" or IP to the other JV participants until a Non-Disclosure Agreement or MOU is signed by all the parties to the joint venture. If confidential or proprietary information is delivered to the other parties prior to the signing of a Non-Disclosure Agreement or a MOU, the foreign company incurs a serious risk that its information will be not be protected by a U.S. court in the event it is later divulged or used by the other party to the joint venture.

Protecting Information in the Event the JV Does Not Occur. In addition, a foreign company should not assume that the joint venture will go forward and that the signing of a Joint Venture Agreement will protect information previously exchanged during discussions and negotiations. The signing of a Joint Venture Agreement alone will not give protection to information that is not "proprietary" or which has been previously disclosed without a promise of non-disclosure. Under U.S. law, if you provide a third-party with confidential information without first requiring the company to sign an NDA, the confidential nature of the information is usually lost, and a court won't protect it. In other words, U.S, courts will not protect information as confidential if the company itself did not take adequate steps to protect the confidential information.

Also, just because information is important to the company does not mean that a U.S. court will decide that the information is entitled to legal protection. In other words, a U.S. Court might decide that the information the foreign company is trying to protect is neither confidential nor proprietary. Even if the company has spent a great deal of time and money developing its IP, a court might still decide that the information is not really proprietary, and it will not protect the company in the event a joint venture partner later discloses or uses this information. Foreign companies are sometimes surprised to learn that U.S. Courts are reluctant to protect from unauthorized use, a company's important business information such as customer lists and marketing strategies.

Such a decision by a court could have a devastating effect on the foreign company, especially if the joint venture partner has become a competitor or a potential competitor. The time to review the information that will likely be disclosed during the course of JV discussions is before any such discussions occur.

Once the foreign company determines what information it will likely be disclosing, it must take all reasonable steps to protect the information as confidential. Again, a U.S. court will not protect information as confidential if it determines that the company itself has failed to take all reasonable steps necessary to protect this information. (The common American expression for this rule is to say, "the Court can not put the toothpaste back in the tube.")

Protecting confidential and proprietary information should be one of the first and most important goals of forming a joint venture. Failure to take the necessary steps to protect information can have a devastating effect on a company – and the full effect of its failure in this regard might not be known until after the joint venture fails or is dissolved. By then, it will be many years too late.

Conclusion. The time to think about protecting your confidential information, technical "know-how," and intellectual property in connection with a joint venture is before any information is divulged to the potential JV partner. A foreign company that is considering entering into a joint venture in the United States should first review its own confidential information and IP to make certain that a U.S. court would agree that such information is entitled to legal protection. The company should also make certain that it has a policy and practice in place that protects its confidential information and IP. These first steps should be taken with the help of your U.S attorney and accountant. Once the company is satisfied that its confidential information and IP is entitled to legal protection, it must make certain that a Non-Disclosure Agreement is signed with all of the potential joint-venture partners. The NDA must also prevent the JV partner from using your confidential information and IP for any purpose not directly related the JV. The Joint Venture Agreement itself (as well as any Memorandum of Understanding) should also repeat the non-disclosure and non-use obligations. Finally, it is important that a foreign company not rely on its U.S. joint-venture partner to interpret or explain the legal meaning of the JVA. Joint ventures seldom last beyond five or six years, and the foreign company considering a JV should plan for potential issues that will arise when the joint venture has come to an end.

Part II of this article on Preparing for a Joint Venture will address the risks associated with entering into a joint-venture in the United States, including restrictions that are often imposed on joint-venture partners that could have an unexpected impact on non-joint-venture sales.

Please contact Joseph Parisi (jparisi@masudafunai.com) or Ed Underhill (eunderhill@masudafunai.com) if you have any questions regarding this article, Preparing for a Joint Venture.