​​​​​​​​​​​MINING BLOG


​​HOW NOT TO DO AN OPTION AGREEMENT


Option agreements are a common early stage acquisition agreement used in the mining sector. Option agreements are made between the party holding an interest in property of some kind (this person is called the "optionor" and the case discussed below concerned mining claims) and the person (potentially) receiving the interest (the "optionee") who must satisfy certain strict conditions. 

These conditions must be satisfied within a certain period of time and could include things like making a payment or investment, carrying out certain work and/or completing a study. Typically the option proceeds in stages or tranches towards a 100 per cent interest or some other percentage interest.

The conditions must be satisfied on schedule before the optionee can exercise the option and acquire their ownership interest (failing which, the option will expire). In a mining context, where the exercise of an option will result in the acquisition of less than a 100 per cent ownership interest, typically the parties will have also made arrangements to enter into a joint venture agreement and they will have a continuing relationship.

The B.C. Court of Appeal has weighed in on option or earn-in agreements in the mining sector.

American Creek Resources Ltd. v. Teuton Resources Corp. (2015) involved an option agreement between American Creek, a junior exploration company, and Teuton, a mineral prospect generator company. Teuton's business model involves acquiring mining claims and then entering into joint ventures with exploration companies who carry out exploration work as required under provincial mining legislation to maintain the claims in good standing.

Under the option agreement, American Creek could acquire a 51% interest in certain mining claims held by Teuton in Northwest British Columbia. Under a supplemental letter agreement, Teuton would then transfer the mining claims entirely to American Creek and the latter would then hold Teuton's 49% interest in trust for Teuton.    

In order to exercise the option, American Creek was required to issue 100,000 of its own common shares to Teuton and incur $5 million of exploration expenditures from 2007 to 2009, inclusive, in relation to the claims. The term "exploration expenditures" was not defined. The option agreement contemplated that a more formal option agreement would be drafted and signed by the parties (but never was), and that upon the exercise of the option, the parties would enter into a joint venture agreement. The agreement contained many references to exploration work being carried out, as well as the anticipated agreements being prepared, in accordance with "industry standards".

American Creek issued the shares and incurred over $6 million of "exploration expenditures" in relation to the claims, mainly diamond drilling and helicopter expenses. It then sought to exercise the option. Teuton refused to transfer the mining claims on the basis that some of the exploration expenditures were unreasonable and unlikely to produce reliable results. Teuton alleged that the 2007 exploration program had not been carried out by a qualified mining geologist (the geologist having mainly an oil and gas background). If Teuton succeeded in having certain expenditures excluded, American Creek would be below the $5 million threshold.

American Creek Resources brought an action in the B.C. Supreme Court to compel Teuton Resources to transfer the mining claims. American Creek prevailed and Teuton then appealed, arguing either that "exploration expenditures" must be interpreted to mean "reasonable exploration expenditures" or that reasonability was an implied term. On the subject of implied terms, Teuton was much more specific, claiming that compliance with the Canadian Institute of Mining, Metallurgy and Petroleum (CIM) Exploration Best Practice Guidelines was also an implied term and that it was also required, as an implied term, for exploration work to be carried out by a "Qualified Person" as defined in the Canadian Securities Administrators' National Instrument 43-101.

The B.C. Court of Appeal dismissed Teuton's appeal, finding that American Creek was only required to incur exploration expenditures in good faith in relation to the mining claims and (as set out in the option agreement) to file records of the exploration work with the B.C. Mineral Titles Branch to maintain the claims in good standing. The B.C. Mineral Titles Branch approved all of the exploration expenditures for the purposes of issuing work assessment credits. The Court of Appeal agreed that the expenditures were exploration and development expenditures within the meaning of the B.C. Mineral Tenure Act Regulation.

Both the trial and appeal decisions expressed an unwillingness to modify the agreement reached by the parties themselves. In essence, option agreements mean what they say and optionees do not need to go beyond their strict terms.

Take-aways

What could the parties have done differently? While every situation is unique, some general comments are provided as food for thought.

If something matters, it should be spelled out. Even matters expressed (clearly) in point form will generally be better than nothing.

Although it is common for an option to be granted at first by way of a short document, a more comprehensive written option agreement would have been ideal. In addition, a draft version of the joint venture agreement should ideally be attached as a schedule to the option agreement. Alternatively (and as is done more commonly by parties pressed for time), the schedule should at least include the most essential provisions, in prose or detailed point form.  

Essential terms should be clearly defined. The parties could have made explicit reference to third party standards, such as possibly the CIM Exploration Best Practice Guidelines, the definition of "Canadian Exploration Expense" in the federal Income Tax Act (and the definition of "Canadian Development Expense" would also have been relevant) or definitions found in mining regulations. National Instrument 43-101 also provides guidance on what a "qualified person" is and could have been referred to explicitly.

The parties could have included criteria for expenditures or plans. Caps on categories of expenditure are another possibility. Although it can be tricky, they could have taken the approach of making a list of valid exploration expenditures or a non-exclusive, illustrative list. The parties could have made provision for an out-of-court dispute-resolution procedure to avoid publicity.

The repeated reference to "industry standards" may be common, but it is also a recipe for disaster. Although both sides may imagine they know what this means, the parties' actual understanding of "industry standards" may be very different and any shared understandings will evaporate with changes in commodity prices. If the parties end up in court, the view of industry practice preferred by a judge, often based on competing expert witness evidence, is unpredictable. In Canada, the "industry standard" joint venture agreement is a myth.

Finally, the parties could have engaged qualified commercial lawyers at the time they reached their agreement (lawyers were not used). Had they done so, it probably would have been much cheaper than litigating a matter all the way up to the B.C. Court of Appeal (!).

INTERESTED IN LEARNING MORE ABOUT OPTIONS? Please fill out the "Contact Me" form and request a copy of my Understanding Option Agreements in the Mining Industry powerpoint (2017). 




© A.H. MacSkimming​        

​Copyright © Andrew H. MacSkimming, All rights reserved.