Partners in a joint venture may be actively involved in the management of the venture, or they may be non-operating partners whose participation is primarily financial. As the venture proceeds, operating expenses might require additional contributions from the non-operating partners. Calls for contributions are generally classified as cash calls or cutbacks. The primary difference between the two depends on the time frame of the expense; cash calls refer to funding anticipated future expenses, and cutbacks refer to funding actual costs.
Typically, the joint venture operating partner issues cash calls to non-operating partners, and cutbacks to partners.
Defining Cash Calls
When the operating partner in a joint venture anticipates future operating expenditures or foresees the need for additional capital contributions, the operating partner issues a cash call to the non-operating partners. In most cases the joint venture operating agreement signed by the partners at the time of its initiation includes provisions for cash calls, spelling out the announcement terms, the proportional contributions and the payment terms.
Understanding the Basics of Cutbacks
According to the joint venture agreement, the operating partner may be obligated to pay the operating costs of the venture throughout a specified accounting period. At the end of the accounting period, the operating partner distributes an accounting of the operating costs to the partners, who then contribute their equity share of the expenses to the operating partner.
This sequence -- calculation of net operating expenses, accounting to the non-operating partners and the non-operating partners' payments to the operating partner -- is called cutback. The likely origin of the name is that the process allows the operating partner to receive contributions that cut back the gross expenses before partner contributions to the net expenses that afterward remain.
Cash Calls vs. Cutbacks
Most joint venture agreements cover both anticipated expenses and the unanticipated need for funds that may arise in the course of the venture's operation. Anticipated expenses covered by the operating partner during the accounting period and billed to the partners afterward -- cutbacks -- rarely test the joint venture. Other unanticipated expenses and capital needs requiring cash calls that are not fully anticipated may or may not be problematic.
When the terms of these calls are fully covered in the joint venture agreement, cash calls may not provoke disagreement. When the joint venture agreement does not sufficiently spell out the terms or the possibility of cash calls, they can become significant problems. Where no clearly detailed methodology for cash calls exists, the partners may drag their feet in paying them or may refuse to contribute at all.
Avoiding Legal Disputes
Problems arising from the operating partner's call to the non-operating partners for funds are minimized by the execution of a detailed joint venture agreement. The agreement can help the partners' understanding of the scale of future cutbacks by including concrete examples both where the needs may approach a minimum and where they may approach a maximum amount.
The agreement should be frank in spelling out the risk of cash calls, again giving concrete examples. Detail the billing and payment processes. Clearly state the penalties for tardy payment or non-payment, including the terms of eventual default where the non-payment is substantial and prolonged. Many accounting and legal firms offer inexpensive joint venture templates online.
Video of the Day
- Creatas/Creatas/Getty Images