July  28, 1999



Bulletin # 28: The Joint Venture

ZZZ Sheet Metal had developed an outstanding reputation as an HVAC subcontractor. It had handled some smaller projects on which it direct bid the entire mechanical system of a building and retained the mechanical subcontractor as its sub-subcontractor. On most other projects, it acted as a sub-subcontractor to the mechanical contractor. Neither approach sat particularly well with both ZZZ and the mechanical contracting firms. Each subcontractor preferred to be in charge.

When the HVAC subcontractor was approached about working on the expansion of a large hospital, the same dilemma arose. The project had a large air-handling component, but also included a very significant piping/water system installation. One of the ZZZ executives suggested the possibility of a joint venture with a mechanical subcontractor to bid the entire mechanical system. The subcontractors would not need to wrestle over who was in charge of the overall work, since they would be pursuing it together in a cooperative venture.

ZZZ executives spoke with four mechanical contracting firms about a joint venture, but only one indicated an interest. The principals of ZZZ and the mechanical contracting firm met and, after a short discussion, signed a one-page "letter of understanding" stating that the firms were entering into a "50/50" joint venture to bid the hospital project and that they would work together in a "cooperative manner" on the bidding and construction. The letter ended by stating that the parties would follow-up with a more formal agreement that would set out more of the details concerning their joint working relationship.

Staff from the two subcontracting firms then met for hours on end to review the plans and prepare a combined bid. Assuming significant economies as a result of joint purchasing and coordination, the joint venture put together a very competitive bid that was accepted by the general contractor. In the bidding process, they had emphasized to the general contractor the advantages of the coordinated approach having succeeded in the bidding, both subcontractors were excited about proceeding with the joint venture. Each of the parties signed the subcontract form for the overall mechanical system and each party began ordering materials and scheduling its workforce. Both firms were so busy with preparation for the job that the anticipated follow-up meeting of the principals to nail down the "loose ends" of the joint venture was repeatedly postponed.

By the time the executives of the two firms were able to get together, the project was three months underway. There were already signs of strain within the joint venture. It was not clear to the workforce whether the ZZZ project manager had authority over the mechanical subcontractor=s workers and vice versa. Some communications from the general contractor to the joint venture, which were delivered to one firm=s project manager, never made it to the other firm. The firms had different record keeping and accounting systems, which was presenting a problem in keeping track of costs and in assembly of pay requests. The joint venture was also having difficulty ordering materials and equipment, since the vendors were confused over the actual identity of the customer and its creditworthiness. When some problems with the work came to light, the general contractor told each project manager that the two firms would be held jointly responsible for all of the work, since both firms had signed the subcontract.

With all of these issues staring them in the face, the executives realized that their "letter of understanding" did not create a very solid foundation for their joint effort. Each executive brought in his own list of issues and when they sat down, they realized that the lists of unresolved issues had gotten very extensive.

Among the more pressing issues were:

1. Was each subcontractor in charge of its own work or was the joint venture somehow to provide overall management?

2. If the joint venture ran short of cash, were the parties going to be required to contribute to the joint venture and, if so, in what proportions? (As the project progressed, it now appeared that approximately 65 percent of the bid work would be performed by ZZZ and only 35 percent by the mechanical subcontractor.)

3. Were the purchases of equipment to be made by the joint venture or each individual subcontractor? If the joint venture was to be the purchasing entity, how was it to demonstrate its creditworthiness?

4. For whom were the employees on the project working? Were they still employees of each of the subcontractors or had they come to be employed in some way by the joint venture?

5. Should the joint venture have procured insurance with regard to the work (to say nothing of the employees) or was each subcontractor relying on its own insurance?

6. How were any profits to be divided? ZZZ was of the opinion that 65 percent/35 percent would be an appropriate allocation of the profits, given the relative scope of each parties= work. However, the mechanical subcontractor referred to the "50/50" language in the letter of understanding and argued for a 50 percent/50 percent split of profits.

After two days of heated discussions, the two sides agreed that the preferred course would be to split the work between the two firms to the extent possible, with each subcontractor supervising its own employees, buying its own materials and supplying its own equipment and insurance. The "joint venture" had evolved into two separate projects from an operational standpoint, although each of the firms still remained liable for any defects or claims related to the work of the other subcontractor. Issues continued to arise over the scope of work and the proper allocation of the bid price. (At one point the two project managers nearly came to blows over who was responsible for wall openings required for duct work and piping.) Each subcontractor concluded that it would never again participate in a joint venture.

In fact, a joint venture or project partnership may be a very sensible way to pursue a particular project, especially if the contracting firms are very familiar with each other and their quality of work and management. However, as ZZZ and its co-venturer discovered, calling themselves a "joint venture" was a far cry from actually putting a functional venture together. Before any two (or more) firms attempt to bid a project together or otherwise act in a joint venture capacity, it is essential that they work through the issues of management authority, commitment of capital, sharing of risk, division of profits, dispute resolution, and all of the other elements that confront a joint enterprise.

After the parties have worked through the issues, it is also essential that the terms be put into a written joint venture or partnership agreement. In fact, a proposed agreement can be a good starting point for discussions of the various issues. Having the agreement negotiated and signed will not only increase the chances for successful completion of the work, but will also lend credibility to the joint venture in its efforts to bid and obtain work.

 

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