How to manage regulatory risks in your joint venture agreement
Several large companies have recently teamed up in consortiums, announcing their interest in the development of Norway’s first large scale offshore wind farms in the Utsira Nord and Sørlige Nordsjø II areas in the North Sea. At the same time, the Norwegian energy authorities are carrying out a revision of the Offshore Energy Act, the Offshore Energy Act Regulations, and the guidelines for the offshore wind concession process, leaving many unanswered questions in the regulatory landscape.
Where companies are teaming up and potentially committing to large future investments prior to regulatory clarity, it is crucial that elements of regulatory risk and uncertainty are managed appropriately in their consortium/ joint venture (JV) agreements. In this article we touch upon how the parties can manage and mitigate regulatory risk factors in their JV agreement.
Identification of regulatory risks
Identifying risks at an early stage is central when forming a JV in an uncertain regulatory landscape. The following examples show us why:
- While the authorities have been clear that they want a competitive process for awarding exclusivity in the pre-application phase, there is currently a lack of certainty around the allocation process. The proposed auction process for Sørlige Nordsjø II has been criticised, and there is an ongoing discussion around whether qualitative or quantitative criteria should be decisive for the award. Furthermore, the proposed process does not clarify when any payment for the exclusivity award must be made.
- The criteria for pre-qualification, in particular for consortiums, also remain unclear. It is for instance not clear how established the JV’s relation to its participants must be in order to draw on the participant’s competence and financial strength in the pre-qualification process.
- Many involved parties request appropriate support schemes for floating wind and a more tailored tax regime.
- Hybrid grid connections are highlighted as a prerequisite for profitable bottom-fixed wind turbines by several of those interested in Sørlige Nordsjø II, but the regulatory framework and the associated market design remain unclear.
Below are some mechanisms that may be used in order to take account of such unclarities in the JV agreement.
When the goal is evident but the pathway is uncertain, a possible contractual measure is to make the agreement purpose-oriented. This can be achieved by clearly defining the JV’s objective and overall expectations in respect of each party’s contributions, for example by way of technology, know-how, funding, competence, and the like.
In such cases, the parties will need to agree on limitations for the purpose outlined, in order to avoid open-ended commitments. Limitations can take many forms, including financial, geographical, technical (e.g. floating vs. bottom-fixed offshore wind farms) and/or time-bound limitations. A time-bound limitation can more narrowly include whether the parties will submit an application in both the first and later tender rounds, or just in the first round and any long-stop dates. Furthermore, depending on the purpose outlined, parties should consider whether there are certain prerequisites for realisation of their JV project, e.g. reliability on hybrid grid connections. The parties should then consider whether these limitations and prerequisites are viable for further consideration and decision, or if they are true show stoppers.
Ensuring that parties have the right incentives to achieve the project’s objective is crucial. By finding the right incentives for each party, chances are they will be more aligned in decision-making processes, and the JV will more likely navigate successfully through uncertain regulatory waters. The parties’ incentives will, however, largely be contingent on what each party brings (or wants to bring) to the table in the JV.
Some risks and associated limitations may be allocated equally between all JV partners, while other risks should be allocated to the party with the best chances of handling them. This will differ depending on the parties’ individual roles. The parties should therefore have a clear view on which risks are allocated to and accepted by each party. Moreover, a party’s decision-making authority, for example veto powers or exit rights, must be balanced against that party’s risk-taking and involvement.
Flexibility and dynamic solutions are necessary where the regulatory landscape is not yet determined and changes are bound to occur. The parties to a JV agreement should clearly agree on the appropriate processes, as well as designate an authority, in case of changes. One option includes incorporation of a layered decision-making structure. As an example, an appointed committee with a clear decision-making mandate may have authority to make majority decisions for matters with limited impact. For decisions on changes with a large impact, but which are still within the project’s purpose and limitations, qualified majority or veto rights of the parties’ executives may be introduced. Lastly, changes which go beyond the project’s purpose and limitations may trigger hardship clauses, renegotiation clauses, or a party’s exit option.
For developments that are likely, but not yet certain, the parties can agree on principles relating to such developments already in the JV agreement.
Firstly, the parties can agree on a dynamic budget process, for example one containing an obligation for the parties to revise their budget in case of material changes to the regulatory regime, and certain project “non-negotiables”. Secondly, the parties may pre-agree their position in respect of a likely regulatory outcome. Lastly, uncertainties around the formalities applicable to the company seeking concession can be dealt with by way of mechanisms in the JV agreement. Such mechanisms can ensure that the parties must do what is necessary to form and incorporate the company which will be seeking concession. The parties should, however, consider alternative set ups (e.g. a private limited liability company or a partnership) and any implications the different set ups may have in advance.
The need for dynamic and flexible solutions in the JV agreement, with clear parameters around each party’s contribution, risk, and authority, seems clear. If properly prepared, risks and surprises along the way can be managed by pre-agreed terms in a purpose-oriented manner.