Article. Joint Ventures in the GCC. Article by Alison Hubbard, Partner Corporate and Björn Gehle, Partner Dispute Resolution. Updated: August 2013

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1 Article Joint Ventures in the GCC Article by Alison Hubbard, Partner Corporate and Björn Gehle, Partner Dispute Resolution Updated: August 2013 Introduction In response, amongst other factors, to global financial uncertainty, joint venture activity has been on the increase in the Gulf Region over the last few years, and there is every sign that this will continue as businesses seek to minimise the inherent risks associated with entering new markets. The benefits of a successful joint venture include the sharing of risk, the pooling of complementary skills and capabilities, as well as providing access to new markets. After years of economic growth, the governments of the GCC member states (Bahrain, Kuwait, Saudi Arabia, Oman, Qatar and the United Arab Emirates or UAE ) are regrouping in the face of global economic, and regional political, uncertainty in an effort to build economies diversified from oil, with the result that the Gulf Region is an attractive proposition for businesses looking to expand, and joint venturing is a potential means of so doing. A shared common objective can lead to a match made in heaven for many businesses that choose to joint venture. However, many joint ventures face barriers that can hinder its development and success. Therefore, before committing to what can be a long term, capital intensive venture, it is crucial to get the venture started on the right terms, both legally and commercially. Common barriers to successful joint ventures Holding back can lead to trust problems Mismatch in objectives Clash of culture Management styles, approach to risk, systems, policies, procedures Dominance by a party. Common features of successful joint ventures Trust Communication Strategic compatibility Interaction between colleagues Correct structure. What is a Joint Venture? The term joint venture can mean different things to different people. However, the common features of joint venture relationships are two or more parties working together for the purposes of executing a particular business venture. In the context of joint ventures in the Gulf Region, in addition to the traditional joint venture where both parties contribute to the business venture, there are other relationships that could be classified as joint ventures, for example, an agency/distribution relationship or the local sponsorship arrangement in respect of limited liability companies required by the laws of some GCC member States. However, in the context of this article, we focus on the joint venture relationship in the traditional sense. The Structure of the Joint Venture There are a number of different structures that a joint venture can take. Typically in the Gulf Region, the structure is likely to take the form of a contractual alliance, or limited liability company into which the venturing parties will invest. Ultimately, the laws of the jurisdiction in which the joint venture is to operate will dictate the structure, but several other factors will also influence the decision. Continued on next page >

2 Factors Influencing Structure Commercial objectives Single project/range of projects? To set up a long term cooperation? Tax Will tax impact on the structure? Is repatriation of profits easier in one form of joint venture than in another? Liability How important is it to limit liability? Nationality of the joint venture Do you need a local entity? Is it desirable to retain home nationality? Management What kind of management and decision making structure is desired? Transferability of interest Do the joint venture parties envisage new members? Funding If the joint venture needs access to funding, is it easier to achieve in one form of structure than another? Unwinding How important is ease of unwinding to the parties? The Structure of the Joint Venture Contractual Alliance Also referred to as a consortium or co-operation agreement, the contractual alliance does not involve the creation of a separate legal entity. The relationship between the venturing parties is created by contract; the parties are not stakeholders in a separate legal entity. The contract between the parties will cover, amongst other things, the rights and duties of the parties as between themselves and third parties, the duration of the legal relationship, and how the relationship may be terminated. In a contractual alliance, the liability of members is unlimited. Contractual alliances tend to be appropriate for parties who are coming together for a particular project for a specific length of time, or who do not want to be bound together indefinitely or formally through a special purpose vehicle, or who wish to keep assets and liabilities separate. Contractual alliances are commonly used for bidding for projects, or for bidding and execution of projects, particularly in the construction sector. The key advantages and disadvantages of the Contractual Alliance structure can be summarised as follows: Advantages Lack of formality Relatively inexpensive to set up Tax efficiency (although this depends on the jurisdiction) Usually each joint venture member retains management control over its own resources and personnel Accounting privacy Relative ease of termination. Disadvantages Unlimited liability Potential difficulty in obtaining funding. The Structure of the Joint Venture Corporate Entity Often driven by the need to have a permanent presence in order to be able to carry on business in the Gulf Region, establishing a corporate entity is arguably the most common structure for joint ventures in the region, particularly where the parties intend for the venture to be long term. The entity in question is usually in the form of a limited liability company. A joint venture structured as a limited liability company will be regulated by its Memorandum of Association, Articles of Association and the Shareholders or Joint Venture Agreement. Being a separate legal entity with its own legal personality, the company can own and deal in assets, sue and be sued, and contract in its own right. 3017

3 Pinsent Masons Joint Ventures in the GCC The key advantages and disadvantages of the limited liability company structure can be summarised as follows: Advantages Separate legal identity Assists in creating a clear internal management and employment structure Limited liability Financing company can hold assets in its own name and can access more financing possibilities. Disadvantages Compliance requirements Less flexibility in governance less freedom for changing arrangements Greater complexity involved in termination/unwinding. Regional Considerations Cultural Challenges For those unfamiliar with the Gulf Region, it is worth taking a moment to consider how the cultural differences between the venturing parties can impact upon the progress and success of the joint venture if not properly understood and accepted. It is important to bear in mind that the parties may be negotiating in what is for them a second language. This can present problems in translating some of the more sophisticated concepts associated with joint ventures; for example, Put and Call Options, Russian Roulette, Texas Shoot Out, Deadlock, Reserved Matters. These are concepts that experienced venturing parties will be familiar with, but that is not necessarily the case for the local party. Furthermore, as we discuss below, the legal framework does not generally provide for these more complex arrangements. There is a strong relationship culture in the Gulf Region, with a great deal of emphasis placed upon trust. Therefore, negotiations should be approached with this in mind. While the level of sophistication of transactions generally is increasing in the region, as local parties gain more international experience, long and complex joint venture agreements can be a surprise to local venturing parties who see the transaction as more straightforward; the inference from a long and complex document can be that you are not prepared to take your partner at his word. From a practical perspective, foreign parties to a joint venture will usually need to accommodate a different working week; the usual working week in the Gulf Region is Sunday to Thursday, although in Saudi Arabia it is Saturday to Wednesday. Similarly, foreign joint venture parties need to factor in the shorter working day during Ramadan when observing Muslims fast during the hours of sunrise to sunset. Government and private offices close early during this time, so there is significantly less time in which to liaise with any Government Ministry during Ramadan. Regional Considerations Legal Framework A good understanding of the laws that will apply to the joint venture is key to identifying the most appropriate structure of the joint venture. The countries in the GCC are civil law jurisdictions, with codified statutes, which are still evolving to meet the demands of global trade. In the UAE, for example, several new laws are in draft form which aim to address some of the limitations of the legal framework, however, it remains to be seen when these laws with be formally adopted. In the meantime, therefore, the legal framework applicable to the joint venture is likely to be less sophisticated than foreign venturing partners are used to. As mentioned above, the laws of the countries in the GCC do not generally facilitate mechanisms often incorporated into joint venture arrangements in other more developed jurisdictions; for example, where the joint venture is structured as a limited liability company, where permitted, the Articles of Association will often be tailored to the reflect the shareholder agreement between venturing parties. This generally has the effect of binding the special purpose vehicle to the terms of the joint venture, and can give the shareholders recourse under relevant company laws, as well as in contract. However, in the Gulf Region, companies are limited as to the extent that they can amend the standard form Articles of Association, and so venturing parties must rely on the shareholder agreement to enforce their rights. In some cases, the concepts included in the shareholder agreement may be difficult to enforce as a matter of contract. It may sometimes, therefore, be appropriate for joint ventures structured as a corporate entity operating in the Gulf Region to consider an off-shore holding structure through which to invest. Continued on next page >

4 Similarly, careful consideration should be given to the governing law of the joint venture. In some cases it may be appropriate for the joint venture agreement to be governed by a foreign law even though the operations of the venture will be in the Gulf, particularly if disputes between the venturing parties are to be referred to arbitration, as discussed below. Regional Considerations Foreign Participation Rules Where the joint venture is to be structured as a corporate joint venture, it is important to factor into the equation the impact of any foreign ownership restrictions in the relevant jurisdiction; to varying degrees foreign ownership is limited in the Gulf Region, which means that irrespective of the origin of the venturing parties, a local shareholder may be required to satisfy legal requirements. Foreign Participation in the GCC Bahrain KSA Kuwait Oman Qatar UAE mainland UAE free zones 100% foreign ownership permitted for most sectors 100% foreign ownership subject to negative list 51% local ownership 51% local ownership 51% local ownership 51% local ownership 100% foreign ownership Obviously, and depending on the jurisdiction, if it is not intended that the foreign shareholder will hold a controlling interest, this issue may not be relevant. However, if the foreign shareholder is intended to hold a controlling interest, then clearly the issue must be addressed. Several mechanisms have been developed to protect the foreign shareholder s position in these circumstances; firstly, although the law may require the majority of the legal interest to reside with a local shareholder, in some cases the law permits economic interest (i.e. a shareholder s entitlement to dividends and share on liquidation) to be held in different proportions, so for example, although a foreign shareholder may only hold 49% of the shares in a company, it could be entitled to 80% of the profits. Note, however, that maximum portion of the profits that a foreign shareholder can take may vary depending on the relevant jurisdiction. Another means of protecting the foreign shareholder s interest is to set the threshold for passing resolutions at a level higher than the simple majority that is usually required, which would mean that the foreign shareholder s vote is required before a resolution can be passed. Certain resolutions, such as a change to the Articles of Association, or a resolution to wind up the company will generally always require unanimity. Another important method of ensuring that the foreign shareholder controls the day to day running of the business is to ensure that the foreign shareholder has the right to appoint the executive management team, such as the CEO, CFO and COO, and that the removal of these officers be subject to the consent of both shareholders. In these circumstances it will be essential to ensure that the authority of the officers of the company is carefully set out in the company s constitution and the POA that will invariably be granted to the executives. Similarly, it is equally important to put in place clear corporate governance procedures and policies that clearly define what the board is responsible for, what the executive managers are responsible for and establishing governance committees where appropriate. The issue of corporate governance is becoming increasingly more important in the Gulf Region, particularly following the global financial crisis. In some jurisdictions, a practice has built up whereby side agreements are entered into relating to the management of a joint venture company. This practice is usually adopted outside of the true joint venture scenario, where a local shareholder is required pursuant to the relevant laws, but is not intended to participate in the management of the company. The basic position is that any arrangement that seeks to by-pass the relevant laws would not be enforceable. However, there may be merit in having such agreements in place depending upon the context and circumstances of the arrangement. 3017

5 Pinsent Masons Joint Ventures in the GCC Regional Considerations Corporate Governance & Probity Corporate governance and probity are playing an increasingly important role on the international playing field, with the US Foreign and Corrupt Practices Act becoming a benchmark for international standards of probity, closely followed by EU legislation, such as the UK Bribery Act. Such legislation will have a significant impact upon many international businesses seeking to enter into a joint venture in the Gulf Region. In addition, the jurisdiction in which the joint venture is operating is likely to have its own legislation on the issue, albeit not necessarily in one codified statute. This issue is unavoidable with serious penalties for failure to comply with relevant legislation, so a clear understanding of the relevant laws, as well as a comprehensive approach to ongoing policing and enforcement are of the utmost importance. Regional Considerations Due Diligence The importance of doing due diligence on prospective joint venture partners can not be overstated in view of the potential reputational risk associated with a joint venture gone wrong, or possibly worse, the wrong joint venture partner. Due diligence should, therefore be a key part of the process. However, with little publicly available information, and a potential lack of understanding on the part of a venturing partner as to why due diligence must be carried out, it is not always easy to get to know your joint venture partner. Due Diligence key issues to cover The corporate affairs of the partner Shareholders who are they? Board & Executive management who are the key managers? Market research what do people who have done business with your potential partner say about them? Anti-corruption enquires what policies and procures do they have in place to prevent corrupt practices? Regional Considerations Disputes & Enforcement Most joint venture arrangements will include escalation provisions with the objective of amicable resolution of any disputes. However, the joint venture agreement will also have to provide for those circumstances when the parties can not come to terms on a dispute. The key concern for the foreign venturing party will be the enforcement of any court or arbitral award in the country in which the joint venture s assets are situated. This raises two principal issues: 1) the choice of governing law; and 2) the forum for dispute resolution. Taking first the issue of governing law, while the civil codes of the countries in the Gulf Region generally leave the parties free to choose the governing law of their arrangements, as a general comment, it is often the case that, irrespective of the parties having opted to apply a specific governing law, the local court will instead apply its own domestic law. Where the parties opt for arbitration the venturing parties can be more confident that where an agreement stipulates that it shall be governed by the law of a particular jurisdiction, the arbitrator will abide by such stipulation. This is one of the reasons why most joint venturing parties opt for arbitration as a dispute resolution method. Another benefit of choosing arbitration over litigation in the local courts is the time it takes to get a judgement or an award, as well as the cost which the parties will incur during this process. In the UAE for example, the WTO s index for Ease of Doing Business suggests that it takes an average of 537 days for a matter to move through the courts, at a cost of 26% of the claim value. In addition, the proceedings will be held in Arabic, using procedures that are very different to the procedures adopted in common law jurisdictions, and in fact many western civil law jurisdictions. While arbitration is not necessarily known as the cheaper alternative to litigation, arbitration allows the parties to exercise much more control about the way the proceedings are conducted and therefore to have more influence on the time and the cost devoted to the arbitration. Furthermore, local court judgements in the UAE may be subject to an appeal by the Court of Appeal, and a further review by the Court of Cassation (the court of final appeal). Therefore, in a worst case scenario, three stages of court proceedings may be required, which significantly adds to the time and money required to be spent by a joint venture partner to enforce its rights under the joint venture agreement. In comparison, arbitration awards can not be appealed. Most countries, especially those which base their arbitration law on the UNCITRAL Model Law on Arbitration, allow arbitration awards to be set aside only on very narrow grounds, such as due process and unequal treatment of the parties. Only a few countries allow for awards to be set aside based on an error of law in the arbitration award. Continued on next page >

6 An exception to the general rule of arbitration as the preferred the mechanism for resolving disputes would be the use of the courts of the Dubai International Financial Centre, or DIFC, as the forum for resolving disputes. Since their inception, the courts of the DIFC have presided over civil and commercial disputes involving entities registered, and disputes arising out of transactions carried out, in the DIFC. The DIFC employs English common law principles, administered by internationally recognised judges, with proceedings held in English. The courts also recognise the ability of the parties to choose their own governing law, and permit the recoverability of the winner s costs against the losing side. Until recently, the jurisdiction of the DIFC courts was limited to matters which had a link with the DIFC. A new law passed at the end of 2011 dramatically extended the jurisdictional scope of the courts to allow parties which have no connection to the DIFC to explicitly agree to submit to the jurisdiction either before or after a dispute arises. In addition, recent case law from the DIFC appeals court has clarified the position regarding foreign companies which operate in both the Centre and mainland Dubai, stipulating that its jurisdiction can be invoked even if the dispute relates to a situation occurring outside of the DIFC. As a court which applies English Common Law principles and procedure, claimants and respondents alike will of course be confronted with the usual layers of formality during the process. If the parties choose arbitration as the preferred dispute resolution method, they will need to enter into an arbitration agreement. This is usually facilitated by including an arbitration clause within the joint venture agreement. While the parties are generally free to agree to refer a dispute to arbitration after it has arisen, in practice, parties are rarely able to agree on anything once they are in dispute with each other. From that perspective it is preferable to include an arbitration clause in the joint venture agreement. The arbitration clause needs to be drafted carefully as it forms the basis of the arbitration proceedings. Issues to consider when drafting arbitration clauses The scope of the arbitration clause -- Which matters shall be referred to arbitration? --Should statutory or quasi contractual claims (e.g. misrepresentation claims) fall within the scope of the arbitration agreement? Where should the seat of the arbitration be (i.e. the supervisory jurisdiction of the arbitration proceedings)? What is the venue for the arbitration? Which arbitration rules should apply to the proceedings (e.g. institutional arbitration or ad hoc arbitration)? What is the language of the arbitration? Are there any matters of procedure that should be incorporated (e.g. the number and appointment of arbitrators)? Arbitration clauses can be overlooked or even considered boilerplate because the venturing parties are focussed with optimism on the opportunities their joint venture will present. However, venturing parties would be wise to focus on the issue of dispute resolution at the outset of discussions as it will directly impact on whether, and how, the rights and obligations of the parties are enforced against the other party if this becomes necessary. The seat and venue of the arbitration are also key factors to consider. The seat of the arbitration (i.e. the country whose arbitration laws apply to the arbitration and whose courts have supervisory jurisdiction over the arbitration) should be distinguished from the venue of the arbitration (i.e. the place where the arbitration proceedings will actually take place). While in many cases the venue and the seat will be the same, in other cases the seat and venue are separated for convenience; for example, the seat may be London, but the venue may be Dubai. Some venturing parties prefer to opt for a neutral venue, and so it may be easier to reach agreement on a seat if the seat and venue are dealt with separately. Whatever the outcome of negotiations on this point, the foreign partner should ensure that the seat of arbitration is in a country that is signatory to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 (the New York Convention), which requires the courts of the contracting states to give effect to, and enforce, arbitration agreements as well as foreign arbitral awards. Each of the GCC states is a signatory to the New York Convention, but enforcement can still be time consuming and problematic, particularly as the states in question can limit enforcement of the award for public policy reasons, which is often interpreted differently and more broadly in certain jurisdictions such as, for example, Saudi Arabia. 3017

7 Pinsent Masons Joint Ventures in the GCC Potential GCC arbitration institutions Dubai International Arbitration Centre (or DIAC ) London Court of International Arbitration at the DIFC ( or LCIA-DIFC ) Abu Dhabi Commercial Conciliation & Arbitration Centre GCC Arbitration Centre in Bahrain International Centre for Dispute Resolution ( or ICDR ) local branch in Bahrain Arbitration Centre of the Qatar Chambers of Commerce & Industry. Potential international arbitration institutions International Court of Arbitration at the International Chamber of Commerce ( or ICC ) London Court of International Arbitration (or LCIA ) International Centre for Dispute Resolution in New York (or ICDR ). Joint Ventures in the GCC Conclusions The GCC has seen significant change in the last few years; the oil rich GCC states were not immune to the global financial crisis, and the effects of the Arab Spring in the wider Middle East are palpable. However, as the global economy slowly recovers and the Middle East comes to terms with the biggest political change in many years, the GCC member states are tackling significant economic issues head-on in an attempt to build sustainable and diversified economies. In addition, there is an increased appetite on the part of local businesses for engaging with international partners. Each of these factors contributes to making the GCC an attractive and realistic proposition for joint venturing. About Pinsent Masons LLP Our corporate and commercial team in the UAE includes lawyers fluent in Arabic who advise clients from all the key global financial markets including the Gulf, Asia, Europe and the US. Our local team comprises experienced, solution driven lawyers who are actively engaged with companies looking to participate in the expanding economy of the Gulf. We advise clients at every stage of their development and growth in the region; from initial establishment, to advising on commercial contracts and disputes, to growth through joint ventures and acquisitions. The local team is supported by our wider international corporate team of over 140 lawyers based in the UK and Asia Pacific, which is recognised as a leader in corporate finance, private equity and M&A. For further information contact your usual Pinsent Masons advisor or: Alison Hubbard Partner Corporate and Commercial T: M: +971 (0) E: alison.hubbard@pinsentmasons.com Björn Gehle Partner Dispute Resolution T: M: +971 (0) E: bjorn.gehle@pinsentmasons.com This note does not constitute legal advice. Specific legal advice should be taken before acting on any of the topics covered.

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