If you invest in real estate and have talked to your real estate lawyer at any length, you've probably chatted about joint ventures. There are a lot of great ways to pursue your goals with respect to real estate related investing. And a Joint Venture is a great option to consider. But I’ve come across a lot of confusion with respect to Joint Ventures.
But here are a few grocery list items you want to be mindful of:
1. What a Joint Venture is –A Joint Venture is an alliance (of sorts) between two or more other parties where each party contributes something of value (services, material, or capital) for a specific commercial enterprise or project. As you can see, this is a great strategy where one party has cash (capital) and another has time and knowledge (services). If they both value the other, and they both find a property they want to buy, they can do so via a Joint Venture and thus allocate their respective ownership interest based on the value each brings to the project.
2. What a Joint Venture is not – it is not a partnership, a corporation, or even its own legal entity. When I played hockey in college we had guys with all sorts of nicknames (including an actual ‘Nick’). We had for example ‘rushing Wrigglesworth’ – a defenseman who was famous for never ever rushing the puck. We also named lines; I was on the ‘CNC Line’ which was comprised of two Canadians and a New Yorker. You’ll notice we weren’t all that creative. But the name did describe something real. So names are important.
I always recommend to clients that they communicate correctly to banks, potential co-investors, and their professional advisors in that regard. So be careful not to mix terms and confuse the legal and accounting landscape. There is no such thing as a ‘joint venture partner’ just as there is no such thing as playoff hockey in Edmonton (or to be equitable, in any other Canadian city). If you own a business (real estate or otherwise) through a corporation, you are a ‘shareholder’. The other owners are fellow ‘shareholders’. If you run a business as a partnership, you are a partner and the other parties running it with you are your ‘partners’. And last but not least, if you are participating in a project (notice I didn’t say business) as a Joint Venture, you are a ‘venturer’ and the other parties are your ‘co-venturers’.
"There is no such thing as a ‘joint venture partner’ just as there is no such thing as playoff hockey in Edmonton"
3. Accounting – Since each legal ‘relationship’ is distinct legally, the taxation of income generated through a Joint Venture is treated differently by CRA than income generated through any other vehicle. And trust me, the taxation of income from dividends (as a shareholder), from a partnership draw, or from a joint venture interest, is massively different when you get around to filing your taxes (as are the corresponding abilities to claim expenses, exemptions and credits against that income). Talk to your accountant about this. There’s also a fairly sizable GST issue at play too – more on that next time.
4. Legal Stuff - More to the point for this article, Joint Ventures are, from a legal perspective significantly different than the other ways you may want to do real estate with others. A shareholder has limited liability. A partner or venturer may not. The legal documentation to create, sustain and manage a corporation, partnership or joint venture is distinct and unique with very little overlap. A Joint Venture Agreement may have some things in common with a Partnership Agreement or even a Unanimous Shareholders Agreement. But there are significant differences too. There are also legal documents needed for one that are not needed for another.
For example, where one venturer holds legal title to the underlying real estate property and the other co-venturer(s) are not on title, one would expect at the very least some form of trust declaration stipulating that legal title is being held in trust for the actual benefit of others. In Alberta, lawyers would also recommend a Caveat (encumbrance) be registered on title to the property giving notice that there are beneficial owners. This would protect those not on title from having the property sold or mortgaged or their beneficial interest otherwise impacted by a disposition of title without their knowledge. More on this legal stuff next blog.
5. Bank Financing – in a significant number of Joint Venture arrangements, one party (usually the one with the cash) is appointed to hold legal title and get the mortgage financing that’s necessary for the acquisition of the real estate property. That’s fine and perfectly legal. The problem arises, however, when this legal joint venture relationship isn’t disclosed to the lender. Such an arrangement and set of facts is considered ‘material’ by virtually every lender in that by virtue of the Joint Venture, one party will be holding joint venture assets (i.e. the real estate property) in trust for another party or parties. That is to say, the mortgagor is holding a beneficial interest in title for someone else.
During the most recent boom, many instances of this occurred, but outside the context of a legitimate Joint Venture arrangement – one party ‘fronted’ the loan application, obtained title, but did so entirely for another party, without telling the bank. The mortgagor was paid for his troubles by the ‘real’ owner and eventually just walked away. That’s what us lawyers call ‘fraud’ (the RCMP called it that too). This was done back in the day when Alberta allowed mortgage assumptions too – so as you can well imagine, within a few short weeks actual legal title eventually was conveyed to the previously invisible beneficial owner. So people otherwise unqualified to obtain their own mortgage financing found a way to get mortgage financing.
Anyway, to avoid all the hassle of jail time and civil fraud actions and other such business-interrupting events, simply error on the side of full disclosure.
That’s all we have time for this blog. As already noted above, I’ll flesh out some more Joint Venture details next time and highlight the important terms to have in a Joint Venture Agreement. So stay tuned . . . .
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Originally published in the REIN Real Estate Report