In light of volatile metal prices and challenges surrounding raising equity financing, using production as a financing tool to fund mine development and production provides a viable alternative path forward. Specifically, junior mining companies that are working to develop a project from the ground up and have sometimes not even completed a feasibility study often face particular challenges securing financing and, in the absence of access to traditional financing or equity investments, production-linked alternatives such as prepaid commodity forward agreements fill a void in the market. From a lender’s perspective, these transactions, often originated by commodity trade houses and specialty hedge funds, offer attractive margins, robust security packages and negotiated sweeteners. This discussion seeks to provide an overview of the commodity forward purchase product, an outline of the legal framework and a description of common commercial considerations associated with commodity forward purchase agreements.
While commodity forward purchase agreements are essentially just sales contracts, whereby a buyer agrees to purchase a certain quality and quantity of a commodity from a producer in exchange for an up-front payment, each arrangement is highly customized to reflect the results of the due diligence of the underlying assets, the debtor profile, the relevant jurisdiction for purposes of the perfection of the security package and the nature of the relevant commodity. For example, under a customary gold forward purchase agreement, a gold miner is required to deliver a specified quantity of gold or related proceeds at monthly intervals over a specified term and the transaction will normally be structured to gradually increase to reflect greater production of gold at a developing mine.
Normally, the buyer bears the price risk of the commodity while the seller bears the costs and expenses for the production, transport, refining and delivery of the commodity to the buyer. While the commodity forward purchase agreement may commonly be documented pursuant to New York or English law, the security package relating to the agreement is often tied to the jurisdiction where the mining assets and related operating companies are located and it will be structured with the input of the relevant local counsel.
From a seller’s perspective, this financing vehicle may prove advantageous because, unlike an equity offering or a joint venture, it preserves control of the development process because it may avoid or minimize share dilution and outside input into the day-to-day management of operations. Also, commodity forward purchase agreements are typically associated with advantageous accounting treatment if structured properly (the contract will not be accounted for as debt) and they often do not contain the full suite of financial covenants included in traditional financings and it is common to have a grace period in terms of repayment tied to production and the absence of traditional interest payments.
From a buyer’s perspective, these are often shorter term credits that present a significant financial opportunity for the buyer. The buyer will assume a senior, secured position and typically expect to receive a comprehensive or all assets security package as well as robust representations and warranties surrounding freedom of collateral from liens, effectiveness of concessions and licenses as well as other assurances surrounding due diligence issues that will affect the development of the mining asset. If there is a creditworthy parent company, it is not uncommon to see guarantees issued by this entity in favor of the buyer. Additional credit support in the form of these guarantees or promissory notes may enjoy an expedited enforcement proceeding in some jurisdictions and these issues would typically be considered in conjunction with local counsel.
Apart from structuring the financing as a sale as described in the overview and depending upon the commodity at issue, many commodity forward purchase agreements will require as conditions to closing or to subsequent disbursements, that the seller enter into and maintain contracts for refining and selling the commodity being produced (offtake agreements). The buyer may exercise significant oversight in the commercial terms surrounding these refining and offtake arrangements by providing for eligibility criteria relating to the same (and any breach of these criteria would constitute a breach of the terms of the agreement).
As the mining assets are located in different countries, jurisdictional risk and issues involving documentation and enforcement of liens are significant legal considerations. Many civil law jurisdictions in Central and South America, for example, have intricate requirements to document and perfect security interests that must be followed precisely in order to have an enforceable security interest. Additionally, there are often legal issues involving consideration or corporate benefit that, if not adequately addressed with the expertise of local counsel, may render security packages unenforceable or void or limit recovery under credit support instruments such as guarantees.
The commercial negotiations in the commodity forward purchase context often involve the setting of minimum and maximum prices of the commodity and these set points may either be documented in the commodity forward purchase agreement or in an ISDA Master Agreement. The buyer assumes the risk that the commodity price may fall below the minimum price, while the seller largely assumes the risk that the price may exceed the maximum set price.
Additionally, technical analysis is given significant weight, including any conclusions relating to necessary permits and licenses for operation of a project. There are often commercial discussions surrounding what permits or licenses will be required prior to the buyer making partial or full payments under commodity forward purchase agreements.
Finally, maximizing the benefits of commodity forward purchase arrangements often involves a negotiated agreement on the part of the seller to sell the commodity to the buyer at a discounted rate.
While prepaid forward agreements run the gamut from smaller transactions that fly under the radar to larger transactions that make the headlines, such as the offtake-linked Pretium Resources Inc. US$540,000,000 construction financing for the Brucejack Project consummated in 2015, their strategic value in the commodity space is clearly evident in the case of those producers that are over-levered or lack access to traditional debt and equity markets.