This article was first published on The Lawyer’s Daily website on June 8, 2017.

Recently, in Third Eye Capital Corp. v. Dianor Resources Inc., 2016 ONSC 6086, the Ontario Superior Court of Justice rendered a decision that illustrates the importance of carefully drafting and arranging royalty agreements if the intended result is to have the royalty interest “run with” the land — i.e., to be enforceable against third parties, such as new owners, instead of just a contractual right enforceable against the grantor personally.

The court followed the test enunciated in Bank of Montreal v. Dynex Petroleum Ltd., [2002] 1 SCR 146, 2002 SCC 7, in which the Supreme Court of Canada had held that a royalty interest can create an “interest in land”, provided (i) it is clear from the agreement that the parties intended to grant such an interest instead of just a contractual right to a portion of the oil and gas substances recovered from the land, and (ii) that the interest, out of which the royalty is carved, is itself an interest in land.

In Third Eye Capital, the court found that the royalty interests at issue did not run with the land or grant the holder of the royalties an interest in land, namely because the only right that the royalty holder had obtained was to share in the revenues produced from extracted minerals. Such an arrangement was found to be insufficient to create an actual interest in the land. Notably, the Ontario Court noted that the royalty holder had no right to enter the property to explore and extract diamonds or other minerals.

A few years ago, the Quebec Court of Appeal had reached a somewhat similar conclusion in Anglo Pacific Group PLC v. Ernst & Young Inc., 2013 QCCA 1323. In brief, one of the issues was whether the royalty agreements at issue created a “real right”, which can be asserted directly over the mining property, or a “personal right” enforceable only against the grantor. The Court of Appeal found that the grantors in this case had kept for themselves all the attributes related to ownership and had merely granted a right to share in the profits derived from the sale of extracted mineral substances, despite express wording that the parties wished to create a direct real property interest in the products and the properties in favour of the royalty holder. The Court of Appeal noted, as an example, that in the event of the grantors’ failure to extract the ore or sell it, the royalty agreements gave the royalty holder no right to extract or sell the ore itself.

This approach is somewhat comparable to that of other common law provinces, as we can see, taking into account the particularities of Quebec’s civil law regime on the notions of property and ownership. According to the Court of Appeal, for a royalty agreement to create a real right in mining claims, mining leases and/or mineral substances to be extracted, the granting of some “power that can be exercised directly on property” is required, and this must be done by dividing up the attributes of ownership and assigning one or more of same to the royalty holder. Under Quebec’s civil law, the said attributes are essentially known as usus (the right to use and enjoy the property), fructus (the right to benefit from the fruits and revenues of the property), abusus (the right to dispose freely and completely of the property, physically and legally) and the right of accession (the ability to acquire what the property produces and what becomes unified with it, naturally or artificially).

In the end, the practical difficulties are similar across jurisdictions because royalty agreements are seldom designed to grant the royalty holder with rights that can be asserted directly against the mining property. Yet, without this, royalty holders find themselves at risk of losing the ability to effectively enforce their rights in certain situations, such as if the underlying mining right is conveyed to a third party or if the grantor becomes insolvent. Third Eye Capital and Anglo Pacific are therefore important reminders for the mining industry: parties must be very careful in structuring their mining royalty arrangement because the issue is not what the intent is, but whether such intent is effectively carried out in the agreement.

There are, of course, various ways to mitigate risks. While a full explanation is beyond the scope of this brief article, examples include contractually requiring that transfer of the grantor’s mining property be subject to the royalty holder’s prior consent and conditional upon the purchaser assuming all royalty obligations; requiring publication of the royalty rights in the appropriate public registers; requiring a hypothec (i.e., a lien charging the property) from the grantor to secure its obligations under the royalty agreement; and so forth. Parties could also attempt to create a sui generis real right that gives the royalty holder certain powers exercisable directly upon the property, such as a right to enter the property and extract the mineral and sale same under certain conditions. Perhaps, and subject to any lenders’ rights, a minimal fraction of the real right in the mining property itself could be assigned to the royalty holder. For certain, it will be interesting to see how the industry practice will evolve and how net smelter royalties and other royalty agreements will be drafted outside the proverbial box to better protect royalty holders’ rights.