By Darren Richards
From Barry McGuire’s article about Agreements for Sale, to Russell Westcott’s article on strategies for drumming up money (that actually touched on the subject of Joint Ventures), there are lots of great ways to pursue your goals with respect to real estate related investing. And, as Russell pointed out, a Joint Venture is a great option to consider. But, here are a few grocery list items you want to be mindful of:
- 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.
- What a Joint Venture is not
It is not a partnership, a corporation, or even its own legal entity. 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.’
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 month.
- Legal Stuff
Joint Ventures are massively different from a legal perspective, too. 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 protects 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 month.
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 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 err on the side of full disclosure.
Darren Richards is a partner with Richards Hunter Toogood. He focuses on both residential and commercial Real Estate and Corporate/Commercial Law serving both small and medium sized owner-managed business in the Edmonton and surrounding region. Mr. Richards also acts for major banking institutions and other lenders in relation to their commercial loan facilities. Reach him at: firstname.lastname@example.org or or www.rht-law.ca.