Introduction
It is unarguable that historically, Nigeria has not really leveraged its bountiful and well-endowed real estate (RE, 923,768 km² land mass) as a veritable factor of production to drive economic growth and prosperity. Why are Nigerians yet to optimally tap into our greatest asset? As an illustration, Nigeria’s massive housing deficit is unjustifiable, given the resources available. A lot of institutional challenges would take the blame; they have been, and will continue to attract discussions, but such are not the main focus of this article. Rather, we examine how RE stakeholders can utilise RE JV transaction models to undertake (large scale) RE investments cum developments, thereby helping to reverse Nigeria’s suboptimal RE situation. RE JVs (incorporated or otherwise) are a vehicle/ platform for co-investment by two or more parties: comprising a landowner and developer(s)/equity investors; debt providers are not JV parties for this purpose.
Rationale for RE JVs
The start off point is to ask “the rationale question”: why consider RE JV option at all? RE JVs enable the development otherwise unfeasible or improbable RE projects by harnessing the complementarity (synergy effects) of the JV partnership. A landowner has an asset but lacks the resources to fully develop it. Developing it alone could make the project subject to delays – a common reason for many abandoned projects dotting the landscape, and further creating capital allocation inefficiencies. Or, the property may end up not being developed on a scale that would have been optimal for it.
Also, “solo development” could result in sub-quality output. Frustrated with inability to develop the property, the landowner may sell it off – and thereby realise significantly less value than would have been otherwise possible. Meanwhile, as long as the property remains undeveloped, value is being left unrealised or ‘locked in’. Illustrative of the biblical axiom, that “two are better than one, because they have a good return for their labour” (Ecclesiastes 4:9), JV offers a landowner risk dilution opportunity by not having to assume the entire project risk. This de-escalation of concentration risk could have a very significant impact on the long term financial standing of the landowner, potentially obviating drastic results, like bankruptcy or forced sale of the asset to pay debts.
From the developer or (non-asset owning partner’s perspective), JV offers an opportunity to access land in his preferred location that he probably might have been unable to access; for example, because no one is willing to sell. Or the plots available for sale may be suboptimal for the project/use that the developer is considering. It is also possible that the developer/partner’s resources are limited and would not have been able to fund both the land acquisition and subsequent development. Thus, ‘receiving’ the land as contribution from his partner, frees him to focus on development costs only. Replicating such landowner/partner contributions results in accelerated expansion of developers’ footprint, thereby enhancing diversity of his developed and revenue earning assets. A good example is hotel, and retail chains – JVs will ensure faster rollout as multiple projects (in different locations) can proceed simultaneously.
Examples of the foregoing abound. A ready one is the Imperial International Business City (IIBC) project being promoted by the Elegushi Royal family (landowners) and Channel Drill Resources Limited (Developers) for a ‘smart city’ covering 200 hectares on sand filled land at Elegushi, Lagos. IIBC is very unlikely to be actualized without collaboration between the JV partners. Several other examples include NICON Town (JV between NICON Lekki Limited and Harris Dredging Limited), the Palms Shopping Mall (Persiannas and Actis) and nearby Millenium Homes in Oniru Private Estate, Jabi Lake Mall (Actis and Duval Properties Limited), the Heritage Place (Actis and Primrose Development Company), etc.
In summary, JV rationale mimics the strategic wisdom of alliances in historic and modern warfare, because “there is strength in numbers”. Ecclesiastes 4:10b -13 advises: “But pity anyone who falls and has no one to help them up. Also, if two lie down together, they will keep warm. But how can one keep warm alone? Though one may be overpowered, two can defend themselves. A cord of three strands is not quickly broken.” The complementarity/ synergy benefits of JVs will continue to recommend it as a pragmatic option to get many otherwise unfeasible projects off the ground.
Consummating RE JVs: Key Considerations
Obviously one party would have been mulling, if not to have already decided, that the JV model would be most ideal in respect of a particular project. Since “it takes two to tango”, such party will begin to prospect for potential partner(s) and depending on the party’s experience in RE transactions, certain key considerations will come to play: from due diligence (pre-transaction stage) to execution of the JV contract. Essentially, thorough background work by the partner before proceeding to contract execution reduces the prospects of a failed transaction. It is critical that parties are aligned in order to deliver value on the project. We highlight these issues (which may not necessarily be as sequenced here, in all transactions), below:
A. Identifying and ‘Due Diligencing’ the JV Partner: The relevant party will source prospective partner(s) through appropriate channels, starting with leveraging its business networks. Depending on capacity, they may engage professionals (estate agents/RE advisory firms) to source for potential JV partners or they could undertake the assignment directly, either mode could include advertisements. If the project is significant enough, roadshows and beauty parades may be conducted; and outcomes may include exchange of information material and shortlist or ‘culling’ the field so more detailed attention can be paid to only the more serious candidates.
Key questions are: will the potential partner be the right fit – bringing complementary resources, skills, etc that the other party lacks and which together would create synergy for the project? Are values aligned – in terms of ‘culture’/work approach, ethics, integrity, and also track record of delivering value they promised? Nothing could be worse than a union of two strange bedfellows. Such could not only spell disaster for the project, but untangling could be problematic – expensive, contentious, distracting, time consuming and attract reputational risk/damage.
If initial signals are positive towards a potential deal, the party seeking prospective JV partner may need to engage professionals to conduct legal/regulatory and commercial DD of the proposed counterparty, and vice versa. A key part of the DD is on the asset itself to obtain comfort it meets project requirements. Is title valid and clean? If encumbered, is there scope for its deployment as JV asset or subject of JV investment? If it is a partly developed property at the time a prospective JV partner is to invest, he would be interested technical/structural checks of the property to make sure it passes muster for the intending JV partner to get comfortable about committing resources to its further development.
B.Alignment of Vision and Goals: Prior to, or contemporaneous to the DD, would be the asking and answering of some questions that ensures that the goals and vision of the parties are aligned. The term sheet (in addition to preliminary/marketing or roadshow material), may be a useful tool in in this regard. Mismatch of goals/expectations always spell problems down the line.
Some of the key questions that would arise are: what type of development is being contemplated – commercial (office, retail, hotel), residential (apartment block, detached/semi-detached units (bungalows, duplexes), terraces, etc) or mixed use? What is the target market, and the marketing strategy to underlie the project? Will the asset be sold outright for JV partners to cash out upon sale or leased for long term annualized rental income? If the latter, what sort of management obligations will the JV partners have in respect of the property or will they outsource facilities management service?
What is the financing model – off plan sales, achieving critical mass of commitments by off takers of units or anchor tenants before commencing development, as a form of risk management? Is the project commercially viable, considering current and projected economic realities? Do the JV partners have enough resources to execute the project, what mode of external funding should be pursued if necessary? What kind of terms are the JV partners comfortable with – what will they be willing to give up/cede in order to secure funding? What should be the mix of debt to equity? Will JV partners also be providing shareholder loans, and at what rates – competitive, above or below market?
Are responsibilities evenly spread out and would any party be earning fees for providing services to the project? Can the related consideration be regarded as part of a partner’s equity? Will partners take some units on completion as part of their payout from the project, whilst the core remains as partnership investment asset?
The Orange Island development (located off the Lekki Bridge) provides a good illustration of some of these points between Lagos State Government (LASG) and FW Dredging. Whilst LASG provided the 150 hectare site, same was sand filled entirely at JV partner’s cost and the reclaimed land was divided 50:50 between the parties, with each entitled to freely sell or deal with their allocated portions. Sometimes, the JV may be “loose”, an example being the famous Eko Atlantic City – probably Africa’s largest reclamation project, and envisioned to be Nigeria’s financial hub. On the project, LASG provided “public cum regulatory” support, the developer (Southern Energyx Nigeria Limited) fully funded the reclamation, and entitled to sell the plots, whilst LASG earns consent fees on sales, planning/development approval fees, land use charge, etc. These fees would never have materialised if Eko Atlantic had not been envisioned and the land reclamation consummated.
These success stories does not detract from the fact that whilst pooling together of resources via JV arrangements has obvious benefits, poor planning in the initial stages can lead to an ugly termination or failure of the project itself. A July 2010 Deloitte publication, ‘A Study of Joint Ventures: The Challenging World of Alliances’[1] reported that clarity of the JV strategy, governance and management are top three priorities of interviewees for the study. Obviously, alignment and unity of purpose in these areas is critical to success of the relationship and of the venture.
C. Non-Disclosure (and Non-Circumvention) Agreement/Term Sheet/Letter of Intent: At some point (sequence and timing being a function of relevant transactional circumstances), there would be a Term Sheet (or a Letter of Intent (LOI)/ Memorandum of Understanding (MoU). Typically, this would have been preceded by or incorporate a Non-Disclosure Agreement (NDA) or NDA coupled with Non-Circumvention Agreement (NDNCA), which provides a basis for parties to be comfortable with disclosures of sensitive business information and strategy, in pursuance of trying to reach a deal.
Except for specific clauses (e.g. on confidentiality, exclusivity, dispute resolution) that provides to that effect, Term Sheets, LOIs and MoUs are not binding on parties. They do not compel the parties to transact, but provide an outline of terms that may go into the definitive agreements. The LOI highlights the purpose of the JV (vision/goal alignment) and some other key elements such as equity/capital contribution as the partners may decide. It is used as a basis for negotiation of terms between the parties for the purpose of the successful execution of the JV.
The economic terms set forth in the LOI are a frequent battleground where one party considers them absolute and the other an approximation, especially where disagreements ensue in the course of the JV. In BPS Construction & Engineering Co. Ltd. v. FCDA[2] the Supreme Court per Kekere-Ekun, JSC, held that:
“…It is clear that a memorandum of understanding or letter of intent, merely sets down in writing what the parties intend will eventually form the basis of a formal contract between them. It speaks to the future happening of a more formal relationship between the parties and the steps each party needs to take to bring that intention to reality… Notwithstanding the signing of a memorandum of understanding, the parties thereto are not precluded from entering into negotiations with a third party on the same subject matter…”
As noted earlier, in most cases, the LOI precedes definitive agreements. The Orange Island project which involves reclamation a 150 hectare island by dredging of sand from the bed of the Lagos Lagoon, reclamation of, construction of an access land bridge and infrastructure to service the island provides a good example. The parties signed their MoU in January 2013 and a JVA (between LASG and the Developers’ SPV, Orange Island Development Company) on 9th January 2014.
d. Escrow Considerations:
This approach becomes necessary where the landowner would not be expected to ‘put up’ his entire land as part of his JV contribution. This could occur for a number of reasons such as where the land is a large expanse and the JV project would only occupy a portion of it, whereas there is only one title document for the entire land. In order to restrict the ability of the landowner to use or pledge such land as security in a manner inconsistent with the JV partner’s rights, parties can agree that the title documents would be put in escrow pending partitioning of the land and perfection of title to the JV portion. It is wise for such perfection steps to commence or be concluded before the JV partner begins to commit resources to the JV project. Escrow arrangements whereby title documents are held by third parties (escrow agents which could be banks or trust companies) for release on specified conditions (usually completion of title perfection process to JV portion), also operate as a form of payment security for the JV partner/developer/financial contributor. It is also possible for the JV entity to enter into escrow arrangement for its own title document, after it has perfected its title. Usually escrow costs will be charged to project costs.
e. Structuring Considerations:
- Use a Special Purpose Vehicle (SPV)?
Should the parties have an incorporated JV entity as special purpose vehicle in which they would take shares, especially as foreign investors cannot directly be partners in an unincorporated Nigerian partnership? This is largely driven by section 54 Companies and Allied Matters Act, Cap. C20 LFN 2004 prohibition against foreign companies doing business in Nigeria without undergoing local incorporation, and Partnership in an RE JV would clearly amount to doing business. Secondly, the incorporated JV would be a Nigerian company, therefore issues around foreigners not being able to hold interest in land will not arise.[3]
Transaction dynamics will determine how the SPV model is executed. If the property is already being held by the landowner in an SPV, the JV partner merely acquires equity in the SPV. Sometimes the SPV would be a new entity with the partners as subscribers, and the property would be transferred to it. The Shareholders Agreement (SHA) governing rights, obligations and relationships in respect of the SPV between the shareholder/partners approximates to the JV Agreement (JVA)/Development Agreement (DA). Albeit in some cases, parties may prefer to have both SHA and JVA/DA and both does not have to be necessarily duplicative. Of course where there is no SPV, there would only be JVA/DA. Many of the structuring considerations discussed here would be covered in the SHA/JVA.
Should the parties also consider having a foreign ParentCo for the SPV? This would make for easier and more efficient transactions – the property can be indirectly sold by selling ParentCo offshore. This will significantly save on transaction costs and time (no need for Governor’s consent pursuant to section 22 Land Use Act, Cap. L5 LFN 2004, or any Nigerian regulatory notifications, even to the Corporate Affairs Commission (CAC), since nothing changes at SPV level). Where should be the residence/location for ParentCo? A low tax jurisdiction (where ParentCo as investment company enjoys preferential tax treatment, for example qualifying for corporate income tax exemption on its inbound dividends/nil capital gains tax (CGT) exposure of share transfers by its shareholders), and preferably a country with double tax treaty (DTT) with Nigeria (and thereby enjoy lower withholding tax (WHT) on dividends from SPV), would be ideal. Another benefit of having ParentCo is that the Nigerian SPV (Parent Co’s subsidiary) will not be subject to minimum tax provisions (section 33(3) Companies Income Tax Act (CITA) Cap C21 LFN 2004).[4]
However, the Nigerian transaction cost savings would have to be balanced against the start-up and maintenance costs/compliance obligations of ParentCo. Another advantage to having ParentCo may be its better positioning to raise international finance at relatively cheaper rates than would have been otherwise possible in Nigeria. Its acquisition may also represent easier entry strategy for RE investors wishing to invest in Nigeria. The Nigerian investor/shareholder in ParentCo is able to enjoy the liberty deriving from no prohibition against such offshore investments by Nigerians, and also the ability to enjoy Nigerian tax exemptions on offshore dividends brought into Nigeria via approved channels (Nigerian banks), sections 11and 23(k)PITA, CITA respectively.
SPV is also able to enjoy the ‘pioneer status’ tax treatment of property development companies in pursuant to provisions of the Industrial Development (Income Tax Relief) Act[5] in addition to the transaction optimality referred to above, even if has no offshore ParentCo; transfer of its shares still represent indirect acquisition of its property that validly escapes Governor’s consent. It is however instructive to note that recently the Federal Inland Revenue Service (FIRS) signalled its intention for more aggressive tax enforcement against property companies. For example, by treating property assets of companies that did not file tax returns as their turnover for the purpose of taxing same (though it is hard to justify treating turnover as taxable profits).Presumably the FIRS assessments was meant to be a ‘shock treatment’ to ginger asset rich but non-tax complaint companies into action.
- SHA/JVA Issues
Equity Stake and Capital Contributions: The SHA or JVA/DA will prescribe respective contributions by the parties and the equivalent stakes in the SPV or the project. The landowner may contribute only land and/or cash or services (such as facilitating receipt of regulatory approvals) in addition, whilst the other partner(s) may also take equity stake for cash consideration and/or services such as consultancy services or project management. In line with section 137 CAMA, consideration for shares other than cash must be valued.[6]
Mode of assigning the property to the JV (where landowner is contributing land and same is not yet in the JV), would be stipulated; treatment of perfection costs (if applicable) would also be provided for. Landowner will expectedly give indemnity in favour of SPV (and JV partner) for defects in title. The scope (amount, cap and tenor) of such indemnity is critical. Timelines for payment for the equity stake would be prescribed to ensure that the project does not suffer delays due to equity funding shortfalls, there may be provisions for initial and additional investments/payments, remedies for breach (such as interest on delayed payments, dilution of partner’s stake as a result of inability to meet up with contracted commitments), etc.
Capital Calls (CCs) could also be used to bring cash into the JV. Initial CCs are usually made simultaneously or close to the execution of the SHA or JVA/DA or in accordance with agreed timelines. However, situations arise where additional CCs would be made, such as the acquisition of an asset or operating expense shortfall. Additional CCs may be made for either anticipated or unanticipated events such as the occurrence of an uninsured casualty, increased cost of goods or labour etc.
It is not sacrosanct that the value the developer/partner is bringing to the JV table – sourcing/arranging finance (apart from its own equity contribution), technical/ consultancy services, project management, marketing support and facilitating regulatory approvals – has to be paid for with equity, these could be paid for in cash.
Capital Structure: The JVA/SHA could, pursuant to professional advice received, prescribe (optimal) capital structures. It is common to have a mix of equity and debt, and the equity to debt ratio may be a function of availability of resources of the partners, their risk appetite, relative cost and terms of debt capital, tax benefits, etc. Whilst loan expense is tax deductible, and an “above the line” item, equity risk is greater, albeit the upside too could be substantial for successful projects. Some partners could also commit to providing shareholder loans as a means of capturing value at both ends.[7] Third party debt may also be necessary, and presumably the parties will ensure that SPV gets the most competitive terms possible in its circumstances.
Insolvency Safeguards: To guard against the prospect of the JV project becoming an abandoned project, DD conducted prior to entry into the JVA/SHA should have provided clarity on financial position of partners. In addition, the SHA should have an ‘insolvency clause’ such that where a party becomes insolvent, that fact (as an event of default), triggers deemed transfer of the insolvent party’s interest at a predetermined valuation process. This could be based on market price, a formula or determined by an independent expert.[8] Without such provision, insolvency could severely affect the entire project, liquidators might not be interested in the continuation of the project and could seek to dispose the insolvent party’s interest, often to third parties that may not be the right fit for or complement the other JV partner.
Governance: The SHA/JVA will have provisions for managing the affairs the JV/SPV. Board representation will be dependent on a question of stake, and there may be provision for independent directors – RE experts who will add value with their perspectives. There may also be a Project Management Committee (PMC) comprising representatives of the JV partners who would be reporting to the Board or Project Steering Committee (PSC). Where parties are represented in equal numbers and there is a tie, there could be provision for deference to views of the JV party having technical, consulting or development responsibility for the project. These arrangements ensure that every partner is involved in the decision making process of the JV. The governance framework will cover issues such as board composition and changes thereto, dividend policy, decision thresholds on key issues (veto/supermajority matters), transfer of interests and pre-emption rights, tag/drag along provisions on exits, etc.
Related Party Contracts/Transfer Pricing (TP) Issues: It is not uncommon for JV partners to have contractual relationships with the JV/SPV itself. As noted, a partner could contribute land, another could provide services: would the shares in consideration therefor be issued at a premium, discount or nominal value? Same applies where a partner is an anchor tenant; there would be need to balance the competing interests of the tenant/partner getting a very good deal as part of its “reward” for promoting the project vis a vis, SPV’s ability to maximise its rental income potential from market competitiveness standpoint.
Some of these could be thrown into focus where downturn catches up with long term tenancies whose rent was agreed in boom period, and possibly in foreign currency but which current realities now make untenable. Or tenant may want to scale down because the contracted space is now excess to requirements. Whilst the lease agreement should have renegotiation clauses, the JVA/SHA may also provide guidance. Generally, related party contracts (for example, terms of shareholder loans) should be competitive in order to obviate substantial TP compliance issues.
Profit Distribution: Sharing of profits will generally mimic equity stake/contribution of parties. Parties may earn bonuses, for example the developer, for timely completion. This would be a pre-profit share event (expense to the JV). The transactional realities of the JV could also inform how profit is shared. For example, the Orange Island project was a 50:50 split of the entire reclaimed land, meaning that there is no accounting for profits at the JV level. This means the marketing savvy/strategy of each partner could determine how much it eventually makes from the project. For example, a party may decide to “bank” the land, waiting for prices to increase (however this is vis a vis time value of money), whilst another may decide on immediate sale of its plots, to realise near term value.
Sometimes, the division could be that value is ascribed to the land contribution, and the developer gets the differential between land value and the reclamation costs from sale of plots (or vice versa, where pre-JV land value exceeds reclamation costs), before the balance of plots is shared in agreed ratio. Another variation is for all proceeds to go into a JV Proceeds Account (especially where bank financing was involved), from where the net (cash) proceeds will be shared after all costs have been settled. This means JV has marketing responsibility to ensure successful sale of the entire development.
Dispute Resolution: Any contract worth its salt must have dispute resolution provisions. It is a given that governing law will be Nigerian law, because the subject matter relates to land in Nigeria. However if the SHA relates to ParentCo, then the governing law can be foreign, the most popular being English law[9] or Mauritius (if ParentCo is resident in Mauritius).
Typically, there would be a two or three tiered step – (a) discussions between designated representatives of the partners to amicably resolve the dispute; (b) mediation and conciliation; and (c) arbitration if dispute is not resolved within stipulated timeline. The parties may also prefer regular courts to arbitration, albeit for JVAs involving foreign investors, arbitration tends to be more popular especially as the wheels of justice grind slowly in Nigeria.
The JVA will also provide for resort to court for urgent injunctive relief where necessary. Given that enforcement/challenge of arbitral awards would still make resort to court inevitable, it is important to have appropriate drafting that restricts ability to take frivolous steps in these regard. One of them is by providing that the award shall be final,[10] and also ensure that the arbitral process provisions have clarity. Essentially, in preparing the JVA, the legal practitioner should not treat dispute resolution as a simple one-size-fits-all arbitration provision. Pertinent questions include: should the JVA prescribe sole arbitrator or three man panel? What qualifications should arbitrators have? It may be good to prescribe sectoral/technical expertise/experience requirements. As with all the agreements, the usual considerations apply: the scope of the arbitration clause, spreading of costs and attorneys’ fees, appointment of arbitrator, these must be specifically talked through and agreed in light of JV realities.
It is worth reiterating that serious consideration should be given to setting up a more informal process for resolving disputes whilst the JV is pursuing its objectives rather than a more formal procedure that could stall same, for example vide injunctions. In the event of a dispute, parties may be required to refer to a rapid mediator session involving seasoned JV experts appointed by the MC. Subsequently, the dispute can be referred to arbitration. The objective during the first stage is simply speed, and the reaching of some interim resolution that will not hold up progress on the project.
In 2016, a real estate firm, Afriland Properties Plc reportedly filed a N13 billion suit against LASG over LASG’s termination of their JVA for re-development of Falomo Shopping Complex, Ikoyi. Afriland’s claim, among other issues, was that LASG allegedly terminated the JV without strict adherence to the terms of the JVA. The matter was subsequently referred to the Lagos State Multi-Door Court House for possibility of settlement between parties.[11]
Conclusion
RE JVs will continue to be an attractive business model to undertake new projects whilst managing risk vide pooling resources, thereby overcoming capital and other capacity constraints, increasing asset portfolio/ market share, and in entering new markets, amongst other benefits. It could be an asset optimisation strategy for landowning families, obviating the proverbial “seller’s remorse”, which could be more accentuated by the subsequently significant successes of developer projects that they sold the land for (realising only one time income). The quest to “make up” through various schemes and devises could lead to litigation, which would distract the developer, attract negative publicity and imperil marketing of the project. JVAs obviates these, albeit could have its own set of problems if not well managed.
The landscape is replete with successful and failed JV projects and transactions. It is imperative that investors and prospective JV parties are mindful of “critical success factors”, and ensure that the JV plays to its strengths to deliver profitable outcomes for all stakeholders. The importance of professional advice in facilitating such, enhancing the prospects of success cannot be overemphasized. As Nigeria races to bridge her housing and infrastructure gaps, we hope that the instrumentality of RE JVs will be more frequently and optimally employed.
