CHAPTER 13 NON-PARTICIPATION & DEFAULT PROVISIONS IN MINING AGREEMENTS
| Jurisdiction | United States |
(May 1991)
NON-PARTICIPATION & DEFAULT PROVISIONS IN MINING AGREEMENTS
Fasken Martineau Davis
Toronto, Ontario
TABLE OF CONTENTS
INTRODUCTION
SOME CONSIDERATIONS ON DILUTION
General
Right to
Forfeiture vs. Conversion
Fiduciary Relationship
SOME CONSIDERATIONS ON DEFAULT
General
Stage of the Project
Bargaining Power
Damage Suffered by Continuing Participant
Right to Cure
Insolvency of a Participant
SOME COMMENTS UPON TYPICAL CLAUSES
Simple Dilution
Immediate Forfeiture or Conversion
"Fire Sale"
Loan
"Shotgun"
RELIEF FROM FORFEITURE
General
Sophistication of the Parties
Bargaining Power
Custom of the Trade
Greed and Default
Penalty
Lay the Ground Work
CONCLUSION
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INTRODUCTION
Whenever two or more parties decide to unite for a common purpose and to engross their arrangements in an agreement, it is necessary to consider provisions for less friendly or less mutually supportive times than those that exist at the time of negotiations. Accordingly, the agreement must include provisions which contemplate, and deal with, the possibility that one or more of the participants will voluntarily, or involuntarily, cease to participate in the venture. Involuntary non-participation will more often than not involve default under the agreement, so an appropriate form of "slap on the wrist" for the defaulting party should be contemplated. One of the dilemmas for counsel is to provide a "slap" that is appropriate in the eyes of the parties to the agreement and that is also enforceable at law.
This paper will consider some of the more common dilution and default mechanisms used in mining joint venture agreements. Comments will be limited to the practical aspects of the subject and omit discussion of the more esoteric legal questions that can arise. Canadian practices and law are addressed, and although the joint venture agreement has been used for example purposes, the concepts discussed extend to other forms of agreements, both mining and other.
When one party voluntary decides not to participate, its interest in the project is often diluted. Such dilution is relatively free of potential legal problems, unless there is an attempt to combine simple dilution formulae with other more onerous provisions that might be more common to default provisions. On the other hand, the consequences of default, or involuntary non-participation, on the continuing participants must be considered. These consequences may be truly disastrous, or they may be of little significance, depending, to a large extent, upon the stage of development of the project when default occurs. In Canada, there appears to be a tendency to favour forfeiture, or some variation of forfeiture, to meet the crisis of default, particularly when default occurs after the feasibility study stage.
Dilution and/or forfeiture are certainly not the only methods of dealing with non-participation. The use of "shotgun" provisions and the use of loans (both of which are discussed below) are not uncommon. In addition,
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unique circumstances may well call for unique provisions and, in these situations, the concepts are limited only to the imagination of the parties and their advisors.
SOME CONSIDERATIONS ON DILUTION
General
Voluntary non-participation may result from many factors, including lack of funds or loss of interest in the project. If the non-participation results from lack of funds, the non-participant may still have a high interest in the project and wish to have the opportunity to maintain an interest in it, should its circumstances reverse. On the other hand, the continuing participant will want to receive some "reward" for continuing the project at its sole cost, especially if the project is in its early, or high risk, stage when the non-participation occurs. The dilution provision meets both of these requirements. In general, these provisions:
(a) reduce the non-participant's interest on an equitable basis and permit it to participate at a reduced interest level later on;
(b) reduce the non-participant's interest to a predetermined level at which the property interest is converted into some other form of interest, usually a royalty, either with or without a right of the non-participant to re-enter the project;
(c) convert immediately the non-participant's interest into another form of interest;
(d) eliminate the non-participant from the venture completely, usually by way of forfeiture; or
(e) combine one or more of the above with procedures other than dilution.
Right to Re-enter
The right of a non-participant to re-enter the project under dilution is usually vigorously negotiated. Many major corporations resist such a right; junior corporations that do not have access to ready cash resources want it. The participant that continues has to fund the programme and, therefore, assumes a disproportionate portion of the risk. Accordingly, why should the non-participant be permitted to re-enter the project, even at a reduced interest, when the risk may be substantially reduced? This is probably a fair objection at exploration stages and can be answered by requiring the non-participant to pay some form of premium in order to exercise its right to re-enter. The premium is usually related to the amount of money that was contributed by the continuing participant and would have been otherwise been contributed by the non-participant had it continued in the project. The premium may take the form of an arbitrary multiple of this
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amount or, more commonly at the early stages of the project, as a cost of money factor applied to the amount, or both.2
The objection becomes less supportable if the non-participant has participated in the project for some time and later becomes a non-participant. In these circumstances, the right to re-enter may carry a reduced premium, or no premium at all.
In some agreements a non-participant may be entitled to re-enter at its original level of ownership by paying a substantial premium. Such a premium is often a multiple of the amounts that the continuing participant paid during the non-participation.
In determining an appropriate multiple for a premium on re-entry, the parties will have to consider the cost of money during the non-participation, even if the agreement does not specifically refer to it. This may appear to be elementary. If the continuing participant loaned money to the non-participant, it would expect to receive a reasonable rate of interest and to have that interest capitalized on a regular basis. The premium could, in its quantum, acknowledge this. If, however, the right to exercise the right to re-enter is not limited to a specific time period and if non-participation continues for an extended period, a premium, that appeared to be substantial at the time that it was negotiated, may prove to be inadequate. The obvious solution is to provide a time period within which the right must be exercised, or, to include specifically a cost of money factor in the determination of the premium. It is, however, surprising how many agreements do not do so and rely solely on the multiple of expenditures approach. If the cost of money factor is included, the parties may wish to specify a cap on the premium or to provide that if a cap amount is reached the right to re-enter must be exercised within a specified timeframe, and if it is not, it terminates.
Finally, in the determination of a right to re-enter, the parties should address whether a non-participant is going to have an unlimited right to re-enter throughout the project or whether the right will be exercisable only once or at specified levels of interest or stages of the project. Participants usually will not want a party coming in and out of a project arbitrarily. If, therefore, a party becomes a non-participant, it will usually have a right to re-enter once only (or a specific number of times). Thereafter, the right to re-enter terminates. If the re-entry right can be exercised only once, the parties have to consider at what level the election is to be exercised and the circumstances in which it may be exercised. As a general rule, participants will not, for practical reasons, want to have a right of re-entry exercised in the middle of an ongoing programme, or, to permit re-entry at a sufficiently high level to restore an undesirable degree of control over the project to the re-entrant.
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It is common to have a re-entry right terminate at some mutually acceptable interest level, usually in the order of 10 to 20%. Lower levels of participation are often considered more of a nuisance than an advantage.
In some agreements dilution is provided for without an accompanying right of the non-participant to re-enter the project. The logical question can be asked: "Why not have immediate conversion to the other form of interest if the non-participant is out of the project forever?". The answer often involves a desire to have access to product. Dilution provisions anticipate dilution in accordance with a formula usually based upon the respective contributions of the parties to the project. Therefore, if non-participation occurs after expenditure of substantial amounts of moneys, there is a reasonable chance that, at the time the project comes into commercial production, the non-participant will still have a direct interest in the project. On the assumption that the joint venture will have the usual provisions giving interest holders access to product, the non-participant will be able to take product in kind, subject, of course, to paying its pro rata portion of operating costs. Such dilution provisions are, however, a "two-edged sword". If the non-participant has, in the past, had financial reversals that precluded its continued participation in the project, the same reversals may also preclude its ability, or...
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