Joint arrangement with liability for the obligations of the arrangement
A and B jointly establish an entity (C), which is considered a separate legal structure distinct from its members in the jurisdiction in which it is formed. This jurisdiction requires that such a legal structure has at least two partners but does not have any minimum capital requirements.
A and B each have a 50 per cent interest in C and have joint control over C through a requirement that all decisions regarding C require unanimous consent of A and B.
A and B are each liable for the obligations of C only to the extent of their proportionate share in C. The creditors of C can seek recourse against A and B, but only if their claims against C are unsuccessful. A and B are entitled to receive their proportionate share of C’s net income. In this case, A and B would also be creditors of C and therefore have a claim against the assets of C.
C’s activities consist of buying specific assets from vendors, developing those assets, and selling those assets to customers at a profit. C’s activities are financed through loans (from A and B, and from a third party bank). Once the activities with respect to these specific assets are completed (sold to customers), C will be liquidated.
Analysis
The existence of a separate legal structure, which is recognised in its jurisdiction, indicates that a separate vehicle exists. In analysing the legal form of the separate vehicle, one would consider the following:
- A and B only have rights to the assets of C upon liquidation or default, not in the normal course of business;
- A and B’s obligations relating to C’s liabilities are only enforceable where C has failed to meet those liabilities;
- A and B’s obligations for the liabilities are generally limited to the extent of their respective investments in C; any additional right of recourse held by C’s creditors against A and B is considered outside the normal course of business; and
- A and B are entitled to their respective share of the C’s net income.
Therefore, the initial assessment is that the legal form of the arrangement, when considered in the normal course of business, confers separation between A and B from C and that they do not have rights to C’s assets or obligations for C’s liabilities. This indicates that C is a joint venture.
There are no contractual terms that indicate that A and B have rights to the assets, or obligations for the liabilities, so the arrangement still appears to be a joint venture.
C is primarily designed to resell the developed assets to customers. Therefore, A and B do not have all the economic benefits of the assets of the arrangement. C is financed by multiple sources including third party debt. Therefore, A and B are not substantially the only source of cash flows contributing to the continuity of the operations of C. C continues to have inventory and credit risk with respect to its operations. Furthermore, C is not designed to break-even; its objective is to maximise profit. These facts and circumstances continue to indicate that A and B do not have rights to the assets, or obligations for the liabilities, so the arrangement still appears to be a joint venture.