International Business Transactions - Research Paper Example

Contents Contents Introduction 2 Joint Venture Arrangements 3 Why Joint ventures are used? 6 Different Joint venture vehicles 7 Co-operation Agreement 7 Applicable Laws 9 Legal Documentation Involved 10 Critical Issues in Joint Ventures 10 Joint ventures in Mexico 11 Franchising 12 Franchising agreement 14 Judicial enforcement 16 Conclusion 17 References 18 Introduction Firms expand in different manners and joint ventures and franchising are two important methods as to how the businesses actually grow and develop not only in domestic markets but also in international markets. Joint ventures and franchising therefore are not only good strategic alternatives available to the firms but also provide legal form to the businesses as the firms expand and grow. Increasing trends of globalization and free flow of goods, services and capital therefore made it necessary for international firms to expand and compete at global level therefore joint ventures and franchising present two important viable options for the international businesses to make entry into the new markets. It is also important to note that in some countries like China it is a regulatory requirement that the international firms need to partner with the local players in order to make an entry into the market. Due to this regulatory requirement, international firms therefore have to adapt joint venture arrangements (JVA) or franchising as the most feasible methods for making an entry into the international market.(Yan,2000).1 The overall development of joint ventures specially was done under the English Common Law and each of the party to the joint venture maintains its individual legal entity and character because of the temporary nature of the relationship. The case with the franchising however is different. This paper will therefore attempt to discuss the key differences between the joint ventures and franchising agreements and how businesses can actually use them within the purview of international law. Joint Venture Arrangements Over the period of time, firms traditionally adapted two methods of expanding i.e. build or buy however, joint venture present a third and interesting alternative to the firms to expand and grow at domestic as well as international level. Before discussing the legal issues involved in the joint ventures, it is important to understand the business reasons behind the rise of the joint ventures and how international comes into this overall scenario. There are different commercial or business reasons as to why there is a general increase in the international joint ventures. One critical reason is the increase in the competitive pressures due to globalization which has forced the firms to actually look into new markets and better ways to reduce their costs. It is because of this reason that the international firms have been able to enter into the emerging and developing countries to take advantage of cheaper resources. For example, Apple Inc has formulated joint ventures with the Chinese firms to manufacture their products mainly due to the fact that Chinese manufacturers offer cheap alternatives to produce the same quality at effectively lower costs. This therefore serves as an added advantage and attraction for the international firms to seek entry into such markets where the overall chances of reducing the costs are higher so that the final end products can be sold at the premium pricing in the international market.(Luo & Park, 2004)2 Mainly there are three types of joint ventures i.e. Contractual, corporate and partnership joint ventures. Each type of JV arrangement outlines the rights and obligations of each party to the contract and how they are actually drafted through an agreement. In a contractual joint ventures, the rights and obligations of each of the party are documented in a written agreement however, in corporate joint venture agreements, though the same procedure is adapted, however, it is more extensive. The overall extent of documentation in the corporate joint venture is more extensive and contains diversified range of issues covered in the agreement. There are two important elements which need to be discussed and explored in order to fully understand joint ventures and their overall legal essence. In business terminology, joint ventures are simply the strategic arrangements between two or more parties to accomplish any task of common interest. International firms have repeatedly used this method in order to make some important strategic decisions to expand into international markets.3(Hewitt, 2005). There are different methods or ways through which international firms can actually make an entry into the new market. For example, firms can enter into the new market through making exporting arrangements or they can even inter into the new market as a wholly owned businesses to start a Greenfield project. However, joint venture is considered as the most common method used by the firms to make an entry into the international market. (Shane, 2001)4 There are generally no specific meanings to the term joint venture however, loosely defining, a joint venture is considered as the undertaking or agreement between two or more parties to undertake a common activity of mutual interest. What is significantly more critical is the fact that the control of the entity which is formulated after the formation of the joint venture is mutually shared by each of the party to the contract. This is against the way normally organizations usually act in a parent-subsidiary relationship whereas the overall control remains in the hands of one party. This is a critical aspect of the joint ventures from the legal perspective as defining the overall monetary stakes and control defines the overall rights and obligations. It is also important to note that any party to the contract may exercise more control if it controls at least 51% of the stakes in the joint venture. If this is so, the overall legal and accounting nature of joint venture may therefore be different and the overall relationship may become the one of the parent and subsidiary and the dominant firm may carry different legal responsibilities. (Hewitt, 2005)5 From a legal perspective, however, joint venture can be defined from different perspectives and its exact nature is defined by different variables. Some of the variables include the size of the venture, number of parties to the contract, location, and overall length of the joint venture between the parties etc. These factors therefore define the overall characteristics and nature of the joint venture. Locations play important role because it helps to determine the implication of different laws on the various parties to the contract and define as to how the law will be applied to each party. Since mostly, international parties are also part of the contract therefore defining the overall application and enforcement of law as per the location is critical. Why Joint ventures are used? One of the most critical reasons as to why the joint ventures are used by the international firms is to gain access to the raw materials and other resources. What is also however, significant to note that the international firms also often enter into joint venture agreements in order to take advantage of the technological know how. (Kent, 1991).6 The resulting technological transfer which take place as a result of the joint ventures allow the improvement in the technological capabilities of the domestic firms and it is because of this reason that the countries like China have only allowed joint ventures are the method for making entry into the Chinese market. It is also because of this reason that the joint ventures are often between the international firms and host governments. As such joint ventures are often considered as in line with the overall policy of the government. There are three important reasons as to why the international firms actually engage into the joint ventures. The favorable national laws, the formation of the strategic alliances as well as the tax laws are some of the reasons as to why the international firms actually engage themselves into the formation of joint ventures. National laws of some countries can be more suitable or favorable for a particular type of business and therefore international organizations may find it more economical to take advantage of the investor friendly laws. Taxation is another important reason as to why the international organizations enter into the international joint ventures to not only take advantage of the relaxed tax laws but also achieve the required expansion and growth. (Inkpen & Currall, 2004).7 Different Joint venture vehicles In order to formulate a joint venture, there can be different legal vehicles to be used in order to give joint venture a legal form. Joint ventures therefore can be formed therefore formed either by limited companies, partnerships or limited partnerships or they can be purely contractual arrangements between two or more parties. The overall decision to formulate the joint venture by using any of the legal form of the business however, also depends upon the tax considerations and other legal complications. Parties entering into the contract therefore need to take into consideration different factors before they can actually agree upon a particular legal form. (Mjoen & Tallman, 1997).8 Tax considerations therefore may force the parties to formulate the partnerships however, due to favorable treatment given to corporations; most parties to the arrangement often use limited liability companies to formulate the joint ventures. Though the commercial reasons for forming a joint venture through Limited Liability Company include the ease with which the firm can obtain the finance either from the financial institutions or capital markets but legally each party to the contract carries limited liability therefore the overall attractiveness of using the limited liability company as the most preferred vehicle for the joint ventures is higher. Co-operation Agreement As discussed above that the joint ventures are often the temporary business set-ups and are formulated for a particular period of time before they are wound up by the respective parties. Thus the simplest and most cost effective method through which different parties to the contract can become part of the joint venture is to enter into a cooperation agreement between each other. The formation of cooperation agreement therefore only allows different parties to enter into the contract as the contractors and not as the shareholders in Limited Liability Company or partners in the firm. This legal form is often suitable in situations where parties do not want to go through the legal complications of formulating the companies but rather wish to utilize the simplest form of legal consideration in order to accomplish this task. Most of the joint ventures formulated under this form of cooperation agreements are also called consortiums. 9 (Hewitt,2005). Due to this vague nature of the legal relationship between each of the party, formation of cooperation agreements to form the joint ventures requires a very clear formulation of the contract and different provisions into it. Especially this agreement must set out the obligations and rights of each of the partner to the contract besides outlining the roles and rights of each party to the contract. Another important aspect of forming the cooperation agreements is the clause of indemnity which can actually protect other parties from the losses incurred as a result of the negligence of other party. Thus the cooperation agreements allow a relative degree of flexibility to the parties to the contract to formulate the agreement in such a manner where the rights of each party to the transaction are secured. Applicable Laws First the set of enterprise laws such as companies act will be important for the formation of the joint venture. At the initial stage, when a joint venture is formed, the application of enterprise laws play critical role because it is according to these laws of the land which finally become applicable to both the parties. The enterprise laws therefore not only to identify and define the legal characteristic of the joint venture but it will also define the overall rights and obligations of the resulting business entity, its overall governance mechanism as well as the rules to define the termination of the joint venture. Another important set of laws which will be applicable on the parties to the joint ventures is the contract law which governs the day to day transactions between the each party to the joint venture agreement. Contract laws also define the duties of each party and therefore also provide remedies to the aggrieved party in case of any losses sustained due to the negligent behavior of any of the party to the contract. It is also important to note that the in some cases the application of the contract laws can be for specific nature of transactions. Laws such as sales of goods act can provide exact framework as to how to govern different transactions between each party to the contract. It is also important to note that the parties to the transaction may also be interested in following the UN convention on the international sales of goods. Sales of goods act will also be important in the sense that the joint venture may be involved in third party sales therefore in order to comprehensively cover the transactions; sales of goods act may be one of the most important laws which may affect the joint venture agreements. The relevant application of the tax laws is also another important consideration as the joint ventures are often formed in order to take advantage of the tax heavens. Many international firms therefore consider location as the most important aspect of making a joint venture decision because the overall tax benefits depend upon how good the firm can be able to manipulate its geographical location so that it can avoid paying higher taxes. Legal Documentation Involved There are different considerations which partners to the contract may need to address before they enter into the formal process of legal documentation. Considering the overall nature of the joint ventures, there are two important set of legal documents which are considered as essential. First it is the joint venture agreement between the different partners/shareholders to the contract and finally the memorandum and articles of association of the new company which will be formulated as a result of this arrangement. The overall purpose of having a joint venture agreement is to actually identify and outline as to what will be the roles and obligations of each of the party to the contract. It is also important to note that there are different laws which may be applicable on the joint ventures. Critical Issues in Joint Ventures One of the critical issues in the formation of joint venture formation is the issue of sharing the power and control. The control and power over the property rights, management control and the resources of the joint venture is one of the key issues which need to be dealt with during the formation of the joint ventures. Further dealing with issues such as the relationship of the CEO of the new entity with the board members, The issue of restrictions on the joint ventures is also another critical area which needs to be addressed in order to successfully formulate the joint ventures. Hardcore restrictions such as pricing fixing, limitations on the output as well as sales and allocation of markets and customers are some of the issues which need to be critically addressed by the parties to the contract before the formal agreements are drawn. It is also important to consider the issues which may be arising as a result of the termination or the break up of the joint ventures. Since joint ventures are inherently short lived, it is important that the exit provision must be incorporate into the agreement. Joint ventures in Mexico Most of the joint ventures in Mexico are done with the US companies as more than 11% of the joint ventures amounting to $544 million are made by the US firms since 1950. It is also important to note that most of these investments are actually being merged now with the Mexican government funds. Most of the joint ventures in Mexico are being done in the collaboration with the government and that the Mexico has been now considered as feasible for the international joint ventures. Firms from Italy and Sweden have also invested into the joint ventures in different sectors- most importantly in Steel sector. “10 The above discussion provides a detail description of how the US firms utilized joint ventures as an effective tool to make a successful entry into the market. Franchising Franchising as a business concept is really interesting in the sense that it allows the businesses to use already proven business model. Franchising has mainly developed in US as a result of the expansion of so called chain store type businesses and has become mostly successful for food, grocery and retail businesses. (McCarthy, 1970). 11 The very factor that all the businesses cannot be successfully converted into effective and successful franchises is the fact that franchising works best when businesses show important characteristics of consistent profitability as well as the ease with which it can be replicated. (Shane, 1988).12 Thus the key difference between the franchising and the joint ventures is deeply rooted into the manner in which the businesses are formulated. Though both are considered as successful methods for making an entry into a new market however, the key differences remain. (Martin,1988).13 An important issue in franchising is the use of the copyrights and patents which can also prove as one of the issues of conflict between the two. It is important therefore that the conditions under which the copyrights as well as the patents can be used shall be outlined in the franchising agreement.(Steingold,2009).14 A contrasting difference between the joint ventures as well as the franchising is also the way franchising arrangements can be utilized for the purpose of vertical as well as horizontal integration. (Norton, 1988).15 Joint ventures can also be used for this purpose however, one critical difference is the nature and formation of relationship between the parties which essentially differentiate between the joint venture arrangement and the franchising. One key difference between the joint venture as well as the franchising is the overall nature of the business which will be formulated. Though the business created as a result of the franchising tends to be named after the franchisor however, the ownership effectively remains within the hands of the person who purchase the franchise. As against the joint ventures, where both the parties have their stakes in the business, however, for franchising it is not necessarily important that both the franchisor and the franchisee must have the shareholding into new entity. It is also because of this reason that the new entity effectively remains under the control of just one entity and the parent business may be entirely known with a different name. Another conceptual and legal difference between the two lies in the fact that joint ventures are temporary arrangements and are concluded if the purpose for which it was set up is completed. Franchising however is not a temporary arrangement and can remains intact as long as either party to the contract wishes to remain in the contract. This essential difference between the two therefore offer the critical insight into how the two firms can actually come into contact and formulate a business based on a very unique model. Joint ventures are common in international arena however, franchising mainly remains restricted to the domestic markets. However, franchising is considered as the most effective method of expanding the business wherein the franchisor actually faces the constraints on raising the capital. Without actually tapping the new sources of capital, firms can get into the new markets through the process of franchising. This may however, not be the case with joint ventures as joint ventures may require significant equity participation or the transfer of technology. Since in franchising, the franchisor tend to sell out his business model and in return agree to share the revenue therefore the relative transfer of technological and management competencies remain limited to the one business firms also. As against the joint ventures wherein both the parties contribute in some sense, in franchising only one business model is followed irrespective of the overall nature of the business transaction. It is also important to note that the franchising as a business concept was developed and perfected in America and except for US and China, there is a general lack of legal requirements and the laws for the franchising in other countries. This lack of regulations therefore is quite different from the joint ventures which are comprehensively covered under different regulations. This lack of regulatory cover therefore also offer a greater flexibility as well as the ease with which two parties can enter into the contract for the formation of a franchise. It is also important to note that the traditionally franchises are relatively cheaper to formulate with little or no effort at all in terms of gaining access to the technology and proven business model as the same is already provided by one party. Due to this flexibility as well as the ease, franchising may prove as a more attractive legal alternative for the firms rather than entering into the joint venture set ups. Franchising agreement A joint venture agreement between the parties to the contract outline as to how the parties will behave and act during the duration of the joint venture thus setting out the terms and conditions for the new business set up. However, the franchising agreement is different in the sense; it places certain important covenants over the franchisees for doing and not doing certain acts.(Eckmann, 1965)16 Since in a franchise, franchisee agree to use the business model of another firm, it becomes therefore more critical that the franchisee must follow the rules and procedures as outlined by the franchiser. This is different from the joint venture because in joint venture, parties to the contract are not actually bound by following the rules and regulations of just one party to the contract. In case of franchising, the franchisee first has to ensure that it follows the franchising operations manual of the franchisor. Thus the first and most important aspect of the franchising agreement is to draft the clause within the agreement outlining the complete compliance of the business operations manual of the franchisor. (Brickley, 1999).17 The franchising agreement however, similar to the joint venture agreement in the sense that it is also necessary for both the parties in the franchising agreement to actually define as to how the contract will work. This section of the agreement therefore outlines the overall nature of the relationship between the franchisee and franchisor and defines as to how each party to the contract will actually behave and act. (Agarwal & Lal, 1995).18 Since franchisee have to use the business plan of the franchisor, therefore, the agreement often contains the details about the overall marketing, sales, training and other aspects of doing the business. This therefore provides further clarification to the overall relationship between each party to the contract. (Brickley, Misra & Van Horn, 2006)19 As against the joint ventures, franchising are relatively permanent phenomenon and firms can remain into the relationship for as long as they want or under their legal term. However, franchising agreement also need to carry the provision for the exit strategy which will be adapted by each party in case the business is being wound up. The inclusion of the provision for winding up the business therefore provides the required exit strategy to each of the party to the contract and therefore a mean to end the relationship. This is relatively different from the joint ventures because joint venture agreements automatically expire after the completion of their contractual period therefore the provisions for the exit strategy are often not included in the agreement. Another important consideration is the inclusion of the integration clause in the franchising agreement which basically outline as to prevent other parties for making alterations to the obligations of each party to the contract at a later stage. Judicial enforcement Judicial enforcement of the rights of each of the party under the franchising agreement is another critical difference between the international joint venture and the franchising. Thus the agreement made between both the parties to the franchising agreements often contain the clause for defining the State or the States who will have the judicial enforcement rights in case there are disputes between the parties. (Moorehead, 2001).20 The case of Burger King Corp V Rudzewicz is a very famous case in this regard where the case of the enforcement of the federal State of US was discussed at length by the jury. Conclusion Joint ventures and franchising are two of the important methods as to how the firms can actually expand into either the local as well as international markets. Joint ventures are mostly used in the case of external expansion where the firm partner with the other international firms to formulate a temporary strategic alliance to achieve any common objective. International Joint Ventures can be more challenging due to the issues associated with it i.e. the relationship between both the parties, how they formulate the contracts, the relative exist provisions in the agreement etc. Further, issues like the protection of the rights of minority shareholders, the relationship of the CEO with that of the board etc are some of the issues which need to be considered before formation of the joint ventures. Franchising however, is relatively easier to form and can provide an established company to expand without having access to the more capital as well as resources. Under franchising franchisee uses the business model of a franchisor and undertake to carry out the business activities according to the business model of the franchisor. Franchising however, can also be significantly more challenging because of the way franchising agreements are formulated. The defining of rights and obligations of each party, use of the copyrights and advertisement as well as the legal use of other assets can create significant challenges. The major difference between the two approaches is based on the fact that franchising is easier to formulate as compared to the joint ventures and does not require extensive contribution from either party. References 1. Andrew C Inkpen & Steven C Currall, ‘ The coevolution of Trust, Control, and learning in joint ventures, [2004], OS, 15, 586 2. David H Kent ‘ Joint ventures Vs Non Joint Ventures : An empirical investigation’[1991], SMJ, 12, 387 3. Deepak Agarwal & Rajiv Lal, ‘ Contractual Arrangements in Franchising’, [1995], 32, 213 4. Fred Steingold, Legal Guide for Starting & Running a Small Business (11th Edition, Nolo, London 2009) 193-195. 5. Hans Mjoen & Stephen Tallman, ‘ Control and Performance in International Joint Ventures’ [1997],OS, 8,257 6. Ian Hewitt ‘ Joint Ventures’ (3rd Edition, Sweet & Maxwell, London, 2005) 269-271 7. J Thomas McCarthy, ‘ Trademark Franchising and Antitrust : the trouble with tie-ins’ [1970], CLR, 58,1085 8. James A Brickley, Sanjoog Misra & R Lawrence Van Horn, ‘ Contract Duration: Evidence from Franchising’, [2006], JLE,49,173 9. James Brickley, ‘ Incentive Conflicts and Contractual Restraints : Evidence from Franchising’, [1999], JLE, 42,745 10. James K Eckmann, ‘Antitrust problems in Trademark franchising’, [1965], SLR, 17, 926 11. Judith Blumenthal, ‘Joint Ventures as a vehicle for strategic change; opportunities and pitfalls’ [1991], JOCM, 4, 45. 12. Rajiv Lal ‘ Improving Channel Coordination through Franchising’ [1990], MS, 4, 299 13. Richard Moorehead, ‘ Third Way Regulation? Community Legal Service Partnerships’ [2001], MLR, 64,543 14. Robert E Martin, ‘ Franchising and Risk Management;7’, [1988], AER, 78,954 15. Ronald Charles Wolf, Effective international joint venture management: practical legal insights for successful organization and implementation (M.E. Sharpe, New York, 2000) 172-173. 16. Scott A Shane, ‘ Making New Franchising System Work’ [1998], SMJ, 19, 697 17. Scott Shane, ‘Organizational Incentives and Organizational Morality’, [2001], OS, 12, 136 18. Seth W Norton, ‘ An empirical look at Franchising as an Organizational Form’, [1988], JoB, 61, 197 19. Shelby D Hunt & John R Nevin, ‘ Power in Channel of Distribution : Sources and Consequences’,[1974], JMR, 11,186 20. Yadong Luo & Seng Ho Park ‘ Multiparty Cooperation and performance in International equity joint ventures’ [2004], JIBS, 35, 142 21. Yanni Yan, International Joint Ventures in China: Ownership, Control and Performance (revised edition, Palgrave MacMillan, New York 2000) 10-12 Read More