Joint Ventures: A Viable Option?
The following material is provided for informational purposes only. Before taking any action that could have legal or other important consequences, speak with qualified legal and insurance professionals who can provide guidance that considers your own unique circumstances.
A lot has changed in the design and construction industries in the last decade. Whereas nearly all design and construction projects used to follow the historic design-bid-build method of project delivery, the landscape today features a whole spectrum of choices. From design-build to integrated project delivery, and many options in between, design firms are entering into new and different agreements, configurations and alliances to get specialized projects completed to the owner’s satisfaction.
In response to these changes, design firms began looking at different ways to organize their businesses and alliances to more effectively deliver these projects. One method adapted early in this evolution is the joint venture.
Put simply, in the context of the design and build industries, a joint venture is a business entity comprised of two or more parties that, as a single entity, take the lead role in project delivery. In most cases, it’s two designers, likely an architect and engineer, who partner in a joint venture. However, a design firm may enter into a joint venture with another party, such as a contractor or a developer, in order to develop a strategic alliance and deliver a project or projects.
Regardless of who comprises the joint venture, it is typically set up as a separate legal entity established for a specific and limited purpose. Historically, this was almost always in the form of a partnership. As laws, rules and regulations have progressed, many joint ventures are now in the form of limited partnerships or, more and more commonly, limited liability corporations, or LLCs.
Note that each state and province will have its own rules about establishing joint ventures. Likewise, states and provinces will have their own rules about LLCs and how they can protect members from personal legal liability. Therefore, it is essential to have expert legal counsel investigate applicable laws in the areas where you operate to determine which form of joint venture, if any, will work best for you.
Where joint ventures are recognized, there are essentially two types of entities to chose from:
An integrated joint venture. Here, assets from the two firms are designated as assets of the joint venture. The integrated joint venture operates fairly similar to a typical design firm in terms of its contractual and other relations with its clients. Compensation received from the client is typically shared proportionately by the joint venturers as outlined in the joint venture agreement.
A “shell” joint venture. Here, the joint venture is established without assets. Work that is obtained through contracts with the joint venture’s clients is subcontracted to one or more of the joint venturers. The ultimate profit or loss is divided among members as stipulated in the agreement.
Your choice of which option to take will depend on the objectives of your joint venture, state/province laws and the recommendations of legal counsel. The form of the joint venture should be clearly defined in the joint venture agreement entered into by the joint venturers.
The Joint Venture Agreement Itself
At the root of every good joint venture is a well drafted document that sets up the rights and obligations of the two or more parties to the agreement. There are many templates available that you can start with, including documents from the AIA, the EJCDC, the RAIC, the AGC and the SBA. These are excellent starting points, but any good agreement will be tailored to fit the needs and wishes of the parties involved. That said, the agreement should cover the following at a minimum:
- The parties to the agreement.
- The business purpose of the joint venture.
- The duration of the agreement, including any termination date.
- Responsibilities, rights and duties for operating and managing the joint venture.
- Compensation for services provided to the joint venture.
- What each party agrees to contribute to the joint venture, including assets, employees, property and cash.
- How compensation, expenses, profits and losses will be shared, whether equally or proportionately.
- Who has signing authority for the joint venture.
- An allocation of liabilities by the partners to the joint venture.
Allocation of Liabilities
Generally speaking, joint venturers typically assume “joint and several liability” for the activities of the joint venture, regardless of which party to the agreement made an error, omission or breach of contract due to negligence. This means that any member of the joint venture can be held 100% liable for any errors or omissions committed by the joint venture even if another party to the agreement created the problem. This is regardless of what allocation of liabilities the partners have agreed to in the joint venture agreement.
Many joint venture agreements include indemnities that state each party shall have no liability to the other members for losses arising out of actions or inactions that were taken in the best interests of the joint venture. Again, such agreements only apply to members of the joint venture and would not prohibit a client, contractor or other outside party from seeking remedies from all joint venturers.
Consider this scenario: An architect and engineer form a joint venture. In their written agreement, each party agrees to be 50% liable, regardless of cause, for the errors or omissions of the joint venture.
During their first project as a joint venture, the architect creates a design error that results in $5 million in damages. While the client may agree to abide by the terms of the joint venture’s allocation of liabilities, as long as they are made whole, it is not legally required to do so. Only the two parties to the agreement, the architect and engineer, are bound by its language. If one of the parties, even the one at fault, for any reason cannot pay for its share of the liability, the other party can be held liable beyond the 50% it stipulated in the joint venture agreement.
Consider another potential situation: A large engineering firm forms a joint venture with a small architect office. The engineering firm agrees to take on 75% of liabilities since it handles most of the work and earns most of the revenue. The architect agrees to take on 25% of liabilities. There is a $4 million claim, so, according to the agreement, the engineer accepts $3 million in liability and the architect $1 million. The engineer’s insurer, however, insists that it should only cover half of the liability of the joint venture partnership. That leaves $1 million in potentially uninsured liabilities.
PL Insurance for Joint Ventures
It’s easy to see from the two above scenarios that even when parties have joint venture coverage as part of their professional liability (PL) practice policies, coverage gaps can result. And because of the joint and several liability associated with joint ventures, having adequate insurance is critical. That’s why it is so important to have a thorough insurance review before signing any joint venture agreement.
The first place to look for coverage for the joint venture will be your PL practice policy. Some PL insurers, as a matter of course, will cover your legal liabilities associated with the activities of the joint venture. Others may specifically exclude the joint venture from your practice policy. In such cases, the insurer may, for a price, agree to add a joint venture endorsement to your policy that includes this coverage.
Note, however, that having the joint venture listed as an additional insured on your practice policy likely will not cover the liabilities of other parties to the joint venture. You need to work with your insurer and attorney to make sure your insurance coverages are structured in a way that provides you needed protection. Requirements for coverage limits and deductibles should be discussed. This coordination of insurance coverages can be especially difficult to do when you are dealing with multiple insurance companies.
You may find, upon meeting with your insurance agent, that your practice policy, even with some degree of joint venture coverage, might leave you and your partners with uninsured professional liability exposures. Here are three options to discuss with your agent to fill these coverage gaps:
- A separate joint venture practice policy. Rather than add the joint venture to your practice policy, the joint venture, as a separate legal entity, may be able to purchase a separate practice policy. Here, the joint venture is the named insured and coverage only extends to those projects conducted by the joint venture, not any other work of its individual members. Any projects taken on individually by the members would remain covered by each member’s practice policy.
- A specific job excess (SJX) policy. Here, each joint venturer uses its own practice policy as primary coverage. Then, another layer of insurance is put in place for a specific joint venture project. For instance, each joint venturer could be required by the agreement to maintain $2 million in coverage on their practice policy. Then, the joint venture purchases $3 million more of coverage just for a named project. This is a much less expensive option that having each member of the joint venture increase its practice policy to $5 million.
- A project policy. If you enter into a joint venture to execute a single project, a project policy might be a viable option. Here, the client typically purchases a professional liability policy whose limits are dedicated exclusively to its project and cover the exposures of all design firms working on the joint venture’s project. No other claims from other projects can reduce the policy limits.
Clearly, liability and insurance issues can be complex when structuring a joint venture. That includes commercial lines of insurance as well. Many commercial general liability policies as well as umbrella policies specifically exclude joint ventures. There may be workers compensation issues regarding who is an employee of the joint venture and who is an independent contractor. Also, it may be difficult to find a commercial insurer who will write a separate policy for a joint venture.
Because of all of these issues, you should have your insurance agent help prepare a comprehensive joint venture insurance program for all required coverages including alternative employers’ endorsements, completed operations coverage for GL, waivers of subrogation and additional insurance status. Your PLAN agent should be able to help you explore these options.
Keys to Success
Entering into a joint venture presents many challenges. There are, however, guidelines to follow when setting up a joint venture that can increase your chances of success. Consider:
- Pick a partner or partners who represent a good match of skills that enables you to offer exceptional specialized services. The joint venture should create a positive synergy where the capabilities of the venture are greater than the sum of its individual parts.
- Consider picking partners who are similar to your firm in terms of size. That helps you identify as true 50-50 partners, rather than unequal members. A disparity in company size may signal that you should consider the more typical prime/subconsultant relationship for the project in question.
- Make sure your company culture is compatible with a potential joint venturer. That includes sharing a similar management style and risk management philosophy. Remember: you may be held liable for your partners’ actions and inactions even though you lack any control over their activities.
- Communicate, communicate and communicate. There should be no secrets between joint venturers. This type of business marriage requires honesty and clarity.
- Put it in writing. The joint venture agreement is the backbone of the union. Although joint ventures can be formed without a formal written agreement, this is no time for skimpy and vague documents or verbal agreements. Spell out your roles, responsibilities and scopes of services in great detail. Review the joint venture agreement at least annually.
- Manage risks. Address how professional liabilities will be allocated and handled. Also establish insurance requirements for each partner and, possibly, the joint venture as a separate entity.
- Speak to an attorney experienced in construction law. A legal review by someone knowledgeable of joint ventures in the design and construction industry is a must.
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