Forming Strategic Alliances – The Good, the Bad, and the Ugly

 

Austin AIA Annual Summer Conference

Presented by Brenda Barrett HealeyAugust 25, 2011

DALLAS · FT. WORTH · HOUSTON · AUSTIN · SAN ANTONIO

What is a strategic alliance?

A formal relationship between two or more parties to pursue a set of agreed upon goals or to meet a critical business need while remaining independent organizations

The Good

Why look for strategic partners?

• Cost sharing

• Risk Sharing

• Collaboration on ideas

• Enhance Strengths

• Compensate for Weaknesses

• Economies of Scale

• The whole is better than the sum of its parts

Forms of Strategic Alliances

• Contractual Relationships

• Joint Ventures/Partnerships

• Creating a new entity – Limited liability company/professional limited liability company– Professional Corporation– Limited Liability Partnership– Limited Partnership– Corporation

Contractual Relationship Joint Venture/Partnership

Formation of an Entity/Business

Description Examples of Types of relationships:

Office sharing agreement/Sublease

Agreement to provide services (independent contractor)

Subcontract for services

A general partnership may be formed without any governmental filing by oral or written agreement. Partners are taxed instead of partnership. Partners of general partnerships share liability for debt obligations

Select appropriate form of entity to use:

Corporation

Limited Liability Company

Limited Partnership

Limited Liability Partnership

Professional Corporation

Professional Association

Professional Limited Liability Company

Start Up Costs

Legal Fees to draft agreement that outlines the relationship (service agreement? Independent contractor agreement?)

Fees to draft Joint Venture/Partnership Agreement

Typically greater than to draft service contract for contractual relationship because of multiple issues that need to be addressed in Joint Venture/Partnership Agreement

Advise on appropriate form of entity to use (includes tax planning)

Fees to draft organizational documents (see “Organizational Documents” below for list)

Fees to draft any other initial documents not related to the formation (service contracts; employment agreements; etc.)

Contractual Relationship Joint Venture/Partnership

Formation of an Entity/Business

Initial Capital Minimal to zero; Each side pays their share of start up expenses independently

Depends on terms of agreement

Enough to pay for initial start up expenses and to pay for expenses anticipated until entity is generating enough revenue to pay for expenses out of revenue

Should fund with enough initial capital so that owners do not have make additional capital contributions or loans to the business

Individual Liability Only liability is what is agreed to in the contract or under law

No liability for liabilities of counter party’s business

If construed to be a partnership, each partner has full liability for the liabilities of the partnership

Assuming corporate formalities are maintained, generally not liable for debts and obligations of entity

Participation in Management

No participation in management of counter party’s business

General partners have the exclusive right to manage the business of venture

Provided by statute and governing documents of entity

Transferability of Interest

Interest in contract may be assigned unless prohibited by contract

Generally, a partner may assign right to distributions, but the assignee can only become a partner if other partners consent

Securities law restrictions on transfer and restrictions may also be imposed in the operating agreement

Contractual Relationship Joint Venture/Partnership

Formation of an Entity/Business

Organizational Documents

Contract Joint Venture/Partnership Agreement

Certificate of Formation

Bylaws , Company Agreement or Limited Partnership Agreement (or appropriate variation)

Organizational meeting minutes or consent

SS-4

If corporation, may have S Election form

If corporation – Stock certificates

If Corporation – Shareholder Agreement

Accounting No need to establish separate books for the relationship; but each party has to appropriately account for the costs paid and revenue received from the relationship

Partnership should keep separate books and records

Must keep separate books and records

Fiduciary Duties None Fiduciary duties to partners

Governing body owes fiduciary duties to owners

Contractual Relationship Joint Venture/Partnership

Formation of an Entity/Business

Ownership of Work Created during relationship

As specified in the contract Partnership generally Entity owns

Termination of Relationship Defined term Must set a defined term

when the relationship ends; can always be extended if things go well

Can have a defined term but not required

Is possible to have a defined term but typically do not

Removal or Withdrawal of a counterparty

Would likely be breach of contract and subject to damages

Removal or withdrawal of a partner

Removal or withdrawal of an owner

Matters to attend to at termination

Contract dictates what happens on termination and when termination occurs. Typically no assets of the venture so nothing to transfer

Agreement and law provide procedure and requirements for dissolution and distribution of assets. May require final tax return

Sell (or transfer in exchange for some value) all remaining assets and distribute to all owners in accordance with formation documents

File appropriate legal paperwork to dissolve

File final tax returns upon dissolution

The Bad and the Ugly

Improperly formed alliances an create unwanted exposure

• Unexpected liability to third parties

• Obligations to your “partner”

• Ownership of property

• Regulatory violations

How? Joint Venture as a Partnership

• A joint venture that satisfies definition of a “partnership” is a Partnership

• Texas Business Organizations Code definitions:– Partnership: “An association of two or more persons

to carry on a business for profit as owners creates a partnership, regardless of whether:

• The persons intended to create a partnership; or • The association is called a ‘partnership’, ‘joint venture’, or

other name.”

• Factors used in determining if “partnership” exists (Tex. Bus. Org. Code §152.052)• Receipt of right to share in profits• Expression of intent to create• Participation or right to participate in control• Agreement to share or sharing of losses or liability • Agreement to contribute money or property

– Safe harbors which do not create a partnership

Do you have a Partnership?

• Ingram v. Deere (Tex. 2009)– Psychologist and Psychiatrist disagree if partnership

formed to run pain clinic– Psychiatrist claims had oral agreement for partnership

and to split profits– Trial court initially determined was a partnership and

awarded share of profits before and after trial totaling over $5,000,000

– Reversed – No partnership

• Analysis:– Courts must consider all five factors but no single

factor is either necessary or sufficient as proof• Agreement to share profits not required. Profits as

compensation does not create a partnership. • Absence to share in losses not dispositive, but factor.

– “Totality of circumstances” – Direct proof of parties intent to form not required but

language and how described relationship to others is important

– Control

• Swanson v. Schlumberger Tech. Corp. (Tex. App. Texarkana 1997)– Swanson and Schlumberger (successor to original

party, Sedco, Inc.) in sea diamond mining business together

– Schlumberger exits sea-diamond mining business and buys out Swanson in order to sell full interest to DeBeers and British Petroleum

– Swanson sues for breach of fiduciary duty among other claims, and wins $14 million in damages, and $35 million in exemplary damages

– General evidence of community of interest• Held selves out as partners; letter agreements; original lease

awarded to predecessor and Swanson as partnership

– Evidence of agreement to share profits– Evidence both agreed to be responsible for some

expenses which constituted some agreement to share losses

– Evidence to demonstrate mutual control of project

Types of Exposure

Liability to Third Parties

• Each partner is agent of the partnership (Tex. Bus Org. Code § 152.301)

• All partners are liable jointly and severally for a debt or obligation of the partnership (Tex. Bus Org. Code § 152.304)– Torts (personal injury, negligence, defamation,

fraud)– Contractual obligations

• Ked-Wick Corporation v. Levinton, (Tex. App.—Houston (14th), 1984)

– Joint venture between construction contractor and agent that sold house

– Each party to joint adventure is legally responsible for the act of the other performed within the scope of the enterprise and resulting in injury to a third person

Obligations to Partners

• Partner owes partnership and partners duty of loyalty and duty of care and must discharge those duties in good faith and in manner reasonably believes to be in best interest of partnership (Tex. Bus Org. Code §152.204)

• Swanson v. Slumberger—Found fiduciary duty owed to Swanson

Ownership of Property

• Partnership property is not the property of the partners (Tex. Bus Org. Code §152.101)

• Property does not have to be acquired in name of partnership to be partnership property if transfer document indicates partnership or partner identity (Tex. Bus Org. Code § 152.102)

• Presumed to be partnership property if acquired with partnership property (Tex. Bus Org. Code § 152.102)

• As dissolution, partnership property pays back debts then distributed in accordance with rights to distribution (Tex. Bus Org. Code § 152.706)

• Taormina v. Culicchia (Tex. Civ. App.—El Paso, 1962)– Partner of defunct partnership had rights to receive its

share of goodwill of defunct partnership– Newly created partnership created by previous

partners attempted to use goodwill– Goodwill: same location, same name, same

customers, same supplier – Goodwill is asset of partnership belonging to all

Regulatory Matters

• Tex. Occ. Code § 1051.306 - Registration • Permits Board of Architectural Examiners to adopt

rule to require a firm, partnership, corporation, or association that engages in the practice of architecture, landscape architecture, or interior design to register with the Board

• Rule 1.124– Architectural firm or other business entity offering

architectural services have registration requirements– Registration required within 30 days after creation– Annual registration; Notice when dissolved (30 days)

• Rule 1.122 – Associations– When forming business association with “Non-

registrant” that is not employee, client, or subcontractor or consultant of architect or client, requires written agreement for architect or its firm to be responsible for Construction Documents

• Requires particular provisions of the contract

• Also requires architect to exercise “Supervision and Control” over the preparation of all “Construction Documents”, with limited exceptions

– Rule 1.124 requires registration of the association too

Practical Considerations in forming Strategic Ventures

Key Terms of Strategic Relationships

• Contribution of Capital

• Allocation of responsibility

• Decision making authority– Day to day decisions v. strategic decisions– Material changes to structure

• New “partners”; Change in ownership percentages• Merger/Dissolution

– Avoid 50/50 decision making models

• Distributions

• Allocation revenue between distributions and retained funds

• Termination of relationship and distribution of assets– Physical assets– Intellectual Property

Identifying your Strategic “Partner”

What does a good strategic partner look like?

• Proven ability to deliver• History or solid relationships with other

business partners and employers• Equal or greater level of sophistication

in business management matters

• Complements your strengths; Resources to address your weaknesses

• Similar level of risk tolerance

• Similar values

• Interested in the process of working through the initial start up documents and talking about issues to be addressed in documents

• Has financial ability to shoulder up to two years of little to no income from the venture

• Would you want to have a cup of coffee with them every day?

What does a bad strategic partner look like?

• Multiple previous banking relationships

• Multiple failed attempts at partnerships/ventures/entities (lots of prior partners)

• History of unexplained involvement in litigation

• Bankruptcy filings

• Lack of interest in process to draft start up documents and agreements

• Excessive sense of urgency• Lack of sophistication in business and

management (unless you will be handling this)

• Has your same strengths and same weakness

• Is much more risk averse or risk tolerant than you

• Primarily talks about how successful this is going to be and how much money you are going to make

• Little to no personal cash reserves to support self during tough times

• Values not aligned

Questions?

816 Congress, Ste. 800Austin, Texas 78701

512-708-1804www.hensleeschwartz.com

Presented by:

Brenda Barrett Healey

bhealey@hensleeschwartz.com

512-708-1804

512-206-6469

DALLAS · FT. WORTH · HOUSTON · AUSTIN · SAN ANTONIO