This chapter is taken from Lexology GTDT’s Practice Guide to Mining, examining key themes topical to the international mining community.
This chapter aims to address some key agreements in the mining industry, focusing on how they can affect mining ventures at an international level, as well as what the current related trends, opportunities, challenges and risks are within the industry that are of concern.
High-risk, long-term, capital intensive. These expressions are familiar to mining lawyers, and define mining projects. The risk is not limited to the geological factors, but may be added by political aspects, market downturns, recycling and substitution, development of new technologies, and social and environmental concerns. The time lag between the first drilling and sampling activities, and the commencement of commercial production may comprise a couple of decades or more. Further, cash availability in the market is dramatically influenced by interest rates, market forecasts, variations in demand and the security package, to name just a few.
The industry developed mechanisms to share the risks involved in a project to make it more acceptable to mining companies. Even where the risk may be not so high, but the schedule for exploration, development and mining is particularly long or uncertain, such mechanisms may also be useful to reduce the impact of time. This is also true for access to funds required in a mining project, particularly towards the critical milestones where a pre-feasibility study and bankable feasibility study need to be prepared, or for development and construction purposes.
From a legal perspective, some of those mechanisms involve negotiating and entering into agreements whereby part of the risk may be split with another entity, as in a joint venture or in an earn-in arrangement, or with an entity that will advance funds in exchange for a royalty or the right to buy minerals at a discounted price (as in streaming deals). The purpose of this chapter is to look into those relationships and discuss the main features of joint ventures, option agreements, and royalty and streaming agreements.2 Among the various features inherent to each agreement, there are also two main aspects that deserve a closer review in specific items: differences in perspective from junior companies and majors; and common law and civil law concerns to be addressed in those agreements.
Selected mining agreements
This section reviews some issues to be considered in specific agreements that are frequently negotiated in the mining industry. In the case of joint venture agreements, comments usually applicable to joint ventures in general could also be repeated here, so this section concentrates on specific concerns relating to the mining sector. It will also address option agreements as a structure allowing preliminary access to mining properties and the review of their potential with the possibility of acquiring them, and royalty and streaming agreements, which may represent an alternative to traditional financing mechanisms.
Joint venture agreements
There are a number of reasons why mining companies may enter into joint venture agreements, which may go from a circumstance where the original property owner does not want to give up its ‘ownership rights’ entirely and keep a stake in the property, to cases where it is desirable to have a local partner, or a partner that has exclusivity or familiarity with certain technology that will be useful in the mining project. By and large, however, the main reason for joint ventures in the mining sector is the need to share the risk of the project with someone else, in addition to sharing the costs, which are usually very significant and may well reach 10-digit figures until production starts.
Although joint ventures may be of a contractual, unincorporated nature and have the form of partnerships, particularly in the United States and Canada, corporate joint ventures are more frequent in cross-border transactions, especially in civil law countries. Special purpose entities are incorporated to play the role of the vehicle of the project. The main legal consequence is that liabilities relating to the enterprise will be limited to the joint venture company, but in some circumstances legislation and courts may allow for the piercing of the corporate veil (such as for environmental matters). Another consequence is that title to the mineral property is usually transferred to the joint venture company. In those jurisdictions where legislation does not allow for multiple holders of the same mineral property, this feature gives more comfort to the party that would not hold the property if the unincorporated joint venture structure were adopted.
Joint venture agreements may be complex agreements dealing with various sets of rules and procedures regarding the exploration, development, construction, production, closure and even reclamation of a mine. But even for those cases where the joint enterprise does not require sophisticated arrangements, some key issues will inevitably be addressed in the agreement, such as the contributions of each partner, the apportionment of responsibilities, management and decision-making process, cash calls and dilution.
The joint venture agreement may be combined with, or arise from, an option agreement or an earn-in agreement. In those circumstances, the typical scenario will be for one party to contribute the mineral property and associated information to the joint venture company, while the other party contributes funds and exploration expenditures. In some cases, each of the parties may contribute a set of mineral properties, in an effort to combine businesses. In both situations, the key aspect to determine the interest of each party in the joint venture is the value attributed to the mineral properties. Since the value will change over time considering the geological information available and the level of exploration, the joint venture agreement should clearly set out the rationale and the value attributed to each mineral property.
Although the interest of each joint venture party is defined at the outset of the relationship, it may vary during the life of the joint enterprise. On the one hand, the agreement may provide for mechanisms where one party may increase its interest upon the accomplishment of specific milestones. On the other hand, cash calls need to be met by the joint venture parties and, if such calls are not met, the party in default is usually diluted. Depending on the circumstances of the default – for example, if a party commits to meet a cash call and then fails to do so – dilution may be accelerated.
Usually, joint venture agreements contain a provision whereby if a party is diluted below a certain minimum interest (frequently 10 per cent), its interest in the joint venture is converted into a royalty. In this case, the minority party will exit the joint venture and will become a royalty holder.
The decision-making process must be clearly provided for in the joint venture agreement. Even if the majority party may have control over most of the decisions, the minority party will probably want to take part in key decisions (eg, approving budgets and cash calls, approving a bankable feasibility study, contracting debt and putting a property into production), so supermajority requirements may be put in place. In structures where the roles of majority and minority parties may change (eg, where earn-in provisions may apply), the definition of the quorum and the rights of the minority party may prove difficult to negotiate.
In order to make the project management more dynamic, a board may be set up to deal with technical matters, in which the minority party may have a seat. In any case, the parties must ensure that the joint venture structure and quorum for decisions match those provided for in underlying corporate legislation.
The apportionment of responsibilities is also a matter frequently dealt with in joint venture agreements. One of the parties will probably take the lead in management (and may even charge a fee for that), so the other party should have instruments to oversee the activities and to have access to information. Where the two parties have more active roles, then the definition of the obligations of each needs to be carefully described in the joint venture agreement, with special care given to those situations where one’s obligation depends on the fulfilment of the other party’s obligation.
One last matter involves the right to exit the joint venture. Although forced dissolution and partition mechanisms are not so frequent in the mining sector, given that the mineral property cannot be simply split between the parties, usually each party has the ability to sell its interest to third parties. This right is usually limited by pre-emptive rights and rights of first refusal, tag-along and drag-along obligations, and put and call options.
Option agreements are frequently employed with regard to properties that are at the exploration stage. On one side, the owner of the property needs funds to meet expenditure requirements and to perform exploration works within a certain time frame usually imposed by the law. On the other side, a mining company undertakes to meet expenditure goals and to perform certain works in order to have the right to acquire the property, or to enter into a joint venture with the property owner.
Given the limited amount of geological information available, option agreements usually provide for expenditure commitments of the mining company, within certain time limits, on a stage-by-stage basis. Once the expenditures of the first period are met, the company has the option – but not the obligation – to progress to the next stage, where further expenditures will be required. This means that, as further geological information becomes available, the company can decide whether to move to the following stage or not (ie, whether new commitments will assumed). If the company decides not to progress any further, it loses all expenditures made and holds no stake in the property. In some structures – and depending on how far exploration works went – the company may have earned a right or interest on the property.
Option agreements are usually employed by junior companies that have access to markets and capital when dealing with local property owners that do not have the funds or the expertise, or both, required for the exploration and development of the property. Such agreements are also used by mid-tier companies or even majors, but not as frequently in very early exploration stages.
The typical option agreement entered into at an exploration stage would entitle the company to progress from one stage to the other, and to have the right to purchase the property within a certain period. It is common that option agreements provide for the acquisition of 100 per cent of the property, so that the owner will no longer be involved in the project. There may be a lump payment for purchasing the property, which is sometimes combined with a royalty – either at a fixed rate or at a progressing scale depending on the size of the reserves or of the production. In other cases, the option agreement may lead to a joint venture.
Depending on how attractive the property may be, the property owner may require that an up-front payment be made at the beginning of the option period. This is a price for the right to have the option, which is different from the payment to be made for the acquisition of the property when the mining company exercises the option.
Milestones are usually expressed in expenditure amounts, although periodical payments to the property owner may be required to progress from one stage to the other. Some option agreements may even detail the work to be done by the company to complete a stage (eg, drilling a minimum of X meters). Other milestones may include the preparation or reports on resources and reserves, or even studies as advanced as feasibility studies.
Nevertheless, it is clear that the definition of eligible expenditures in the option agreement is a key aspect to be considered by the parties. Some agreements try to narrow down the eligible expenditures to those corresponding to actual work on the property, such as the cost incurred with drilling and sampling. Other agreements are more flexible and may include administrative costs related to the review of data from exploration works. In any case, it is important that the option agreement defines clearly and in detail the eligible expenditures, and provides for inspection mechanisms and dispute resolution provisions.
Since the option agreement will involve commitments by the mining company, it frequently provides for exclusivity rights in favour of the holder of the option, so that third parties cannot undertake exploration in the same property. Accordingly, the property owner should not be allowed to sell it to third parties, nor enter into any sort of arrangement that would create an interest of a third party over the property.
In cases where the property owner has already undertaken some exploration (usually when the owner is a junior company, or a company that may not be considering that property in its core business strategy), there is already some geological information available. Here, the milestones to be met may involve not only the performance of exploration works, but also the preparation of reports and studies to add value to the property, such as scoping studies, pre-feasibility studies or even bankable feasibility studies. The structure of those option agreements tends to be more sophisticated as they usually lead to long-term relationships, such as joint ventures, aiming at putting the property into production.
Royalty and streaming agreements
Although royalty agreements and streaming agreements are different types of transactions, they are addressed in this section given their common feature of serving as an alternative means to have access to finance.
Royalty agreements provide for the right of a party to participate in the results of a mining operation, either by receiving a percentage of the production in cash or – less frequently – in kind.
Royalty agreements may have different origins. In some cases, the royalty is part of the price of acquiring the mineral property from a former owner. It may also be tantamount to a finder’s fee. In other cases, it works as a financing mechanism so that the royalty holder advances funds to the mining company to be used in the development and construction of the mine. As in a project finance structure, the royalty holder assumes part of the risk of the project, since its remuneration will depend on the mining company successfully putting the project into production. However, the royalty is not limited to a principal and interest, but is usually represented by a share of production through the life of the operation (although limitation clauses may be negotiated).
There are different forms of calculating a royalty, the most frequent being an outright royalty calculated based on sales; a net smelter returns where certain deductions may be allowed; and a net profits interest where the royalty will be calculated based on the profit generated by the operation, so a long list of deductions are allowed.
Royalty agreements usually have inspection mechanisms and access to information to allow the holder to verify if the royalty has been properly calculated and if the deductions were allowed, including the right to call for audits. These agreements also restrict the ability of the property owner to sell it without the royalty holder’s consent, particularly in jurisdictions where the royalty cannot be registered against title, in which case the purchaser of the property will probably be required to adhere to, and be bound by, the royalty agreement.
One key issue of royalty agreements is to ensure that the right to mine is not lost, so compliance with legal and production requirements is a major requirement.
Some royalty agreements provide for the right of the property owner to purchase the royalty (and cancel it). Another feature that may be inserted in those agreements is the requirement for a minimum payment if production has not reached a certain level, or if the property has been put into care and maintenance. This represents an increase in the cost of the royalty for the mining company.
Special attention must be given to the mechanics for the payment of the royalty. Some jurisdictions impose restrictions in the remittance of funds, so depending on how the royalty is structured and where it is paid, there may be tax implications. Likewise, if the royalty is paid in kind, there may be export-control restrictions and tax implications.
Streaming arrangements are contracts for the ongoing supply of mineral production under which, upon advance payment of a premium, the buyer agrees to purchase, at a fixed, discounted and predetermined price, part of the mineral production from a property. The stream may last during a certain period or even throughout the life of the mine. The mining company receives an upfront payment, which enables it to develop, construct and operate, or expand, the mine. This arrangement allows the mining company to capitalise on the basis of resources and reserves at a cost usually below that of loans.
Streaming transactions have become more frequent in the mining sector, initially with regard to precious metals, but transactions that are more recent also involve base metals operations. Besides representing a fundraising mechanism to develop a mineral project, streaming also has the effect of guaranteeing a purchaser for part of the future production. Moreover, contrary to capital investment financing, streaming arrangements enable mining companies to minimise their risk of dilutions to shareholders and avoid debt financing costs, particularly at times when credit access conditions are unfavourable.
Streaming transactions may also benefit the purchaser in a scenario of increasing commodity prices, as it will be able to freeze the price of a future mineral purchase tending to escalate, and resell such product at market prices. Similarly to financial derivatives, streaming arrangements fix the minerals price, avoiding the purchaser’s exposure to possible upward market price movements. Differently from hedging transactions,3 however, streaming transactions usually contain a provision that payment to the purchaser will not be made at a predetermined price but rather at the lowest between a percentage of the market value and the amount agreed per volume of production. Because of these specific features, streaming companies have reported high return rates, particularly when the mine’s production exceeds initial expectations.
As in royalty transactions, streaming agreements involve certain risks, which must be assessed. One of them is the possibility of the production being none or insufficient, preventing the seller from delivering the product volume as anticipated. Another risk is market volatility, as oscillations may affect the profit margins originally envisaged by the purchaser, and ultimately render production and, consequently, the streaming itself, unfeasible. From the mining company’s end, the streaming arrangement should not involve too large a share of the mine production, otherwise the overall revenue of the mine may be severely impacted as the sales price of the stream is, by definition, lower than the market price.
Different approaches to mining agreements
Given the fact that mining transactions tend to involve multiple jurisdictions and companies with different profiles, this section deals with two aspects that are generally faced by mining lawyers when dealing with agreements: the perspectives of different types of companies, and the implications of different systems of law.
Juniors versus majors perspective
The main reason a junior company with a promising mineral property would enter into a joint venture agreement with a major is when it requires the expertise and the money of a major company. The latter may also be the reason for entering into a royalty or streaming agreement with a third party. If this is indeed the case, the later the agreement is negotiated, the better for the junior. The more advanced the project, the more value has been created, and the more leverage the junior will have in the negotiations.
Moreover, the junior (unlike majors) will probably have the best negotiating position at the beginning of discussions with the major or a third party that is willing to buy a royalty or streaming. In fact, this is likely to be the only time the junior will have any negotiating leverage. When it comes to negotiating joint venture agreements with majors, such agreements should not have ‘agreement to agree’ provisions, as it may prove to be hard for juniors to negotiate at a fair level with majors once the project progresses.
Throughout the joint venture agreement or an option agreement, be it during the earn-in stage, development or an expansion, the last thing a junior would want is for the major to be able to slowdown, stop investing and lose interest while still holding on to the mineral property. Majors have many projects. Their investment priorities may change quickly, and exploration and development funds once dedicated to the joint venture can go elsewhere. The slowdown of the major may mean death for the junior. It is common to see juniors that hold only one or few properties, so the junior wants to ensure that money is spent on the ground and good information is generated, as soon as possible, to add value to the property and to its shareholders.
From a junior’s perspective, the joint venture agreement or option agreement should establish fixed periods for the major to reach certain thresholds, such as the definition of a resource, preparation of scoping studies, pre-feasibility and feasibility studies, and construction and production decisions.
Another commonly seen feature is for the joint venture agreement or option agreement to allow the major to make cash payments to the junior to extend deadlines for the fixed periods, in order to preserve its options rights or interest over the property. If payments are set at the right values, this should have the effect of keeping the major on track, while meeting the immediate cash expectations of the junior’s shareholders.
Civil law versus common law concerns
Transactions in the mining sector are usually cross-border. Although many mining companies and sources of capital come from countries such as the United States, Canada or the United Kingdom, which are traditional common law jurisdictions, the mineral properties to be invested in may be located in other common law or civil law jurisdictions. This may present more challenges than expected from a legal standpoint.
Many international mining companies adopt the approach of having standardised agreements to be used in different jurisdictions, to facilitate business. However, the particularities of the local legal system and legislation must be considered, especially when entering into a joint venture agreement or an option agreement in a civil law jurisdiction.4 Even in cases where the mineral property is located in a civil law jurisdiction but the contracting entities are originally from a common law jurisdiction, the implications of local legislation and the civil law system need to be taken into account. Drafting a joint venture agreement or an option agreement from a foreign law template, and simply stating that the agreement is governed by local law and subject to the jurisdiction of local courts, may not be good enough to address the matter.
Considering that in a joint venture agreement or an option agreement the specific purpose company will probably be local, and the mining property will also be in the hosting country, it is very likely that the enforcement of rights and obligations will have to take place in the hosting country. Having concepts of foreign law interpreted and enforced in the hosting country can be challenging and in some cases even ruled invalid, especially if the legal systems are different.
One example of a common law jurisdiction concept that may not be applicable in some civil law jurisdictions is the case of negotiations in good faith. Canadian courts have held that there is no general duty to negotiate in good faith at common law, unless explicitly provided for in an agreement.5 Conversely, some civil law legislation requires that all negotiations and agreements be done in good faith, and this duty can be considered in court. Even where the legislation may not exist, in civil law jurisdictions the parties may resort to general principles of law, and good faith would be considered one of those.
In addition, the nature of certain rights – be they commercial or corporate, such as in a joint venture, or concession-based mineral rights, as in an option or royalty agreement – may change dramatically from common law to civil law systems. Further, legislation may supersede and prevail over certain contractual provisions in civil law jurisdictions, such as in those matters considered as public interest.
Understanding those differences and the potential issues they may pose to enforcing contractual provisions in court is essential for certainty of contract, and ultimately for reducing the risks in a mining project. Likewise, having those matters properly addressed in the agreements that deal with the interests of the parties, and ensuring that the contractual provisions are adequate regarding the applicable legal system, will reduce room for contractual disputes.
This chapter presented some mining agreements that are largely used in the sector, with an emphasis on the specific features of each agreement that are inherent to the mining business. The risk element and the long-term funding needs that comprise exploration, development and construction until production starts, require structures that are unique to mining, and in relation to which mining lawyers need to have a comprehensive approach. The most relevant issues involving joint venture agreements in mining, option agreements, and royalty and streaming agreements were reviewed here.
In addition, some concerns that are usually overlooked were addressed, such as considering the nature of the parties involved in typical mining transactions – for example, junior companies and major companies – and the cross-border nature of various agreements, which requires that the differences between the common law and the civil law systems be accounted for in the negotiation and execution of such agreements.