Construction Joint Ventures - Anomaly or Breakthrough?

1. 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

2. 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)

3. 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)

4. 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)

5. 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)

6. 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

7. 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

8. 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))

9. 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

10. 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

11. Client/contractor JV Client Contractor (Investment/ support/return) (Investment/expertise/resource/return) Client JVCo (TPC2005 contract provision of works and services, payment and performance measurement) Transfer to JVCo for capital receipt TUPE/assets/goodwill employees

12. 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

13. 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

14. 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

15. 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

16. Developer and Funder/Service Provider JV Funder Land Owner Funder Service Provider (Investment/ support/return (Investment/ finance/return) (Investment/expertise, resource/return) (Involvement/ support/return) Developer Funder/Service Provider JV Concession Agreement (Financing/design/construction of facilities and provision of utilities and energy management services) Award of Contracts for finance/development of network transmissions lines Agreements for provision of utilities Development Agreements and Leases Development Customers Other contractors

17. 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

18. 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

19. 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?

20. 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)

21. 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

22. 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