Unincorporated joint venture. A brief legal memo on rugulation

To implement some project, sometimes an enterprise does not have money, property, or professional knowledge, but with that, there is another enterprise which has that money, property, or knowledge, and is interested in implementation of the project of such a kind. For example, an enterprise has a ground plot on which, due to lack of money, it does not manage to build some facility which would bring profit. At te same time, another enterprise has money and desire to build, for example, a restaurant or a shopping center, but it (enterprise) does not manage to get a ground plot for that purpose.

In this case and in a number for similar cases, it is not always worth while pushing one’s boulder uphill independently, getting a load of credits and perhaps entering into tough competition with other persons interested in such projects. It is much more correct and useful to unite the available resources of the enterprise with resources of another enterprise, and to implement the intended project together, with the united efforts, and to divide the earned profit according to who how much invested in the common business.

To implement such joint projects, it is not necessary at all to create a new legal entity. In case a project is rather risky and/or it is a long-term project, it is much more efficient to conclude a joint activity agreement between the enterprises.

By that agreement, according to Article 1130 of the Civil Code, its participants undertake to operate jointly, without creating a legal entity for reaching a certain goal that does not contradict to law. Joint activity based on such an agreement may be performed both by means of uniting the participants’ contributions (simple partnership), and without uniting participants’ contributions. In the latter case (when concluding a joint activity agreement without uniting the contributions), each of agreement participants uses his own capital assets, bears own expenses, attracts own financial means. That is, in fact, implementing one’s part of the project independently, without using the means and resources of the other enterprise, only agreeing the organizational matters of implementation of the project with it (with the other enterprise), and also sharing the profit with it in proportion with final share of participation in the project.

When making a joint activity agreement in form of simple company (simple partnership agreement), though, the parties make contributions, such as property, money, abilities and skills, business connections and/or business reputation, into the joint activity. By default, those contributions are considered to be equal to the cost, unless otherwise implied by the agreement or by actual circumstances, and there arises the right of the joint shared property for the agreement participants concerning that.   The joint shared property is considered to be also the products made as a result of the joint activity, and the benefits and profits earned from such activity. Accordingly, using that property is possible only by mutual agreement of the agreement parties. The profit earned from results of the joint activity in this case is distributed proportionally to the cost of participants’ contributions to the joint property, unless otherwise stipulated by the contract or agreed by the parties.

The following can be referred to the main advantages of activity based on the joint activity agreement:

• There is no need to register a new legal entity.  The simple partnership is not of that kind. For implementation of a joint project, it is enough for the enterprises to sign a joint activity agreement.  
• In case the joint activity is performed by means of uniting the contributions, such contributions become the joint shared property of their participants. That is, they all become owners of the property that was made as a contribution to the joint activity. Therefore, for example, while investing money and/or business connections into construction of a facility on a ground plot made as contribution by the other party, the person become the owner of that ground plot and has the right to use it on equal terms, unless otherwise provided by the agreement.
• Possibility of making not only the property as contribution to the joint activity, but also the skills, knowledge, abilities and capabilities, business connections and reputation, information and other kinds of contributions, concerning which it was agreed by the parties.
• Flexibility of simple partnership agreement concerning both the legal framework of the property made as contribution and concerning management of the joint activity.  As stated above, the participants themselves may cancel the application of the joint shared ownership for the property made as contribution. They may also independently define its cost, procedure of keeping and compensation of expenses connected with such keeping. Besides that, they can set independently the procedure of performing the joint activity: the business can be carried on by all participants or only be individual participants. No general meetings with the majority dictate, no elections of the board of directors by majority of votes – everything only by joint and mutual agreement provided by the contract.
• Possibility of ceasing the joint activity relatively quickly and painlessly. It is enough just to dissolve the simple partnership agreement, or, in case it is an open-term agreement, to withdraw from it, having notified about that three months before the day of withdrawal from the agreement. In case of termination of the agreement, the things that were passed for the joint ownership and/or for use shall be returned to the participants who provided them, and the rest of property (in particular, profit from the activity) shall be divided among participants proportionally to the cost of their contribution.

However, along with advantages, some disadvantages are typical for the joint activity agreements:

• Lack of stability. Performance of the joint activity, including that in form of simple partnership, requires consent of all participants. Otherwise an agreement cannot be concluded, and the concluded agreement may cease to have effect relatively easily. On top of that, even if the agreement is not terminated, performance of the joint activity may become impossible in case there is no consent of all participants.
• Indefiniteness of responsibility: According to Article 1138 of the Civil Code, in case the simple partnership agreement is connected with performance of entrepreneurial activity by all of its participants, those participants are jointly responsible on all joint obligations regardless of the reasons of their arising. Consequently, in case the result of the joint activity is just getting debts, then the creditors may oblige any of participants to pay those debts, regardless of his share.
• Tax difficulties. Accounting of results of the joint activity should be kept by a participant authorized for that, separately from the accounting of operations of such participant, and the joint activity agreement itself is subject to registration at the tax authorities. But the main thing is that the operations on transfer of goods, works, services as contribution to the joint activity and the return of such goods (services) fall under the term of “supply of goods”, “supply of service”, and, accordingly, they are subject to VAT-taxation. Clause 196.1.7 of the Tax Code can be confirmation for that, too. With that, getting a tax credit on those operations is rather difficult due to the fact that the simple partnership is not a legal entity.

However, most of those disadvantages can be eliminated by the competent planning of the joint activity.

This material was prepared by the lawyers of the “Pravovaya Pomoshch” (“Legal Assistance”) Company.

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