CHAPTER 2 PRELIMINARY AGREEMENTS

• Jurisdiction: United States

Mining Agreements III
(May 1991)
CHAPTER 2
PRELIMINARY AGREEMENTS
George E. Reeves
Knutson, Brightwell, Reeves & Oldham, P.C.
Denver, Colorado

INTRODUCTION

I. TERMS

A. "Preliminary Agreement".

In this paper, the term "Preliminary Agreement" is used to encompass all documents, whether binding or nonbinding, which contemplate the execution of a further, binding document by the parties. The term encompasses the non-binding "Letter of Intent" and the binding "Agreement to Negotiate" and "Preliminary Contract".

B. "Letter of Intent".

The term "Letter of Intent" is used to refer to a non-binding document which may be merely an expression of intent,¹ or may be an agreement of the parties which, for one reason or another, does not bind the parties to the Transaction, but which contemplates the execution by the parties of a further, binding document setting forth the terms of the Transaction between the parties.²

C. "Agreement to Negotiate".

The term "Agreement to Negotiate" is used to refer to a document which contains the binding agreement of the parties to negotiate but does not bind the parties to the terms of the

[Page 2-2]

Transaction.³

D. "Preliminary Contract".

The term "Preliminary Contract" is used to refer to a document which, either by its express terms or by necessary implication, binds the parties to the terms of the Transaction, but which nevertheless contemplates the execution of a further, binding document by the parties.⁴

E. "Formal Agreement".

The term "Formal Agreement" is used to refer to the further, binding document contemplated by a Preliminary Agreement. This agreement is formal only in the sense that it is the final expression of agreement of the parties. It is not necessarily more formal in the matter of format or execution.

F. "Other Agreements".

The term "Other Agreements" is used to refer to agreements ancillary to the Formal Agreement contemplated by the Preliminary Agreement. The necessity for Other Agreements may become evident only when, in preparing the Formal Agreement, it appears that certain matters are more conveniently handled in a separate document. For example, a small mining company may desire not only to commit its mining properties to a mining venture but may, as a part of the same Transaction, desire to sell some of its shares to the other venturer. In such a case, a separate Stock Purchase Agreement may be preferable to

[Page 2-3]

including stock purchase provisions in a mining venture agreement.

G. "Transaction".

The term "Transaction" is used to refer to the complete arrangement between the parties, which will usually be embodied in the Formal Agreement and the Other Agreements.

II. REASONS FOR USING PRELIMINARY AGREEMENT

A. Fix Basic Terms and Conditions of Formal Agreement (and Other Agreements)

The primary reason for using a Preliminary Agreement (whether binding or nonbinding) is to fix or memorialize the basic terms and conditions of the Transaction into which the parties contemplate entering. In order to facilitate further negotiations it is particularly important to determine at an early date the form or structure of the Transaction; i.e., whether the Transaction is to be a lease, purchase, joint venture, stock purchase, etc.

Complex transactions are negotiated bit by bit, agreement being reached upon one term or group of terms before the parties move on to a discussion of other terms. The broad contours of a Transaction may be agreed upon at an early date, leaving numerous details to be negotiated. A Preliminary Agreement, even one which is nonbinding, can serve a useful purpose by providing a summary of the result of negotiations to date. The parties are then able to concentrate their efforts upon the

[Page 2-4]

remaining terms of the Transaction, rather than continually revisiting the terms upon which substantial agreement has been reached. Sometimes, the submission of a proposed Preliminary Agreement by one party and its rejection by the other party may result in the realization that the parties are not as close to an agreement as they believed, and that the negotiations should be either intensified or terminated altogether.

B. Provide Comfort to Other Party, Management, Lenders, etc., that Transaction is Viable

A Preliminary Agreement, even though not binding, may provide assurances to each of the parties (and particularly to those levels of management not immediately involved in the negotiations) that the other party is serious about entering into the Transaction and are not merely engaged in "tire-kicking". The negotiation, preparation, and execution of even a relatively simple mining agreement requires time, effort, and expense which can be ill-afforded if one of the parties is not serious about consummating the proposed Transaction. Similarly, a Preliminary Agreement may be useful in convincing third parties that the Transaction is more likely to be consummated than not. For example, a Preliminary Agreement may be desirable or even necessary to enable a party to obtain financing.⁵

C. Permit Early Commencement of Operations

A property holder may be reluctant to permit exploration or

[Page 2-5]

mining operations on the property in the absence of some assurance that the mining operator is serious about entering into an agreement, and not merely seeking a "free look". The mining operator, on the other hand, may be reluctant to commit funds for exploration without some assurance that an agreement with the property holder will ultimately be forthcoming. A Preliminary Agreement, even though not binding, may facilitate the commencement of operations by making the entry of the mining operator upon the property referable to the Transaction to be embodied in the Formal Agreement. Alternatively, the Preliminary Agreement, even though not binding the parties to the Transaction, may contain provisions binding on the parties regarding the mining operator's commencement of operations on the property. Such an agreement should provide for the eventuality that the Transaction is not consummated.

D. Fix Commencement Date of Transaction for Tax and Other Purposes

For some purposes it may be necessary to establish that the Transaction was effective at a date before the date the Formal Agreement is executed.

For example, a mining operator may agree to reimburse a property holder for exploration and development expenditures incurred by the property holder before the date the Formal Agreement is executed by the parties. The mining operator will not be able to take deductions for such expenditures for federal income tax purposes unless he had an interest in the property

[Page 2-6]

when the expenditures were made.⁶ A binding Preliminary Agreement may serve to fix the commencement date of the Transaction so as to enable the mining operator to take advantage of these deductions.

For another example, a mining operator may desire to take advantage of the statute authorizing the performance of group assessment work on mining claims "held in common".⁷ The statute does not require that the mining claims be held by the owners as tenants in common or joint tenants, but does require that there be "a proper agreement between the owners of said claims" and that the work be "part of the general plan or scheme for the development of the several claims".⁸ A Preliminary Agreement may serve as an agreement between the owners of claims setting forth a general plan or scheme for the development of the claims for the purposes of the group assessment work statute.

E. Provide for Exclusive Negotiations

A binding preliminary Agreement will, in and of itself, take the property off of the market. A non-binding preliminary Agreement may provide that the owner will not negotiate with any other party regarding the property.

III. REASONS FOR NOT USING PRELIMINARY AGREEMENT

A. Formal Agreement Can be Prepared as Quickly and Easily as Preliminary Agreement

If a Transaction is relatively simple, or if the Preliminary Agreement is intended to be binding and therefore would itself

[Page 2-7]

be relatively comprehensive, it may in the long run be quicker and easier to negotiate the Formal Agreement directly, rather than go through the stage of negotiating a Preliminary Agreement.

B. Premature Commitment to Terms and Conditions of Transaction

1. Commitment Made Without Tax, Legal, etc., Advice.

A Preliminary Agreement will more likely than not be negotiated by someone in a mining company's exploration department. The structure and terms of such an agreement may be carved in stone before it has been reviewed by the company's legal or accounting departments.

For example, it is common for such a Preliminary Agreement to provide that the party acquiring an interest in the property will "earn an interest" in the property only after it has expended a certain amount of money in exploration on the property. From a tax standpoint, however, it is usually to the benefit of the party acquiring an interest in the property to set up a tax partnership and to acquire an interest in the property at the outset, subject to defeasance if the required expenditure is not made. However, once the structure of the agreement has been set as an "earn in", renegotiation to a tax partnership may not be possible, or may be possible only by making concessions which would not otherwise be required.

For another example, a Preliminary Agreement may contemplate a mining venture to be governed generally by the provisions of

[Page 2-8]

Rocky Mountain Mineral Law Foundation Model Form Mining Venture Agreement (Form 5), with one party contributing the property and the other party contributing cash toward the first $X million of expenditures. Form 5, however, does not provide for recoupment of disproportionate contributions of cash, and unless the preliminary agreement does so, the party agreeing to make the cash contributions...