Last week, we discussed the complexities of metals exploration chapter 11 bankruptcy cases and addressed several of the notable issues that arise in those cases. The discussion of significant issues continues below.
Enforceability of Rights of First Refusal Mining exploration is often undertaken by partners, one of which may contribute the mining properties and the other is responsible for exploration and development. These arrangements, such as joint venture exploration, development and mine operating agreements, contemplate earn-in periods during which the party responsible for the actual exploration and development of a mining project can acquire a percentage of ownership in the project by making certain agreed upon levels of expenditures over a period of time. Once the expenditure levels are met and all other contractual requirements are satisfied, the exploration party will acquire a co-ownership interest in the property itself. These agreements frequently provide for a right of first refusal that can be exercised by either party (following the completion of the earn-in period and the acquisition of a property interest by the exploration party) in the event that the other party desires to sell its property or joint venture interest.
Although contractual rights of first refusal are generally enforceable under state law, the rules can change in a chapter 11 bankruptcy case where the name of the game is maximizing the value of the debtor’s assets for the benefit of all creditors and stakeholders. Some courts have declined to enforce contractual rights of first refusal in the context of section 363 sales if enforcement would frustrate or materially interfere with the debtor’s ability to maximize value (e.g., where the right of first refusal would chill bidding). The right to ask a bankruptcy court to override a contractual right of first refusal is a powerful tool and should be considered by a debtor as it evaluates available alternatives and devises its restructuring strategy. Conversely, the non-debtor party must be aware of the risk that its bargained-for right of first refusal may be limited or deemed unenforceable at the end of the day.
Sales of Co-Owned Property Taking the example of an exploration and development joint venture one step further, if a debtor believes that it will be able to maximize value by selling the entirety of the co-owned property rather than just its own interest in the property, it has the right to ask the bankruptcy court for authority to sell 100% of the property pursuant to section 363(h) of the Bankruptcy Code. This is particularly helpful where the debtor owns a minority interest in the property and, thus, ordinarily might expect to suffer a discount in the value of its interest compared to the interest of the controlling joint venture party. From the non-debtor partner’s perspective, it may seem as if the bankruptcy process is completely stacked against it – not only is it at risk of losing its contractual right of first refusal, but the debtor also has the right to seek authority to force a sale of the entire property over its objection. However, a forced sale under section 363(h) comes along with a powerful right in favor of the non-debtor partner – a statutory right of first refusal to purchase the entire property under section 363(i) of the Bankruptcy Code that, based on current case law, seems to be strictly enforced even if the ability to maximize value is frustrated.
Royalty Agreements – Executory Contracts or Real Property Leases? Another significant issue is the treatment of mining royalty agreements. Depending upon applicable state law, royalty agreements may be considered either non-residential real property leases or executory contracts. This distinction is important as it bears upon whether royalty payments coming due postpetition are required to be paid in the ordinary course. If the agreement is an executory contract, the general rule is that a debtor does not need to timely perform postpetition obligations pending its decision to assume or reject the contract – such executory contracts being enforceable by, but not against, the debtor. Non-residential real property leases, however, are afforded special treatment under section 365(d) of the Bankruptcy Code such that a debtor is obligated to timely perform all postpetition obligations (subject to certain exceptions) as they arise under non-residential real property leases. Therefore if a mining royalty agreement is determined to be a real property lease, the debtor will be required to make the postpetition royalty payments as they come due.
Reclamation Bonding In any mining operation, land is disturbed and operators incur substantial reclamation obligations under environmental laws and regulations. Irrevocable surety bonds are often required to be issued for the benefit of the environmental authorities. These bonds serve as a backstop in the event the mining company fails to satisfy its reclamation obligations. Because of the irrevocable nature of reclamation bonds and the fact that the bond obligates the surety to the environmental authorities (not the debtor), the status of a reclamation surety bond issued prepetition as an executory contract is subject to question. If the bond is an executory contract, then premiums due postpetition are administrative expenses. But, if the bond is not an executory contract, then such premiums are merely prepetition claims. Moreover, even if the bond is an executory contract, administrative expense status for postpetition premiums may still be subject to challenge because such obligations arguably do not arise as a result of a transaction with the debtor’s estate. An irrevocable bond issued prepetition must be performed by the surety as a matter of law regardless of whether premiums are ultimately paid.
Subcontractor Claims Mining operations also frequently involve the use of a primary mining contractor (known as a contract miner), who in turn may contract with any number of subcontractors to perform different aspects of the mining work. In most cases, the debtor has contractual privity only with the primary contractor and the subs may not be able to assert direct claims against the debtor. Subcontractors, however, often file claims against the debtor and may even seek to assert mechanic’s liens. Debtors should consider whether subcontractor claims are legitimate.
Conclusion The foregoing is a brief, high-level discussion of some of the key issues that arise in the context of mining cases. Needless to say, each case presents its own complexities and these issues and numerous others will need to be carefully considered by debtors and their advisors as they evaluate restructuring alternatives and endeavor to devise a successful restructuring strategy. These issues also must be considered by creditors and other stakeholders as they grapple with the best way to respond to a mining insolvency case.