CHAPTER 7 ADDRESSING THE CONFLICTING CONCERNS OF PARTICIPANTS IN A MINING PROJECT

• Jurisdiction: United States

Mining Agreements III
(May 1991)
CHAPTER 7
ADDRESSING THE CONFLICTING CONCERNS OF PARTICIPANTS IN A MINING PROJECT
John F. Welborn
Sasha A. Karpov
WELBORN DUFFORD BROWN & TOOLEY, P.C.
Denver, Colorado

Small Mining Company, Inc. ("Small") is a public company whose sole assets consist of a mining prospect and the limited but optimistic data and information Small has been able to compile on the prospect. Small does not have a consistent cash flow, has little money and has not paid a dividend in several years (at least since Mr. Small's kids started going to expensive private colleges). Its share price teeters on the brink daily and it believes that its one, elusive hope on the horizon is to find a knowledgeable, well-financed mining company to explore this mining prospect and to develop and exploit the minerals (probably the Mother Lode) which Small knows are there. The company which Small is looking for, Big Mining Company, Inc. ("Big"), must have financial resources and mining expertise, and it must have a genuine interest in the prospect.

This paper is about the legal and business relationship between Small and Big, and the risks which these parties face as they move forward with their deal.¹ It is an effort at identifying some of the key issues which should be addressed when two mining companies, each coming at a mining prospect from a different perspective, decide to engage in joint exploration and, perhaps, development and exploitation of that prospect. The purpose is to explore ways that those who document the deal can help it work on the theory that it will work if it does not result in a dispute or in unforeseen liability or financial harm to one party or the other.

Small and Big do not share the same concerns and risks in this deal, except, of course, for the obvious risk that the prospect might not contain valuable mineralization, by anybody's standard, after Big has fully evaluated the prospect in the manner contemplated by the parties. The parties are not equally concerned about this risk since Big undoubtedly does not have all of its hopes pinned on this one prospect, whereas Small probably does. Nevertheless, as long as the parties have a clear idea of what it will take to evaluate the prospect fully, and as long as that clear idea is translated into a mutually acceptable exploration plan which is then carried out, this particular risk is one both parties assume when they make the

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deal. If the reason the project fails is a simple lack of mineralization, then neither party is in a position to complain.

In reality, however, the reason a joint mining project fails is rarely that simple. Having found a Big which has expressed a willingness to come into the project, Small still has several concerns any one of which could result in that dispute between Small and Big we are trying to avoid:

1. The concern that Big will evaluate the prospect just enough to condemn it in the eyes of third parties, i.e., Small's creditors, shareholders or potential partners, but not enough to evaluate the prospect in the manner or to the extent contemplated by Small. Upon Big's withdrawal, Small will be left with a significantly and, in Small's opinion, an unnecessarily devalued asset.

2. The concern that Big will find an ore deposit, but that Big will still withdraw for one or more of several reasons including reasons which could not and did not exist at the time the deal was struck.

3. The concern that Big will find an ore deposit, like what it sees and move into development and production at a pace which Small can't meet with the result that Small is spent into rapid dilution.

Big also approaches this project with some trepidation and has its own unique concerns:

1. The concern that the estimates of what it will cost to evaluate the prospect are low and that Big will have to make a decision whether to stay in the deal without enough information to do so.

2. The concern that its commitments and obligations in the deal will not be flexible enough to accommodate changes in Big's funding (budgeting) or corporate philosophy or in the markets. This is of special concern if the exploration period is long.

3. The concern that it will not find a valuable ore body but that by exploring or just being involved with the prospect it will incur costs and/or liabilities in excess of the amount it has budgeted for its investigative efforts.

TECHNICAL, DECISION MAKING AND CONTROL ISSUES

COINCIDENCE OF TECHNICAL STANDARDS AND COMMUNICATION

If Big fails to live up to Small's prospect evaluation standards or if Big's definition of a commercially viable ore deposit turns out to be significantly

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different from Small's, it may simply be the result of incompatibility between the parties and their failure to be fully aware of the expectations which each has for the prospect. Other commentators have discussed the importance of this compatibility, but it cannot be emphasized too much, and compatibility includes more than an ability to work together effectively. The negotiations must include an analysis of each party's technical expectations for the deal. The documents must reflect these negotiations in their entirety and must reflect the technical requirements which are important to each party.

Thus, if the initial deal is struck between a senior Big official and Mr. Small himself, both of whom are probably engineers or geologists and are approaching the deal from a technical perspective, then those two should help prepare or, at least, closely review the documents, before execution, and make certain that the deal they negotiated is both consistent with and reflected in those documents. If, for example, Mr. Small and the senior Big official conclude their negotiations thinking that deep exploratory drilling in a particular area of the prospect is how the exploration money should be spent, then the documents should be specific on this point. There should be an agreed exploration plan which is broader than the typical one-year initial program and budget. If the agreement as written, provides for sole funding by Big with some vague initial work plan or no work plan at all, it may well be that two or three years and hundreds of thousands of dollars later, Big will have spent its budget and yet not done what Small thought it would do and should do. Only Mr. Small will remember that meeting with the senior Big official who is not around, and that memory will be full of resentment, especially if Big has not found an ore body. Small is left with nothing good to tell its shareholders, and the blood is bad between Small and Big to the detriment of both.

This lack of coincidence of technical standards may also result from the fact that Big has changed since the deal was struck. Changes in markets, budgeting or even corporate philosophy, beyond the control of those in the company responsible for this project, are common especially in today's relatively volatile mining world. Although Small needs some protection against these types of changes, Big has competing concerns, and it needs the flexibility in the deal to accommodate these changes. Big also needs the flexibility to be able to pull out if it finds that, even though the exploration plan was thoroughly discussed and is clearly provided for in the documents, it is simply not money well spent. While Big can accept not finding anything of value, it does not want to waste significant amounts of money in the process.

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The traditional way of providing this flexibility for Big, and yet some protection for Small, is to require that Big spend money in set increments or for certain periods of time, or both, and to allow Big to withdraw without further liability at the end of each increment or period of time by giving advance notice of withdrawal. This means that all Small can count on is that first increment of spending, typically the initial program and budget. Beyond that Small must wait see if Big makes further commitments. In the meantime, the prospect is off the market, and if Big has not been spending money the way Small wants it spent, Small is doubly frustrated.

Therefore, Small shares this desire for flexibility in the sense that it probably wants Big to be able to find a way to justify staying in the deal, especially if Big is doing or can be persuaded to do what Small wants in terms of how the money is spent. If what they planned isn't working and this is at the core of Big's discomfort, the documentation should provide a mechanism for changing that plan. An important aspect of this mechanism for change is communication, but not just the usual annual or semiannual management committee meeting in which the majority party or manager tells the other party a minimum amount about what is going on.² The agreement should provide for effective reporting and for frequent meetings of the management or technical committees and, preferably, both. Additional lines of communication can be opened if a Small engineer or geologist is actually "seconded" to the project and to Big's staff.

Most importantly, however, the communication requirements of the agreement should be followed, and every time that communication occurs or a meeting is held, there should be a detailed and accurate record of what occurred or was said or agreed to, signed by the parties.³ Often, the best way to achieve this is to designate a secretary who is disinterested enough, and yet knowledgeable enough about what is going on, to take accurate minutes. The tendency when one party provides the sole funding, or has the majority funding responsibility and is managing, is to skimp on these meetings and on the record of them. They are, however, each party's insurance against the disputes or, at least, they can be meaningful protection in the event of a dispute. This communication helps Big fulfill its fiduciary obligation to keep Small informed and it helps to eliminate any basis...