Question

Energy Works is forming a joint venture (JV) with Big Oil, Inc. for the extraction of proved oil reserves in the artic. Both ventures wish to share in the risks and rewards of this venture, while benefiting from each other’s technical expertise and sharing of key assets. Energy Works will contribute a floating production storage and offloading facility (FPSO), valued at $100 million, along with $20 million in cash, to the venture in exchange for a 50% equity interest.

Big Oil will contribute its arctic drilling permit, also valued at $100 million, along with $20 million in cash, to the venture in exchange for a 0% equity interest. Assume that the cost basis of the contributed assets is the same as the fair values of theses assets. Profits and losses of the venture will be shared based upon the quit interest held by each investor.

Operations of the joint venture will be overseen by its Board of Directors. Each venture will receive two seats on the Board, for a total of four seats, and all significant decisions of the JV require the unanimous consent of the Board, with any dispute to be settled by an independent arbitrator (binding arbitration). The Board has appointed Energy Works to manage the day-to-day operations of the FPSO facility. Additionally, both ventures will provide employees and managerial personnel with technical expertise to perfom day-to-day operations for the JV. Energy Works will not receive separate compensation for its role as manager. The joint venture will be legally organized as an LLC.

1. In your opinion, what are some of the most critical resources that Richard should consider – and key questions he should ask – in his effort to understand this proposed transaction?

2. Assume that you have been asked to review a lease agreement to determine whether it should be classified as a capital lease or as an operating lease. In this case, knowing that this is a unique type of transaction that may be governed by its own set of rules, you should begin by searching for guidance specific to this type of transaction. Your first researchable question for this contract might be: “Should the lease agreement be classified as an operating lease or as a capital lease?” What browse path might be an appropriate starting point for this question?

3. Take a moment to practice identifying a single, researchable question for the following issues:

a) A company ships its widgets to a customer on December 31 but has not yet collected payment from the customer. The customer has promised to pay within 30 days but has never purchased good with this company before. Researchable question?

b) A customer is suing the local grocery store for a slip-and-fall incident. The grocery store believes the lawsuit will likely be considered frivolous and rejected by the court. The grocery store must decide whether to record or disclose this matter. Researchable question?

Can I get some ideas or answers for theses questions?

Answer 1

1. Some of the key questions that need to be asked to understand the JV agreement:

1. Both the parties contribute equally interms of the contribution towards the JV. Big Oil’s interest in the JV is mentioned as 0%. This should be 50%, being an equal partner. Was tht a typo?
2. The Board has appointed “Energy Works” to manage the day-today operations. In that case, who will execute the banking transactions and signing of cheques. If this has to be only “energy works”, then conflicts might start.
3. If the management of affairs is with ‘Energy works”, there should be clear understanding of the roles and responsibilities including the responsibility of publishing the financial statements onperiod basis.
4. No separate fee is mentioned for managing the day-today activities by Energy Works. This needs to be specified.
5. Incase the JV business is not workable, the agreement should provide for exit clause.

1. To determine whether the lease agreement entered into by the JV is “Capital Lease” or “Operating lease”, the following points need to be considered.

1. Whether the lease term is for the major part of the economic useful life of the asset.
2. Whether the ownership of the asst is transferred to the lessee at the end of the term. (in this case, lessee means the Joint Venture)
3. Whether the lessee has the option to buy the asset at end of the lease term, for a price which is substantially lower than fair value at the date of exercising the option and it is certain, at the inception of the lease, that such option will be exercised.
4. If the Present value of lease payments, substantially equals the fair value of the asset.
5. If the asset is of a specialized nature that only the lessee can use it without major modification.

If none of the above conditions (which can be seen only from actual scrutiny of the terms of the agreement) are satisfied, then the lease is Operating lease.On the other hand, if any one or more of the conditions are satisfied, then it is “Capital lease” (financial lease)

The below 2 questions are unrelated to the above “JV” question.

The questions should be approached in the following manner.

1. a) (i) Whether there is various contract/purchase order on whose basis the shipment was made.

(ii) Whether delivery was made and accepted by the customer?

(iii) Book revenue if above conditions are satisfied.

(iv) if after passage of 30 days, if the customer has not paid, then check if there is any evidence that he will not pay the dues.If so, then make provision towards non payment.

b. The shop keeper and the clerks are responsible for negligence, if the fall is due to their negligence.As the employees negligence happened during the course of their employment, the shop is responsible.It may however be noted that if the employee had acted willfully out of personal motives, the employer (shop) is not responsible.(as per Tort’s law)

Even, in frivolous cases, existence of case against the company need to be disclosed in Annual report.