Canada: Recent Developments In Québec Mining Royalties

In Québec, as elsewhere in Canada, mining royalties are often granted, along with cash and/or share consideration, to sellers in property option transactions. Mining royalties are payments made to the holder by the owner of a mineral project. The most common types of mining royalties are the net smelter return (NSR) royalty — which is based on proceeds of production from a mineral project less smelting, refining and transportation fees paid by a smelter or refiner to the owner — and the net profit interest (NPI) or net proceeds (NPR) royalty, which are both based on profits after deducting costs relating to production.

Until recently, the established view in Québec had been that a mining royalty did not create an ownership or property right, but rather a personal right. This is an important distinction because a royalty holder with a personal right only has a recourse against the grantor of the royalty. As a personal right, the royalty could effectively be worthless if the underlying mining claim is transferred to a third party and such new holder of the claim did not contractually assume the obligations of the grantor under the royalty agreement or if the grantor becomes insolvent. In order to protect against these risks, the best practice that has evolved in Québec has been to secure the obligations under the royalty agreement with a hypothec and to include in it restrictive covenants with respect to transfers to third parties and registration.

In a notable recent development, however, the Québec Court of Appeal held in Anglo Pacific Group PLC v. Ernst & Young Inc. ("Anglo Pacific") that it was possible for the holder of a mining claim to grant a property right, not only in the mining claim itself, but also in the minerals underlying the claim that the holder becomes entitled to extract upon the issuance of a mining lease with respect to the claim. In other words, it is possible for the holder of a Québec mining claim to grant a royalty in minerals that is a property right, though the right would be subject to the issuance of a mining lease and would only become effective or "attach" to the minerals at the earliest when the mining lease is issued and, more likely, when the minerals have been extracted.

Property Rights or Personal Rights?

All things being equal, a royalty holder would prefer to have a royalty that gives rise to a property right rather than a personal right largely because the right is enforceable directly against the property, it is not affected by any subsequent security granted by the owner to third parties (including its lenders) and it is not subject to loss if the underlying mining claim is transferred to a third party or if the grantor becomes insolvent.

One of the main practical difficulties with trying to create royalties contemplated by Anglo-Pacific that constitute property rights may be that the royalty holder must be granted a direct right in one or more of the ownership attributes of the property (the right to use, enjoy the products from or dispose of the property) and these rights must be capable of being exercised directly over the property. While this is clear enough in principle, in practice royalty agreements are rarely drafted with a view to providing a royalty holder with property rights that are this broad. There is also the question of whether the grant of property rights may require the holder to assume certain obligations or liabilities of an owner, such as environmental liabilities, which would evidently be problematic from the royalty holders' perspective.

Unfortunately, while Anglo Pacific establishes that it is theoretically possible to create a royalty that gives rise to property rights, the decision contains very little information as to how this should be done in practice. Accordingly, one of the biggest challenges in drafting a royalty that creates property rights may be that, although it will likely be more complicated and costly than a typical royalty agreement, there is no certainty the parties will have "met the threshold" of creating a property right unless it is contested and a court ultimately makes that determination.

The main advantage of drafting royalty agreements to create personal rights is that it provides a predictable level of comfort with respect to enforceability. The disadvantage is that the royalty holder is always dependent on the agreement with the owner to enforce its rights. If the covenants in the agreement are breached, the royalty holder may not be made whole and even the hypothec securing the obligations may not provide protection if other secured debt has a preferential ranking. In theory, a royalty holder with leverage may be able to negotiate with the owner to ensure that its hypothec is not subordinated to the hypothec(s) securing project financing though, in practice, this is rarely an option.

Drafting Québec Royalty Agreements

Surprisingly, even though it has long been generally accepted that mining royalties in Québec create personal rights, many people incorrectly assume that royalty agreements create real rights and fail to request the necessary contractual protections (such as obtaining from the grantor of the royalty a hypothec to secure those rights). While there are a number of important provisions to consider from a royalty holder's perspective in drafting a good agreement, the inclusion of the following are particularly important:

  • defining the property with respect to which the royalty is payable as encompassing the mining claims and any mining lease issued pursuant to those claims;
  • a clause requiring the royalty holder's consent to a transfer of the underlying claims or mining lease or a novation clause that makes the transfer conditional on the assumption by the purchaser of all royalty obligations;
  • a clause requiring registration of the royalty agreement at the Public Register of Real and Immovable Mining Rights available through GESTIM and the hypothec on the RPMRR and, once a mining lease is granted, the Land Registry; and
  • a clause requiring notice to the royalty holder of any third-party transfer or the issuance of a mining lease.

It is also important from the perspective of a royalty holder in this context to obtain a hypothec from the owner to secure the obligations under the royalty agreement. Hypothecs entered into to secure royalty rights should, amongst other things:

  • not only charge the claims in question but also the universality of all present and future immovable assets and mineral rights (such as a mining lease) relating to the mining claims in question (which will avoid having to obtain a new hypothec from the owner once a mining lease is issued, for example);
  • charge the universality of all present and future movable assets relating to the charged immovable and mineral assets; and
  • include a covenant on the grantor's part to advise the royalty holder in writing of any newly acquired immovable or mineral assets in order for the royalty holder to assure that its hypothec is perfected against such assets.

The decision in Anglo-Pacific means that there are now more possibilities than ever in drafting Québec royalty agreements. Regardless of which road parties choose to go down, it is important that agreements be drafted correctly and take into account the peculiarities of Québec's civil law, in order for the parties to obtain the benefits of their bargains.

This article is a condensed version of an article on Québec contractual royalties that was originally published in Le Point: Natural Resources magazine (Volume 2: Number 1).

To view original article, please click here.

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.

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