CHAPTER 2 MARKETING STRATEGY AND THE LAWYER: DIFFERENT METHODS OF SELLING AND HEDGING USED IN THE MINING INDUSTRY

• Jurisdiction: United States

Mine to Market: The Legal Issues
(Mar 1985)
CHAPTER 2
MARKETING STRATEGY AND THE LAWYER: DIFFERENT METHODS OF SELLING AND HEDGING USED IN THE MINING INDUSTRY
William D. Harrington
St. John's University School of Law
New York, New York

The American mining industry has become, to a degree it has never been before, market-driven.¹ In the view of some observers, this shift in orientation has come too late. Notwithstanding rising demand experienced by most segments of the industry,² the difficulties faced by the industry as a whole (even by aluminum, although not yet by gold) are well-known:

— overproduction;

— excess capacity;

— the contraction of metals mining in four short years from a $9 billion to a $6 billion industry;

— a 60% reduction in employment since 1981;

— net losses since 1981 totaling in the billions;

— a frightening debt ratio for the industry of over 40%;

— share prices trading over a third below their book value;

— the collapse of producer prices;

— a flood of imported metal aggravated by the strong dollar, cheap labor costs, the absence of costly health, safety and pollution regulations and the need of most of these commodity-dependent producing nations for dollar-denominated foreign exchange.

This confluence of horrors only recently led a highly-respected business periodical to pronounce "The Death of Mining."³

But this pronouncement may well prove premature. One reason which suggests this is the reemphasis which pervades the industry today on marketing. Indeed it is this marketing orientation, which has never been thought of as a major characteristic of the industry,⁴ that has brought us together here today for the Foundation's Institute on Mine to Market.

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The subject of this paper is a broad one; indeed it is obviously too broad to do it justice in the space permitted. Its purpose, however, is both more modest and more limited, and this is to sketch an overview of different approaches, relevant to the lawyer, which are being employed and, in some cases, newly-developed within the marketing sectors of the industry today. There is, of course, little that is new, and not each approach is applicable to each segment of the industry. The thought was, however, that such an overview would sensitize us as lawyers to thinking of other practicable options in counseling clients in their marketing strategies. Accordingly, part I outlines from a contracts practice perspective the basic approaches being used in the industry today, together with their major advantages and pitfalls. In part II several possibilities of marketing as a financing tool are sketched. Part III presents an introduction to use of the commodity futures markets, and to some of the hazards associated with their use, as a marketing tool. Part IV is a conclusion.

I. CONTRACT PRACTICE

Contract practice, of course, varies widely throughout the mining industry. At the same time there are some clearly isolable and relatively common features, such as the one-year term contract, which was for so long the bulwark of the industry, the spot sale, and the long-term supply contract, each of which is briefly addressed below. In addition, there are some clearly discernible newer trends in the industry's response to its markets, such as the increasing use of consignment sales programs, metal "lending" and swaps, also addressed. Finally some observations on pricing trends, distinctions in approach between sales of raw and refined products and the emergence of "economic force majeure" are offered.

A. THE BASIC BREW

The basic trio of the metals markets — the one-year term contract, long the primary focus of the fall "mating season" and calling for spaced installment deliveries over its duration with corresponding payments (in happier days, at the "producers' price" prevailing at the time of delivery); the spot sale contract for one or two lots of product forthwith or in the nearby future; and the (all-too-rare) long-term supply contract, which, if not yet extinct, has surely become an endangered species — these need no belaboring among participants of the background and experience of those at this Institute. At the same time, several trends are becoming quite evident.

1. The Buyer's Market. That the industry is facing a buyer's market and probably will continue to do so for some

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time is hardly news. But from this economic fact flow some less-obvious consequences.

2. Erosion of Boilerplate. Participants at the Institute who work on the "commercial" side will have noticed with increasing regularity the need to tailor contracts to meet the marketing reality. Not long ago a seller could lay his "standard form" down on the buyer's desk and expect no challenge to the standard terms and conditions set forth in the smallest of print on the rear and containing (typically) the most imbalanced provisions favoring the seller that one could imagine. But in a long-term buyer's market, it is evident that this practice could not continue to prevail, with the consequence that the proportion of "dickered terms" sales has been rising dramatically at the expense of producer boilerplate.

3. The Rise of Spot. While it would be foolish to overstate the point, there has evidently been a sharp rise in spot sale contracting as the expense of the traditional one-year arrangement which has for so many years been the industry's market foundation. This counsels, of course, that much more attention be given to the standard form boilerplate of these contracts than has customarily been warranted.

4. Pricing Variance. An unprecedented array of pricing alternatives is now prevalent, and typically the longer the contract, the wider the array actually provided for by the parties. A number of these variations are described below.5

B. CONSIGNMENT SALES PROGRAMS

During the course of the last twelve-to-eighteen months, there appears to have been a very large increase in many segments of the industry of consignment selling. In light of the perceived benefits of consignment sales, this is quite understandable in a buyer's market. At the same time, the practice is fraught with danger and has rarely been explored in the legal literature.⁶ While the writer has attempted to analyze these risks in substantially more detail elsewhere,⁷ it is useful, in light of the increasingly widespread use of consignments, to focus briefly on the major legal issues, most of which remain unresolved.

Consignments are transactions pursuant to which material is physically delivered to a second party, usually for redistribution, but in which the first party retains title until the second party sells the material as agent for the first party. The second party's obligation to pay for the material does not arise until the "sale" takes place. A variation on this traditional definition has been widely adopted in the metals industries. Under this variation, the expectation of the parties is that the consignee, rather than selling the material as a distributor, will itself be the

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ultimate consumer and will thus itself "purchase" the consigned material, which it physically holds, as the material is needed in its operations. This variation, I would suggest, makes the legal issues which I perceive in consignment practice as it exists today even more difficult.

Consignments serve four important commercial purposes, and an appreciation of each makes clear why their use has become so much more widespread recently. First, they enable the consignee to keep the goods off the balance sheet, eliminating his need to finance them. Second, they function as security for the consignor to the extent he can support his claim to have retained ownership. In the third place, they may, in some circumstances, enable a supplier to achieve the same economic effect as he could were he to engage in resale price maintenance. And fourth, they are viewed by many as a vehicle to legitimize conduct which otherwise would be characterized as price discrimination.

Consignment sales programs as utilized in the metals industries present substantial legal problems in two areas: commercial law and antitrust law.

1. The Commercial Issues. As a commercial matter, consignments are treated under Articles 1, 2 and 9 of the Uniform Commercial Code. The relevant provision of Article 1 makes clear that unless a consignment is intended as security, the seller's reservation of title is not a security interest, but that a consignment is in any event subject to Article 2's specific clauses dealing with consignments.⁸ Laying to one side the linguistic difficulties of the referent,⁹ it seems clear that the intent of the drafters was that consignments would be covered by section 2-326(3), which provides as follows:

Where goods are delivered to a person for sale and such person maintains a place of business at which he deals in goods of the kind involved, under a name other than the name of the person making delivery, then with respect to claims of creditors of the person conducting the business the goods are deemed to be on sale or return. The provisions of this subsection are applicable even though an agreement purports to reserve title to the person making delivery until payment or resale....However, this subsection is not applicable if the person making delivery

(a) complies with an applicable law providing for a consignor's

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interest or the like to be evidenced by a sign, or

(b) establishes that the person conducting the business is generally known by his creditors to be substantially engaged in selling the goods of others, or

(c) complies with the filing provisions of the Article on Secured Transactions (Article 9).

In effect, therefore, the Code provides alternative mechanisms whereby a consignor may protect the consigned material from the prior or conflicting claims of the consignee's creditors. These alternatives were doubtless a compromise between creditor and...