A new way to joint venture

December 01, 2001 |

In today's competitive, fast-paced and constantly changing construction market, participants need to be receptive to alternative vehicles used to implement the ever-increasing number of project delivery systems.

Joint ventures, while not a true project delivery system, are nevertheless vehicles that can be used to deliver the system itself. The phrase 'joint venture' is usually understood to be something closely akin to a partnership created by two or more entities to carry on a single project. In actuality, a joint venture can be much more. For example, coventurers can form a number of different types of entities to carry out their enterprise, including a corporation, a partnership, a limited partnership, and the newest kid on the block - a limited liability company (LLC).

The choice of which entity to use for any particular type of joint venture is driven by a combination of tax and nontax considerations. Generally, joint venturers want flow-through tax treatment, control over the joint venture and limited liability. The use of an LLC as a substitute for either a true joint venture or a corporation allows the parties the best of both worlds - they enjoy limited liability like a corporation and avoid the double taxation associated with a corporation.

Factors to consider

The general rule is that each member of a joint venture acts as both principal and agent in relation to its coventurers as to those things done within the apparent scope of the venture and for its benefit. Thus, as in a partnership, a venturer can bind its disclosed and undisclosed venturers, assuming the venturer has the authority to act. This potential liability is to be contrasted with the ability to be protected from liability by the corporate shield.

Like the traditional corporation, the LLC provides a liability shield for its owners, who are called 'members.' However, because of the flexibility afforded by the various state LLC statutes, the members of the LLC can design the LLC to accomplish many different management and control issues that they otherwise would not have been available to do under the partnership or corporation alternatives. For example, an LLC can be formed such that any one of the members, regardless of that member's ownership percentage, has complete authority to operate and control the business and affairs of the LLC. Thus, an LLC may be more beneficial than a limited partnership because the members are able to participate in the management decisions without risking their limited liability status.

From a tax standpoint, a domestic LLC may be taxed as a partnership, unless an election is filed with the Internal Revenue Service to be taxed in some other manner. Thus, the members are taxed directly on their share of the LLC's profit, if a profit is earned. Additionally, the members can deduct the losses of the LLC in most situations. A problematic aspect in this regard is that not all states have elected to follow the federal tax treatment of LLCs.

Depending on the specific economic relationship between the members of a joint venture, additional agreements may be necessary to properly allocate responsibilities among the members. For example, if the LLC will be subcontracting all of its work to the individual members, it may be necessary to enter into various indemnification agreements among the members to make sure that liabilities are properly allocated among the members in accordance with the terms of their economic agreement. Although this has the effect of undoing some of the benefits afforded by the LLC for limited liability purposes, the LLC structure still offers a group of contractors the administrative convenience of forming a joint venture in the form of an LLC in order to bid and complete the project as a single entity.

Use of LLC for design/build

Joint ventures and LLCs are particularly well suited for construction projects, especially large projects such as public works, highways, tunnels, power dams, bridges, canals, seaways and power projects. Projects that combine a need for extraordinary financial resources with corresponding risks, as well as complex and technical knowledge are typical candidates for the use of joint ventures or LLCs. These entities are logical means to merge engineers and contractors or various parties with different areas of technical expertise with different financial capabilities or entities that have divergent geographic roots.

From the owner's perspective, these entities are ideally suited for design/build work, where one of the primary goals is to attain single-source responsibility for both design and construction. When a design firm and a contractor form a joint venture or LLC, the owner is singly responsible for quality, performance, cost and scheduling issues. In a design/build relationship, the contractor loses its argument that the drawings are defective or late, and the owner no longer need coordinate the work of the designer and the builder. The owner still can hire an independent design firm to watch its interests.

On the other hand, the owner should be concerned about dealing with a joint venture or LLC in that the entity formed may be undercapitalized and incapable of satisfying any judgment or claims arising out of the project. The owner should attempt to negotiate to gain access to the assets of the individual venturers or members as distinguished from the probable limited assets of the new entity.

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