Joint Ventures: Financing Considerations and Potential Pitfalls

If you are an investor, developer or lender in a joint venture that is proposing to finance the property that is the subject of the joint venture, it is important to protect your interests by considering how to address a number of issues that commonly arise in this context.

These five financing considerations warrant careful attention in the structuring of joint ventures.

1. Separate Mortgaging Rights. Separate mortgage rights allow a joint venture partner to mortgage its undivided interest in the project, even if the other partner does not. To mitigate risk for the non-mortgaging partner, the loan’s principal amount and interest rate should be capped, and protective terms should be included in the loan agreement, including a requirement that any lender assuming the mortgaging partner’s interest agrees to be bound by the obligations under the joint venture arrangement. To avoid the mortgage being assigned to a competitor or unsuitable lender, the non-mortgaging partner should be aware of who holds the mortgage and prohibit its assignment or syndication. If the mortgaging partner defaults, the non-mortgaging partner should receive written notice and an opportunity to cure. If enforced, the lender and any successor shall remain bound by the right of first refusal, transfer restrictions and other key joint venture provisions. Where both parties agree to proceed with joint financing, the mortgaging partner’s lender must subordinate its loan to the shared mortgage.
2. Addressing Shortfalls. Shortfalls in value can occur following project completion or from sale proceeds. It is important to clearly define which party will be responsible for any shortfalls or whether these will be shared by the joint venture partners in their respective ownership proportions.
3. Funding Imbalances. Differing capital contributions may lead to mismatched funding approaches. Staged capital contributions can address this, allowing one partner to fund upfront, and the other at a later date. Cross-collateralization agreements can allocate debt repayment proportionately. Dispute resolution clauses can also be helpful, as financing disagreements may arise and become disruptive.
4. Guarantees. Lenders often require additional corporate or personal guarantees beyond joint venture security. They will also insist on joint and several liability, allowing them to pursue either partner for the full debt. Partners must discuss these obligations early, as some investors may be unwilling or unable to provide guarantees due to tax or regulatory constraints.
5. Revisiting Financing Structure. Financing should be assessed throughout the lifecycle of the joint venture, as market conditions often shift from when the joint venture was initially entered into. Regularly revisiting and adjusting the financing structure helps partners stay aligned and avoid future issues.

Have more than five minutes? Contact Daniel Kofman or any other member of our Commercial Real Estate group to learn more.