Spell out details on mining exploration
Exploration option agreements negotiated by sophisticated parties mean what they say and nothing more, says the British Columbia Court of Appeal in a recent decision called American Creek Resources Ltd. vs. Teuton Resources Corp.
That might sound simple — perhaps even obvious. But the American Creek decision has major implications for the way parties set up option agreements, a common way to fund exploration in the Canadian mining industry.
“The American Creek decision will definitely change industry practice for drafting the exploration agreements that are the lifeblood of the industry,” says Josh Lewis of Fasken Martineau DuMoulin LLP in Vancouver.
Typically, the company holding the property grants another company the option to earn an interest in the property by exploring it. The agreement usually prescribes the amount of the expenditures that must be made, but the description of those expenditures can vary from deal to deal.
American Creek sought to enforce its option to acquire a 51 per cent interest in certain mining claims that Teuton owned in northwestern B.C. American Creek by demonstrating that it had spent the $5 million mandated by the exploration agreement. But Teuton refused to transfer the interest, arguing that the expenditures were unreasonable.
The appellate court ruled that absent a standard in the agreement itself, such as rea-
sonableness,
it would not impose a qualification on the expenses. American Creek’s only obligation was to make valid “exploration expenditures,” which it had done. Consequently, no inquiry into the reasonableness was necessary and Teuton was obliged to transfer the 51 per cent interest to American Creek.
Brian Abraham of Dentons Canada LLP in Vancouver says the case sets a “positive precedent” for optionees.
“To meet its exploration obligations under a standard option agreement, an optionee must (only) show that it has incurred expenditures in good faith,” he says.
If miners want specific qualifications, such as reasonableness or perhaps a cap on spending, they need to negotiate those terms into exploration option agreements, Abraham adds.
There are guidelines that can help, Abraham says. Standards for incurring exploration expenses can be found in the best practices of the Canadian Institute of Mining or by reference to the definition of “Canadian Exploration Expenditures” found in the Income Tax Act.
“Optionors could also include objective conditions, such as requiring a certain amount of drilling, geophysical or geochemical work, as criteria for determining the reasonableness of expenditures,” Abraham says
For his part, Lewis maintains that the mining industry does in practice recognize a “basic obligation” to be reasonable in performing exploration agreements — but that hasn’t been much help in dealing with grey areas that arise.
“The problem is that there is no standard as to what is reasonable,” he says. “So the lesson learned is that applying a standard should become part of the negotiations.”
The difficulty that arises is that commercial pressures militate in favour of a short document to get things going.
“The usual practice is to have a term sheet, a letter of intent, or a memo of agreement in the first instance,” Lewis says. “The parties quite often intend to replace these documents with more fulsome agreements, but that doesn’t always happen.”