Rights of First Refusal (ROFR) are common in the partnership, joint venture and shareholder agreements that permeate the mining industry.1 In broad strokes, a ROFR is engaged when one party seeks to exit the project. It functions by granting the non-exiting party the first opportunity to acquire the exiting party's interest. In some quarters, there is a perception that ROFRs primarily benefit senior producers, their principal purpose being to allow a senior to consolidate 100% ownership of an asset, often after commencement of production when its junior partner seeks to monetize its position to fund new exploration activities. Alternatively (or additionally), the ROFR may serve to protect the non-exiting party from being saddled with an unwanted partner, provided that it has the financial capacity to do so. In either case, the perception exists that junior partners will often lack the financial capacity to purchase their majority partner's interest, let alone assume the full burden of the capital and operating expenditures associated with a producing mine and, as a result, some may believe that a ROFR is of limited value to a junior partner. However, as starkly illustrated in the recent Ontario Superior Court of Justice (OSCJ) case of Barrick Gold Corporation v. Goldcorp Inc., 2011 ONSC 3725 (Barrick), a ROFR can be incredibly valuable in the hands of a junior partner. A potential purchaser of a senior's share who fails to appreciate the potential power of a ROFR in the hands of a well-represented junior does so at its own peril.
Factual Circumstances of the Barrick Case
Xstrata Copper (Xstrata) and New Gold Inc. (New Gold) were partners in a Chilean copper/gold project known as El Morro, with Xstrata holding a 70% interest, and New Gold holding a 30% interest. Their relationship was governed by a shareholders agreement that contained a ROFR along with ancillary restrictions on the parties' ability to transfer their rights or interests. Xstrata ran an auction process that culminated, in October 2009, in an agreement to sell its 70% interest to Barrick for $463 million, conditional upon the non-exercise or expiration of New Gold's ROFR by January 7, 2010.
New Gold was a junior company lacking the financial capacity to exercise the ROFR on its own, and Barrick counted on this fact in its approach to New Gold, ultimately to its detriment.
For its part, New Gold recognized that the Xstrata auction process might provide it with an opportunity to maximize the value of its own 30% interest. When it became clear that Barrick would be entering into an agreement to purchase Xstrata's 70% interest, New Gold commenced discussions with Barrick for the sale of its 30%. Barrick was ultimately interested in acquiring 100% ownership of the project, but believed that it would have significant leverage over New Gold once it completed its acquisition of the 70%. In particular, as controlling stakeholder, Barrick would be able to sequence El Morro behind its other Chilean projects, thereby delaying production and placing pressure on New Gold to exit the project at a low price.
Based in part on its assessment that it would be able to acquire the 30% at a very low price at some later date, in October 2009, Barrick offered to purchase the 30% interest for $135 million. This offer, which New Gold characterized as "low ball," was well below the interest's indicative value of roughly $198 million, based on the sale of Xstrata's 70% interest for $463 million. New Gold rejected this offer, and talks with Barrick broke off temporarily.
New Gold then began a formal value maximization process in November 2009 through which it actively marketed not only its own 30% interest, but also the possible sale of either: 1) a 100% interest in the El Morro project through the exercise of its ROFR over Xstrata's 70% and the tender of its 30% stake or 2) a 70% interest of the El Morro project through the exercise of its ROFR.
Barrick was broadly aware that New Gold was engaged in a value maximization process, but was unaware, at least initially, that New Gold was expressly marketing options dependent on an exercise of the ROFR. Even when it learned that New Gold was proposing options that involved a ROFR exercise, Barrick doubted that New Gold's process would gain any traction. Rather, Barrick believed that New Gold was simply out in the market making noise as a means of compelling Barrick to increase its offer for the 30% interest.
However, New Gold's marketing did gain traction with Goldcorp Inc. (Goldcorp). Although it had been interested in El Morro for some time, Goldcorp had stayed out of Xstrata's auction process, in part out of a belief that it could not compete with Barrick owing to the synergies available to Barrick through its other Chilean projects. However, in December 2009, Goldcorp found itself faced with an opportunity to acquire a significant stake in El Morro, at a fixed price in a rising metal price environment and without the risk of having to compete against Barrick. In early internal correspondence, Goldcorp described the situation as follows:
The dynamics this deal sets up are very interesting. Barrick and Xstrata have set the price and so Barrick cannot come back and compete on the purchase of the Xstrata interest. If we acquire the ROFR, we simply pay $465m and there is nothing Barrick (or Xstrata) can do to stop it.
Goldcorp initially wished to acquire 100% of the El Morro project by first purchasing New Gold's 30% interest (including the ROFR over Xstrata's 70%), then exercising the ROFR to acquire the remaining 70% at the fixed price of $463 million. However, it soon realized that such a transaction was precluded by the fact that Xstrata held a reciprocal ROFR over New Gold's 30%. As such, any effort to purchase New Gold's 30% would give Xstrata (and in turn, Barrick) the opportunity to swoop in and consolidate 100% ownership of the asset.
Recognizing that the 30% interest would have to remain with New Gold, at least for the time being, Goldcorp and New Gold focused their attention on structuring a transaction for the 70% interest with "sweeteners" to enhance the value of New Gold's interest, while committing to talk in good faith about a possible deal in respect of the 30% after the 70% transaction closed.
To this end, they worked out a proposed transaction whereby: 1) New Gold would exercise its ROFR and enter into an agreement with Xstrata for the purchase of the 70% interest; 2) New Gold would assign its agreement with Xstrata to a subsidiary created for the purpose of acquiring the 70% interest; 3) Goldcorp would lend the subsidiary the $463 million purchase price; 4) the subsidiary would close the transaction with Xstrata and 5) New Gold would thereafter transfer the subsidiary to Goldcorp.
As compensation for entering into the proposed transaction, Goldcorp offered to New Gold:
- a cash payment of $50 million;
- a firm commitment to commence commercial production by a certain date and a construction guarantee with monetary penalties in the event of default or delay; and
- an amendment to the shareholders and funding agreements, relieving New Gold of its commitment to pay any funding expenses until the commencement of commercial production and reducing the interest rate payable on outstanding carried funding loans.
Prior to accepting Goldcorp's offer, and on the eve of the ROFR expiry, New Gold advised Barrick that it had a deal in the works involving an exercise of the ROFR. New Gold gave Barrick a final opportunity to submit an offer for the 30% interest. Understanding that it faced the prospect of losing the asset entirely, Barrick returned with an offer of $300 million (being over $100 million above the indicative value of $198 million derived from the $463 million price for Xstrata's 70% interest.) However, New Gold declined Barrick's offer, and exercised its ROFR the following day.
Barrick objected to the validity of New Gold's ROFR exercise. Considering itself bound by the ROFR, Xstrata closed with New Gold's subsidiary, thereby exiting the project. In a subsequent transaction on the same day, New Gold sold its subsidiary to Goldcorp, resulting in Goldcorp and New Gold being 70/30% owners of the El Morro project.
Barrick sued Xstrata, New Gold and Goldcorp for approximately $750,000,000 in damages, alleging a breach of contract (by Xstrata) and numerous torts (by all defendants). The crux of Barrick's complaint was that by agreeing to a pre-arranged onsale of the 70% interest, New Gold had effectively transferred the ROFR to Goldcorp, in breach of the transfer restrictions contained in the shareholders' agreement. Accordingly, argued Barrick, New Gold's ROFR exercise was invalid, and Xstrata was contractually obliged to close with Barrick.
Following a 35-day trial, the Hon. Justice Wilton-Siegel J. of the OSCJ dismissed all of Barrick's claims. In particular, His Honour held that New Gold's exercise of its ROFR after having pre-arranged an immediate onsale to Goldcorp was proper and valid.
Takeaways From the Barrick Case
Perhaps the most obvious takeaway from the Barrick case is that ROFRs can be effectively leveraged by minority partners looking to maximize the value of their interest. Through ingenuity and creative lawyering, New Gold was able to leverage a non-transferable interest with no inherent monetary value into, alternatively, 1) an offer of $50 million dollars and a significantly improved position in the El Morro project that included a construction guarantee subject to significant payments for delay and decreased financial commitments pending construction and 2) an offer to purchase its 30% interest for $300 million (being 222% of the value that Barrick originally offered for that interest).
Thinking more broadly, the lesson may be that ROFRs can serve different purposes for differently situated parties. The inclusion of a ROFR in a partnership can have a number of repercussions for the initial partners, as well as for third parties looking to enter into the project. These repercussions, and accordingly the issues that a party should consider when dealing with a ROFR, will depend on the individual circumstances of the party.
A ROFR may provide a senior mining company with an effective means of ultimately consolidating its position, if that is its goal. However, a senior who foresees an eventual sale of its majority interest should consider how a ROFR may impede its ability to get top dollar for its interest. By way of illustration, Goldcorp was willing to pay in excess of $50 million more than Xstrata was able to command through its auction process. It may be that, in light of the Barrick decision, more companies will stay out of initial auction processes, preferring instead to take their chances at acquiring the interest through the non-exiting shareholder's ROFR after a strike price has been set.
In appropriate circumstances, a senior may wish to negotiate restrictions or conditions on a junior's ability to resell the interest (for example, the inclusion of a "premium share" provision entitling the senior to a proportion of any premium the junior receives through an onsale).
A junior mining company may be eager to have their agreement contain a ROFR if they perceive that their senior partner will likely exit the project first. In such circumstances, a ROFR may afford them the opportunity to find themselves a partner more desirable than the proposed purchaser, as was the case for New Gold. However, as with senior companies, a ROFR is likely to depress the value of a junior's interest if it seeks to exit the project first. Indeed, the depressive effect may be significant where the senior is widely known to have the financial capability to exercise the ROFR, because potential purchasers may decide to save themselves the time and expense of engaging in a process to set a price if the ROFR is likely to be exercised in any event.
Moreover, the existence of mutual ROFRs may affect the options available to a party seeking to maximize the value of its interest after its partner has accepted a conditional offer. For example, the fact that Xstrata (and, accordingly, Barrick) had a ROFR over New Gold's 30% interest effectively precluded New Gold from transacting with Goldcorp for the entire asset, notwithstanding that New Gold had actively marketed the 100% interest.
Finally, a prospective purchaser should consider how the existence of a ROFR might frustrate its intended transaction. Had Barrick given due regard to the potential of New Gold exercising the ROFR through a partnered onsale, it may have been inclined to take a different approach to its negotiations in respect of New Gold's 30% interest. In all likelihood, Barrick could have secured the 30% interest and neutralized the threat of the ROFR in October 2009, at a price well below the $300 million it ultimately (and unsuccessfully) offered in January 2010.
The ubiquity of ROFRs in the mining industry may give rise to the misconception that such provisions are mere boilerplate requiring little thought or attention. Companies that adopt such an attitude may miss out on leveraging opportunities, or find themselves watching a lucrative opportunity disappear with the unanticipated exercise of a ROFR. Given the complexity of the considerations at play when dealing with ROFRs and indeed with other seemingly innocuous contractual provisions, mining companies would be well advised to obtain legal advice both during the negotiation of agreements and when considering a value maximization process. After all, as the situations of New Gold and Barrick aptly demonstrate, creative and innovative legal thinking may well be the difference between negotiating yourself a windfall and watching your deal fall apart.
1. For the purposes of this article, the distinct legal relationships that arise out of these various business arrangements will all be captured by the term "partner."
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.