Participation Agreements: Templates, Best Practices, and Key Provisions

All About Participation Agreements

Participation agreements are a commonplace way of defining a relationship between parties who conduct business with the expectation that they will share in the proceeds. A participation agreement is similar to a joint venture or syndication except that an agreement amongst the members of the group is common even when there is no effort to make money.
Participation agreements are most commonly used to define the relationship between a vessel owner and a lender who has provided funding for the purchase or renovation of the vessel. Lenders commonly insist on a participation agreement so that the lender may invest in the gross proceeds of a vessel along with other investors because of a desire to limit its liability and exposure.
A participation agreement has a number of characteristics:
• It is typically 15 pages long;
• Parties described as "Participants" must sign the agreement;
• Each Participant’s participation is set forth in an exhibit which lists a percentage of each distribution (defined below);
• There is a "Distribution Agent," "Payments Agent" or "Registration and Transfer Agent" who is responsible for making distributions;
• Distributions occur at least quarterly;
• Net proceeds are distributed to Participants according to their percentage of participation.
One of the issues addressed by a participation agreement is how the participants will divide the proceeds from the business . Commonly, net proceeds will be distributed by the parties according to the following sequence:
First: The costs and expenses of the Distribution Agent. This includes the cost of preparing the distribution, paying a trustee, or any other cost that a distribution agent independently incurs.
Second: Payments Installment Amount. The agreement defines an Installment Payment as "a one quarter dividend, income or cash flow distribution payable to the Participants out of the Net Proceeds from the preceding Quarter (this includes a non-cash dividend, a non-cash income or a non-cash flow distribution)." The Installment Payment is a sum of all the Installment payments due and unpaid prior to the date of the current distribution.
Third: Repayment of Loan. The distribution agreement requires the broker to pay the principal amount (plus interest) that is due to the lender.
Fourth: Default Amount. A Default payment is any payment that has come due and has not been paid by the borrower.
Fifth: Deferral Amount. A Deferral Amount is any amount that the borrower has elected to defer, pursuant to the terms of the agreement.
In addition to these distributions, the agreement awards Participants an amount equal to 10% of the cost of financing for any money owed by the borrower to banks or other banks providing financing to the borrower.

What to Look for in a Participation Agreement Template

When utilizing a template for a participation agreement, it is essential that the most salient aspects necessary to hold a prospective joint venture arrangement together be included. These components typically include clauses outlining the obligation of each party with respect to escrow account deposits and distributions. The parties are also obligated to account for their respective costs and expenses, as well as their share of gain, loss and liabilities.
Payment terms and procedures must be disclosed. Each party’s ownership interest is usually documented as a percentage of the net profits or customarily achieved reserves produced from development, exploration or production activities. Financial obligations typically include: joint account cash calls; payment of overdue parent or affiliate loans; 3-year and 5-year program fees; shut in or inactive well fees; production fees; operating fees; and abandonment and reclamation fees. The agreement must also make clear how oil and gas property obligations and liabilities will be divided, addressing topics such as surface reclamation and release bonds.
The termination clauses of a participation agreement are generally centered on the time frame of parties’ participation, the period to drill an exploratory well, technical feasibility, and delineation of reserves. The template can address obligations related to legal compliance, third-party agreements, and disputes.

How to Edit and Modify a Participation Agreement Template

Participation agreements will typically present the general structure and basic expectations for all participating lenders. But they will often have some sections, such as capital calls or management fees, with blanks for amounts or rates. Some participation agreements may even have blank paragraphs for the allocation among the parties of some of the remaining terms.
In addition, many participating lenders will have their own standard clauses that they use for their own loan transactions, and may want to include even more of these clauses in a participation transaction than usually appear in a loan transaction. Also, the borrower’s approval of the transaction will often come with its own set of requirements.
Thus, any participation agreement template will require some amount of customization to fit the needs of the specific transaction.
The following are some examples of common clauses in loan agreements that are often included as-is or customized in participation agreements:
With regard to certain clauses, participating lenders may want to add even more provisions that appear in the lender’s own loan agreements that address specifics with regard to the loan to be shared by the participants, but that are not likely to be in the original loan agreement between the borrower and the lead lender.
Even if a clause does not need to be addressed in the new participation agreement, it may be necessary to review it to determine whether or not the new participating lender is going to require an amendment to the original loan agreement between the borrower and the lead lender. For example, if the original loan agreement has a prohibition against borrowing additional sums by the borrower, the new participating lender may need an exception to this prohibition in the original loan agreement.

Common Pitfalls to Avoid

When drafting your participation agreement, you will want to avoid the following common errors:
Loose language: Be clear in what you want from a participating organization. Stick with specific terms like "physically" typing data into the system, rather than "entering" data. This will limit the risk of misunderstandings.
Overly specific or complex language: Agree to the terms of your participation agreement quickly and simply. Using a 15 page contract for a small project could slow down the whole process as you look for ways to make sure you are covered at every turn. Creating a simplified agreement template for smaller projects could help you save time at this stage and focus on the essence of the agreement.
Not including terms for conflict resolution: All agreements should contain a way to resolve conflicts that may arise , usually through mediation. If you have not outlined a specific process for resolving conflict in the original agreement, it can make the situation difficult to navigate.
Avoiding proper definitions: When defining terms in your participation agreement, be as specific as possible. Be sure that you have defined each required term for maximum accuracy.

Legal Implications and Compliance Issues

As with any other legal document, adherence to the law is a critical issue when it comes to participation agreements. Of primary concern in hospital participation agreements are the Stark Law as it applies to referrals to and from physicians and the anti-kickback statute which prohibits kickbacks in connection with the referral of Medicare and/or Medicaid business. To comply with the Separation Requirements of the Stark Law, each hospital that is setting up a participation agreement with a non-owned physician practice must perform a fair market value analysis of the services provided by the participating physician and the compensation paid to such physician under the applicable participation agreement. Since this analysis must be performed on an "individual basis", hospital system with more than one hospital and physician practice must look at identifying the following for purposes of applying the Stark Law:

• The identified compensation arrangement (for example) is it a rental arrangement, or personal service arrangement to which Stark applies?
• The physician’s services, including the physician’s specialty.
• The hospital’s services, including the hospital’s specialty.
• The location of the services to be provided.
• The income generated by the physician’s services to the hospital, and
• The costs of the services provided by the hospital to the physician. If Stark applies, we need to determine if it falls under either the Bona Fide Employment Exception or the Personal Service Arrangement exception, and if so whether it falls under any of the safe harbors to the Stark law. With regard to the Anti-Kickback Statute, it is important to note that payments for medical staff and other administrative services are not protected under the Stark law since they are only applicable to "direct or indirect compensation" for the furnishing of a physician’s services. An entity who is running afoul of the Stark law however, may also be violating the Anti-Kickback Statute. Therefore, the hospitals need to be careful to evaluate the compensation arrangements not only for Stark compliance/limitations, but also for the Anti-Kickback Statute. Rather than being fair market value, payment in excess of fair market value for services compensates the referring party for its referral of business to the entity making the payments, and violates the Anti-Kickback Statute. In addition to the above considerations, hospital participation agreements should also comply with any and all applicable licensure requirements. For example, a physician who is not licensed to practice medicine in the state where the hospital is located would likely be prohibited from providing services under a participation agreement.

The Best Online Sources for Participation Agreement Templates

High-quality participation agreement templates can be found in a variety of places. Some online resources offer free templates while most legal services websites will have free sample templates available to view or download. It’s important to point out that participation agreements are state-specific. Before creating one, practitioners should check for the most up-to-date templates from their state bar associations, insurance commissioners or other governmental websites.
Virtually all of the most important documentation needed to complete a transaction—such as corporate documents, franchise agreements and licenses—are available on franchising’s industry-standard business document website. So why not participation agreements? The answer is very simple: each participation agreement is negotiable and will differ, depending on the levels of risk the parties want to take and how much they are willing to spend up front and the way they would like the deal to be structured. While it may not be economically practical for a small franchise system to hire an attorney to draft one-of-a-kind amendments and other such legal documents , even the smallest company needs an array of model contracts, forms, and legal documents, most of which are "cut and pasteable." The best places to obtain these documents are:
• Your local OurAssociationsOnline.com chapter. These chapters offer local and regional resources tailored to franchise members. Most offer free materials related to best practices in franchising, and some chapters offer incomplete but helpful materials at a reasonable price.
• Your state bar association (especially those with a franchising section). Many state bar associations have templates available to members, including participation agreements. Some states charge a nominal fee to access these forms.
• Commercial websites such as Nolo.com, Findlaw.com, Virtualpremise.com, and others. These sites charge a subscription fee or one-time cost, and can provide you with high-quality templates and related information.