Examples of Joint Ventures
Joint ventures (JVs) in the mining industry are on the rise. In 2019, Barrick and Newmont partnered to combine their assets in Nevada – creating the world's largest gold complex. This is a classic example of companies finding synergies in the co-location of their assets.
In the same year, Teck Resources announced the completion of its joint venture with Sumitomo Metal Mining Co to develop Quebrada Blanca 2, the expansion phase of Teck's copper mining operations in Chile.
Juniors with promising deposits have also been increasingly successful in attracting the attention of majors interested in expanding their exploration portfolios. In fact, several large miners – such as Rio Tinto and South32 – have explicitly committed to collaborating with junior and mid-tier companies on exploration projects around the world.
Why form a JV?
There are a number of reasons why mining companies may enter into joint venture agreements. This may go from a circumstance where the original property owner does not want to give up its "ownership rights" entirely and wishes to keep a stake in the property, to cases where it is desirable to have a local partner with good knowledge and connections, or a partner that has mining expertise or familiarity with certain technology that will be useful in developing the mining project.
By and large, however, the main reasons for JVs in the mining sector is the need to share the risks of the project with someone else in addition to sharing the costs.
Those risks and costs can be amplified in mining projects given that the time lag between first drilling and sampling activities and the commencement of commercial production may be a couple of decades or more.
Risks are not limited to geological factors, but include political uncertainty, market downturns, development of new technologies and social and environmental concerns and – as we have seen this year – natural (or possibly man made) disasters such as pandemics.
Cash availability in the market is dramatically influenced by market sentiment towards the industry, which is often painted in a negative light. The upshot is that market capitalisations in the sector have been challenged and companies – particularly juniors – often struggle to raise capital.
Alternative funding does exist – from royalty to streaming to offtake agreements. Private equity firms have also been investing more actively in the sector.
Yet despite these options many mining companies remain capital starved. This has led to consolidation in the sector, particularly in the gold space, as companies attempt to gain the heft they need to attract financing and strengthen their performance metrics, and to JVs too.
What form do JVs take?
Although JVs may be of a contractual, unincorporated nature, particularly early stage ventures, or have the form of partnerships, notably in the United States and Canada, which can give rise to tax advantages, corporate JVs are more frequent in cross-border transactions, especially in civil law countries.
Special purpose entities are incorporated to play the role of the vehicle of the project. The main legal consequence is that liabilities relating to the enterprise will be limited to the joint venture company, which can be attractive to the parties. Note however, that in some circumstances legislation and courts may allow for the piercing of the corporate veil (such as for environmental matters).
Another consequence of corporate JVs is that title to the mineral property is usually transferred to the joint venture company. In those jurisdictions where legislation does not allow for multiple holders of the same mineral property, this feature gives more comfort to the party that would not hold the property if the unincorporated joint venture structure were adopted.
What are the key issues for Mining JV agreements (JVAs)
JVAs may be complex agreements dealing with various sets of rules and procedures regarding the exploration, development, construction, production, expansion, closure and even reclamation of a mine. The agreement attempts to cover the life of the mining project and so could endure for many decades.
Even for those cases where the joint enterprise does not require sophisticated arrangements, some key issues will inevitably be addressed in the agreement, such as the contributions of the joint venture partners, the decision-making process and deadlock. As with JVAs in other sectors, exit provisions are extremely important.
Dealing with funding contributions
The JV parties will need to agree on a funding program for all mining operations, starting with scoping studies, initial drilling and resource definition, pre-feasibility studies, bank feasibility studies and then a full construction program and associated budget. Once the mine is in production it is normal to draw up an annual program and associated budget, which may still require funding at least at the early stages.
As discussed funding can come from the parties or from third parties such as project finance banks, ECAs and alternative funders such as streamers and offtakers.
Each party normally commits to fund its respective share of construction costs pursuant to the applicable program and budget, including any cost overruns. The company will issue regular cash calls against the agreed budget. Funding can be by way of share capital subscriptions and/or shareholder loans, normally a mix of both so as to allow for tax efficiency – loan interest can normally be deducted from profits by the project company - but taking into account restrictions such as thin capitalization rules.
Cost overruns can be a contentious subject, particularly where one partner has a majority interest in the project and is heavily involved in managing the operations and providing services. The minority partner may seek to impose limits on cost overruns – say not more than say 15% of agreed budgets – so as to limit its overall financial exposure.
Failure to fund normally gives rise to alternative remedies for the non-defaulting party, such as non-straight line penal dilution, which can be say up to three times the shortfall; the option to treat the contributions as demand loans to either the company or the non-defaulting party should it choose to fund the shortfall; an action for damages might be brought against the defaulter; and/or the suspension of the defaulters voting and dividend rights. Persistent default can sometimes trigger a requirement to transfer the defaulters share in the JV.
There is an argument that failure to fund cost overruns beyond any agreed threshold, say 15%, is not a default item and that these remedies should not apply – or, in the case of dilution – should be straight line or non-penal.
Most JVs include elimination rights, whereby if a party's shareholding ultimately is diluted below a defined level (frequently 10%), then its interest in the JV can either be acquired by the other parties pro rata or is converted into a royalty.
Decision making in a JV scenario
The decision making architecture for the JVA will depend on the number of the parties and their respective shareholdings: from the classic 50:50 "deadlock" JV scenario; to the two party "majority: minority" scenario; to the more complex "multi-party" scenario.
In certain jurisdictions, the government of the country will require a share in the venture in return for allowing mining operations to proceed. For instance, in Chile, Codalco normally takes a 10% shareholding in mining operations, which is in effect a free carried interest. The other parties interests are diluted pro rata accordingly.
In corporate JVs, decisions are taken by the board of directors whose composition will ordinarily reflect the proportionate shareholdings of the parties.
In the classic 50:50 JV, the board will be inherently deadlocked, assuming no casting vote is prescribed, so it's important to include mechanisms in the JVA which allow for the business to operate even when the parties cannot agree on matters.
In the majority: minority scenario JV, the majority party will have control over most day to day decision making, and will in effect operate the JV. The majority party is likely to be the operator/manager of the JV and provide management services, albeit normally on a nil cost or a cost plus basis. Nevertheless, the minority party will normally want to take part in key decisions.
Similarly in multi-party JVs, where different interest faction groups can form a majority, the minority party will often still want to take part in key decisions.
So, it has become normal in mining JVs to include what are known as Special approval rights - which require a 75% majority "pass" mark and Supermajority approval rights – which require a 90% majority "pass" mark. Here are typical examples:
Special approval rights:
The following actions will require an affirmative vote of holders of at least % of shares in JVco:
- Annual operating plans and budgets
- Material change in the facilities to be constructed pursuant to the construction plan and budget
- Any single unbudgeted capital expenditure exceeding US$[●]million
- Voluntary curtailing of production by 25% or more for 30 or more days
- Voluntary termination of production other than on exhaustion of mineral resources
- Incurrence of debt by JVco/Mineco other than pursuant to an approved financing plan, or for ordinary course working capital needs
- Settlement of litigation in excess of US$[●]million
Supermajority approval rights:
The following actions will require an affirmative vote of holders of at least % of shares in JVco:
- Metal hedging activities of JVco
- Other than in connection with the approved financing plan, grant of security over project assets or JVco shares in any Mineco
- Change in distribution policy of JVco or its subs
- Change in constitutional documents of JVco or its subs
- Liquidation, dissolution, etc. of JVco or its subs
- Changes in capital structure
The board will often set up committees to oversee certain aspects of the mining operations, notably a technical committee and an environmental and social committee. The committees will have their own terms of reference and a composition which normally reflects the overall board representation, especially where they have delegated authority.
In all cases, consideration needs to be given to whether local law also includes shareholder approval rights for certain actions – and at what level – and protections for minorities, for instance against actions that might be regarded as "unfairly prejudicial" to the minority shareholders.
The parties also need to consider the extent to which their appointee directors on JV company boards can act solely in the interests of their appointing shareholders, given they may have fiduciary duties to act in the interests of the JVco.
How to deal with deadlock
Deadlock is inherent in the classic 50:50 JVA. It can also arise in other JVAs which have minority approval rights if those approvals are not forthcoming.
Resolving deadlocks is an art form and normally starts with an escalation procedure whereby the issue is referred for consideration to senior executives within each party's own organisation.
Should that fail, then there is a philosophical debate about how best to resolve deadlocks. Some commentators take the view that there should be no "circuit breaker" in the documents and the parties should thrash it out – or the joint enterprise will fail (and that should be incentive enough to find a solution). Since most mining operations are not divisible between the parties then the ultimate threat of dissolution is one that should concentrate minds.
This school of thought normally argues that deadlock experts or arbitrators are in no better position to decide the issue than the parties themselves, and that other circuit breakers – such as forced sale or buy provisions - tend to favour one party or the other, normally determined by commercial strength as opposed to merits of the dispute.
Should the parties decide on a referral to experts or arbitrators, a mechanism for appointing them and the terms of their terms of reference need to be included in the JVA. Similarly with forced sale and buy provisions - of which there are many exotic variants - such as "Russian Roulette" and "Texas shoot out".
Deadlocks regarding budget approval are normally addressed in the short term at least by allowing the board of the JV company to operate according to the prior year's budget, pending approval of the current year's budget.
Mining JVs and anti-trust considerations
There are two key anti-trust considerations which arise in the context of mining JVs:
- merger control; and
- more general competition law concerns in relation to information sharing and cartel law.
A number of merger control regimes will catch JVs solely upon the basis of the parents' group turnover (notably the EU, China, South Korea, Turkey and Ukraine) and without reference to the turnover of the JV. This can have the unwelcome result that merger control can apply (1) irrespective of where the mine is situate; and (2) before the mine is productive and generating turnover of its own.
With increasingly high penalties for missed merger filings (the latest EU penalty was €124million), parties must ensure that they comply with merger filing formalities.
Although capable of catching a JV solely upon the basis of the parents' turnover, the EU merger regime has an important carve out for JVs which will not play an autonomous market-facing role (the technical term is a non-full-function JV). This requirement has potentially important consequences for mining JVs:
- if the JV parents market and sell the mine's output, with the result that the mine is a production JV but not a selling entity, then EU merger control will not apply (there are refinements on this principle, for example it can still apply if the mine makes only low levels of third party sales on the market(s)); and
- while the mine is at an exploration/development phase, and before extraction, production and sales, EU merger control will not apply upon the basis that the JV has not commenced its market presence.
Importantly, these types of exemption are not generally applied by merger regimes outside the EU.
Merger control regimes apply to changes of control of an entity (typically a holding vehicle for interests in the mine). The precise legal form of the entity is not relevant, i.e. merger control will apply irrespective of whether the mining JV is an unincorporated contractual JV, a partnership or an incorporated entity.
Global merger control tests (in particular the thresholds based on turnover) will be applied to those JV parents holding and/or acquiring control. In a 50/50 deadlock JV structure, both parents will be seen as exercising "joint control", upon the basis that the JV cannot make strategic operational decisions, unless both parents agree. In a majority/minority scenario, while the majority owner's control will ordinarily flow from a controlling majority voting position, the key criterion for control in the case of a minority parent, will be the ability to block key strategic commercial decisions. While the list of relevant key strategic commercial decisions is in practice open-ended, the adoption of the budget and business plan, the hiring and firing of senior personnel and a control over capital expenditure if set low enough to catch operational spending, are all widely recognized as key examples.
General competition law considerations
The holding of equity interests by investors in mines that compete in relation to the same commodity can raise competition law concerns in two key areas:
- the obtaining and disclosure of commercially sensitive information (CSI); and
- the potential facilitation of cartel activity.
Because investors are likely to have board or equivalent representation in the management structures of the mining JV(s), as a result of their equity stakes, they will also, typically, have access to the CSI of competing mines, including costs, pricing and other commercially sensitive information.
Investors in mining JVs are often engaged in the trading of a mine's output, either in their own right under off-take arrangements, and/or in a capacity as a marketing or sales agent. As a result of these types of activity, there is scope for a potentially anti-competitive dissemination and use of CSI in relation to competing mines, which in an extreme scenario, could facilitate and/or lead to a cartel type infringement in the relevant market(s).
Practical solutions to these competition law exposures have been developed in relation to mines and mine equity interests. First, through a careful internal ring-fencing of the administrative and reporting mechanics for holding and managing competing investments, including in particular the use and dissemination of competing CSI. Second, via anti-trust compliance training and advice.
Contractual disputes in mining JVs
Of course, areas in which we are seeing disputes arise in the sector are also areas where particular thought should be given to the drafting in the light of specific factors affecting the project and likely risks.
Force majeure and Common Cost Escalation provisions have been a major issue for many participants in light of the effects of the COVID-19 pandemic on logistics, demand, workforce availability, and operating capacity, consequently we have seen an increased volume of disputes and potential disputes invoking these provisions or doctrines. These disputes can be complex and highly fact sensitive but key issues to think about are:
- what triggers exist;
- have those triggers been tripped (e.g. "epidemic", "act of God", "changes in law, order, rule or regulation", "Act of Government or State") and does the clause need to result in prevention/hindering/increase in resulting costs;
- if so, what effect does the clause have (perhaps excusing non-performance, diminished or delayed performance, or alternatively changing the economic factors that drive a deal, for example, permitting variations in pricing or entitling parties to recover additional costs);
- what limits there are on the clause, these might be express or implied e.g.mitigation/business continuity requirements, in the provision or the applicable law; and
- Causation – this is absolutely key.Many significant disputes arise where there are competing causes of a failure to perform and the COVID-19 pandemic is no exception.Parties should be cautious about their prospects of using force majeure arguments where there is a competing cause that would have delayed or prevented performance in any event.In general terms, a party will need to prove, but for the force majeure event, it would have performed save where it can argue that the particular clause suspends the obligation to perform rather than simply dealing with the consequences of it (i.e. is a contractual frustration clause).English law in this area is complex.So, there is therefore substantial room for significant disputes.
Additional pressure on decision making, deadlock and dispute resolution provisions. Difficult and volatile economic conditions affecting many JVs are creating a heightened risk that many common forms of dispute will increase in frequency. These include:
- price re-negotiation disputes arising from volatile commodity prices and the imperative for particularly state parties or local partners to extract value from the project in the short to medium term notwithstanding economic headwinds;
- disputes surrounding the circumstances in which projects may be suspended, mines may be closed, or production reduced and the circumstances in which such action can be taken;
- circumstances in which indexing provisions did not anticipate the effects of an event like the COVID-19 pandemic; and
- disputes surrounding default of one of the JV parties.
The interaction of an increased likelihood that these disputes will be pursued by a party for economic reasons and the fact that such matters may interact with Cost Escalation or force majeure arguments or actions which require and urgent response as a result of rapidly changing circumstances, make the clarity of the wording around deadlock, dispute resolution and special/super majority approval provisions particularly important. Each dispute turns primarily on the precise wording of the agreement in question and the practical impact and timing of any remedies available in view of the counterparty. Parties are well advised to involve an arbitration specialist at an early stage. This will help them understand how the available processes and remedies can be best utilised and to ensure that every box is ticked and that a paper trail is created which will ultimately be as persuasive as possible before a tribunal. Through doing this, a party is most likely to convince a recalcitrant JV partner to reach a sensible commercial settlement before a full scale dispute becomes necessary or to ultimately succeed in any arbitration.
It is essential in such disputes that a party has clarity as to how decision making and any dispute resolution procedures interact and in circumstances where critical decisions continue to need to be made in circumstances where there is a substantial ongoing dispute, careful consideration of potential scenarios at the outset are likely to significantly mitigate a non-defaulting party's risk exposure and increase its leverage.
Bilateral Investment Treaty disputes involving state parties are also likely to increase for similar reasons, as well as the imperative for state parties to maximise the return on their interest in a JV. Recent years have seen substantial disputes arise from attempts by for example Tanzania and Zambia to levy additional taxes and royalties so as to vary the commercial balance of operations with varying levels of success. Decisions which have been seen as favouring foreign investors and stifling legitimate resource nationalism policies have driven changes to the approach to international arbitration and bilateral investment treaties in a number of African states rich in mineral resources. The effects of the COVID-19 pandemic may also allow those states intent on Resource nationalism to exert additional pressure on their commercial partners. Examples might include:
- ·opportunistic attempts by state parties in OHADA jurisdictions to force JV partners to inject more equity due to alleged "Undercapitalisation":The COVID-19 pandemic has put additional stress on JV companies which can result in JVs in OHADA jurisdictions arguably falling below the required level of capital.States have in the past sought to use any such difficulty and the potential adverse consequences for the investment in the JV as leverage to force commercial actors to contribute further capital or renegotiate the commercial terms of the arrangement with the state partner; and
- licensing: State parties who are dissatisfied with the returns from the JV or the way in which the project has been operated during the COVID-19 pandemic (shut downs etc.) might also be more inclined to use license renewal as leverage to extract improved terms for the state. The practical risk of this will of course depend on the terms and duration of mining licences, the lifespan of a project and whether the state concerned is taking a long or short term view of the position.
In these cases, it is vital for parties to think about the nature of the protections provided to them by both domestic law and relevant Bilateral Investment Treaties (as well as any intergovernmental arrangements) and to frame their arguments in terms of those protections so as to improve their leverage in negotiations from the outset.
Originally Published by Mayer Brown, November 2020
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