Joint venture or misadventure?

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The Economic Times
16 July 2011 by

Arpinder Singh,
PartnerĀ and National Director
and
Yogen Vaidya,
Senior Manager

Over the last five years, the number of new joint ventures in the country has increased from 10 in 2005 to 72 in 2009, according to Bloomberg.

Infrastructure, defence, insurance and retail are examples of some of the sectors where joint venture route has been the preferred mode of entry for global companies. As the headline suggests, joint ventures can, at times, become risky adventures, and this calls for careful review and precautions at every step of the process, i.e., partner selection, setting up and operations.

While there is a rise in the number of joint ventures, so also is the trend of increasing number of call-offs, termination and separation. This may result in business and reputation loss for the company and affect shareholder confidence. The 40:60 joint venture between one of India's largest conglomerates and a US multinational corporation formed in the 1990s was called off in the 21st century.

The grounds for the split were lack of synergy between the two partners and tiff between the promoters over cultural integration and professional differences. As per market perception, nearly 70% of the investors back away from deals in emerging markets after conducting an enhanced integrity check on partner company.

To quote another example, in a particular case of a large potential investment in infrastructure sector, the joint venture was called off due to a late-stage detection of legacy regulatory non-compliances and sugar-coated portrayal of facts. Recently, it has been observed that in order to tackle such an eventuality, more investors are getting an enhanced integrity check on the target company.

A pure-vanilla due diligence will not help, as the issues are not lying on the surface and a deep dive is required to get the intelligence out. The drafting of the joint- venture contract can also be a cause for long-drawn legal battles. Typically in the oil and gas sector, the joint operator agreement plays a major role throughout the tenure of the production-sharing contract.

Recently, it has been noticed that there is a rise in the number of disputes both in India and across the globe especially around sharing of cost and profit petroleum. The recent telecom scandal in the country has resulted in a scare among foreign joint venture partners over their business prospects in India considering the allegations of regulatory non-compliances and bribing by an Indian partner.

Also, on analysing other reported cases, it has been observed that breach of terms and conditions were ongoing since the beginning of the joint venture, but due to lack of monitoring mechanism, it was never detected and noticed. In another case, it was observed that the partner was involved in manipulation of revenue-sharing agreements and was overcharging shared cost to the joint venture.

New-economy sectors are more vulnerable to breach of IPR risks, as the dependence on knowledge, innovative techniques, technology and other forms of IP is significantly high. A joint-venture partner can divert the IP to its own set of firms and gain mileage from the same.

Take the case of a joint venture between a French food products manufacturer, which owns about 25% stake in one of India's largest cookie manufacturer. It is alleged by the Indian company that the French manufacturer registered a cookie brand in several countries without its knowledge, and the same is not permitted as per the existing agreement between the two. A joint venture can also become a sham device for siphoning off funds where a partner swindles the venture of its profits or misappropriates funds or assets.

This has been clearly established in a case where a state-run industrial infrastructure corporation has accused its partner, Gulf region's largest land and real estate developer, of defrauding the state. In another case that was widely reported, partners in a joint venture were involved in asset misappropriation schemes such as diversion of funds, irregular related-party transactions, fraudulent disbursements, larceny, misuse of factory premises, purchase of assets for external ventures, etc.

Thus, such eventualities not only cause harm to the company from the financial and regulatory compliance perspective but also have a significant impact on its reputation. Reviews from forensic accountants have uncovered potential risks in the books of account, for example, undisclosed related-party transactions, undisclosed liabilities, fudged revenues, under- reported costs or liabilities, diversion of funds, personal profiteering, etc.

It has been observed that more and more corporations in India have started following the global best practice of conducting enhanced integrity check on the potential partner before entering into a joint venture. Also, after setting up the venture, detective checks such as contract compliance reviews and end-use monitoring are also increasingly being undertaken.