Presentation ———— April 2013

Presentation ———— April 2013

KCCLA and Sweet & Maxwell Fifteenth Annual LectureConstruction joint ventures – anomaly or breakthrough?

Dr David Mosey, (soon to be) Professor of Law and Director of the Centre of Construction Law at King’s College, London, and

Consultant to Trowers & Hamlins LLP

What is a JV?

● JV - “A contractual arrangement in which resources are combined – be they equipment, expertise or finance – by two or more participants with a view to carrying out a common purpose” (Vivien Ramsey - Construction Law Handbook)

● Construction JV – “a number of firms collaborating on a project, or a number of projects, with a view to sharing the profits, each firm being paid on the basis of its agreed contributions in kind or in financial terms” (Stephen Gruneberg and Will Hughes - Understanding Construction Consortia: theory, practice and opinions)

Construction JVs – a model for collaboration on construction projects?

● A means to tackle “deeply rooted structural reasons” that lead the UK construction industry to focus on “short-termism” and sustain “adversarial attitudes” (J Bennett: Construction – The Third Way)

● A means of reconciling “tribal” behaviour among different disciplines of consultants and contractors (NJ Smith – Engineering Project Management)

● A basis for creating “bilateral power” in team relationships rather than “unilateral power” driven by “coercion” (I.MacNeil – Economic Analysis of Contractual Relations)

● A means to clarify the “motivation” necessary to ensure that participants “willingly do their parts in the whole undertaking” (Milgrom & Roberts – Economics Organisation and Management)

JV - anomaly or breakthrough?

● Worth digging deeper in terms of common/divergent interests and systems governing JV control, reward and liability

● Anomaly if a construction JV distorts or blurs the roles/duties of JV members or fails to deal with divergent commercial objectives

● Breakthrough if a construction JV establishes a commercially viable model for greater efficiency and integrated working among construction project team members

● Need to review carefully whether harmonising of interests through a JV is vulnerable to “antagonistic sub-goal pursuits” (OE Williamson – Transaction – Cost Economics)

Construction JVs – anomaly or breakthrough?

● Is it true that people need to be “coerced to perform using a strict contract applied in an arms length manner” and that collaboration is “not only impossible to achieve but an inappropriate way of doing business”? (Cox & Townsend – Strategic Procurement in Construction)

● What about the risk of the “free rider” making a minimum contribution to a JV and undermining its success? (Milgrom & Roberts – Economics Organisation and Management)

● And why do 31% of construction JVs end in dispute? (EC Harris research figures for 2010)

JVs in the UK and international construction landscape

● Horizontal JVs – between group of clients or group of consultants or group of contractors in order to strengthen market position –response to particular market sector or individual project/programme of work

● Linear JVs – between consultants and/or capital project contractors/ specialists and/or repairs and maintenance/facilities management contractors/ specialists in order to present a comprehensive solution over the life cycle of a project/programme of work

● Vertical JVs - between (one or more) clients and (one or more) contractors or between (one or more) contractors and (one or more) subcontractors or suppliers

What drives the vertical JV?

● Clients seeking greater transparency in their dealings with contractors and subcontractors/suppliers

● Clients seeking a part of the profit generated by contractors and subcontractors/suppliers in relation to their own project/programme of work or third party business

● Contractors responding to the above opportunities

● Contractors recognising the fundamental role of a subcontractor/supplier in relation to a particular market or project/programme of work

JV governance options

● JV company limits liability (or would do if clients did not insist on joint and several liability) and creates financial flexibility in terms of control and financial/ tax planning

● Limited liability partnership JV as above, plus greater tax flexibility for members with different tax treatments

● Contractual JV with a separate JV entity lacks corporate governance but offers simpler exit arrangements

● And a director of a JV company owes a duty of good faith (Re Smith & Fawcett Ltd (1942))

JV case studies

● Client/contractor JV (UK) – North of England local government Limited Liability Partnership for repairs and maintenance services

● Main contractor/M&E subcontractor JV (UK) – Midlands contractual JV for prisons project

● Funder/Service Provider JV (Bahrain) – Contractual and corporate JV for utilities and energy management

Client / contractor JV

● Limited Liability Partnership JV

● £65m per annum repair and maintenance services

● Client transferred workforce/work stream and delegated responsibilities in return for capital receipt, long-term commitment and added value (e.g. employment and training)

● Arguably the sheer scale and potential overcame potential conflicts of interest

● Open-book pricing with profit share

● Efficiency governed by performance measurement and risk of losing exclusivity

Client/contractor JV

Client

JVCo

Contractor

Client

TUPE/assets/goodwill employees

(TPC2005 contract provision of works and services, payment and performance measurement)

(Investment/expertise/resource/return)

(Investment/ support/return)

Transfer to JVCo for capital receipt

Client/contractor/sensitivities

● Turnover or profit? – Contractor share of savings and value of potential contract extensions needed to exceed attraction of increased profit on rising turnover

● Business stability or reduced workload? - Minimum turnover guarantee so that savings and efficiencies were balanced by award of additional work

● Motivation or complacency? – Staged capital payment to client and performance-based contract extension provisions secured ongoing JV members’ commitment

Main contractor and M&E subcontractor JV

● Contractual JV

● £200m capital project under prisons alliance

● Early design input by main contractor and M&E contractor in collaboration with client design team

● Single project JV driven by need for close main contractor/ M&E subcontractor relationship

● M&E design innovations

● M&E critical deadlines

Main contractor/M&E subcontractor JV – sensitivities

● Primary liability of main contractor to client, exposure of M&E subcontractor limited to M&E part of project

● Sense of JV joint endeavour limited by ultimate ability of main contractor to issue instructions to subcontractor in line with client instructions to main contractor

● M&E subcontractor right of objection/consultation could not prejudice contractual demands of client build programme

● Performance of main contractor influenced client perception of M&E subcontractor, addressed through membership of contractual Core Group and Design Team

● Joint working on design and risk management subject to strict contractual deadlines for notification of prospective change and risk issues

Funder/Service Provider JV

● JVs a strong tradition in the Middle East linked to requirements for local equity shares in consultants/contractors as well as client and funder investments as owner/developer

● Corporate JV between Funder and Service Provider for provision of utilities and energy management services

● Utilities - Chilled water system, reverse osmosis plant, waste water treatment plant and associated infrastructure to provide services to Development

● Developer comprised separate corporate JV of Funder and Land Owner

● Grant of Concession Agreement by Developer to Funder/Service Provider JV covering design and construction of facilities and provision of utilities and services

Developer and Funder/Service Provider JV

Funder Land Owner Service Provider

DeveloperFunder/Service

Provider JV

Other contractors

Concession Agreement

Funder

(Involvement/ support/return)

(Investment/ support/return

(Investment/ finance/return)

(Investment/expertise, resource/return)

Development Customers

(Financing/design/construction of facilities and provision of utilities and energy management services)

Agreements for provision of utilitiesDevelopment

Agreements and Leases

Award of Contracts for finance/development of

network transmissions lines

Funder/Service Provider JV - sensitivities

● Funding of distribution network and transmission lines by Developer (including Funder) and funding of other Utilities facilities by Service Provider JV (including Funder)

● Alignment of Utilities development with completion of other development projects and uptake by customers of Utilities

● Reconciliation of interests of Funder as JV partner of Services Operator and of Developer

● Interface between distribution network/transmission lines and remaining Utilities facilities and customer facilities

● Impact of remedies for failure to meet capacity or failure to provide facilities

IBM and three local authorities – client/contractor joint venture: “South West One”

● Reported only in press so facts not verified

● Corporate JV

● £585m 10 year shared services project

● IBM 75%, Somerset County Council 11.75%, Avon and Somerset Police Authority 8.15%, Taunton Deane Borough Council 5%

● Dispute over payment, KPI, performance, changes to contract, shortfall in expected savings

South West One - sensitivities

● Client JV partner reverting to traditional client role

● Financial dependence of JV on IBM finance and support of IBM parent

● JV loss (2011) of £6.8m and accumulated net liabilities (2011) of £43.2m

● “Partnership” attitude and culture at an end?

So what goes wrong and why?

● JVs often hastily created to close a deal or support a bid

● Is there a need for a JV? – Clients can obtain transparency, control and even profit share through construction contracts without investing in JVs

● Client and contractor directors will have conflicting loyalties to their own companies and the JV

● Even with clear corporate governance, there is no guarantee of consensus – “When there is a divergence of interests, even moderate sized groups often find it impossible in practice to reach a unanimously acceptable decision” (Milgrom & Roberts – Economics Organisation and Management)

Construction JVs and emerging trends

● Multi-party alliance or consortium –horizontal JV with company/LLP/contractual governance issues and related liability questions

● Project partnering –multi-party, horizontal, linear (and vertical?) structure analogous to JV with its own contractual governance and incentivisation systems – at what point does project partnering translate into a construction JV, does it need to and does this dilute other contractual rights and obligations?

● New asset management structures – potential for long-term client/contractor repairs and maintenance JVs(with or without the LLP structures) e.g. client provision of workforce to JV to maintain stability and increase VAT efficiency

So what future for construction JVs?

● JVs are attractive business models for joint working

● Complex JV governance and potential conflicts of interest should lead to alternative non-JV solutions more often than they do

● Breakthroughs where JVs create efficient construction teams through combined skills and common purpose

● Anomalies where JV purpose or members’ roles are not clear or where members’ objectives may conflict

● Anomalies can be overcome where potential conflicts and tensions are recognised and worked through in JV governance and project delivery contracts