In the Canadian mining industry, the granting of a royalty interest is often an attractive financing alternative to dilutive equity issuances and can also be useful in M&A activities and other mine development strategies for junior and senior issuers alike. When seeking to acquire or dispose of royalty interests, one of the more pertinent questions to answer is whether a royalty interest grants the holder rights against both current and future owners of the mining property. A royalty that grants the holder rights against all future owners is properly categorized as an interest in land. For vendors and purchasers of royalty interests, attention should be paid to whether a mining royalty is merely a contractual right or an actual interest in land. This article will outline the law in Canada on when a mining royalty constitutes an interest in land and the contractual safeguards royalty holders can take to protect their interests.
What is a royalty interest in the context of mining? A royalty interest is the ownership of a portion of a mineral resource or the revenue it produces. The holder of the royalty interest is entitled to a stake in the output of the mining property’s production. In Canada, the three main types of royalty interests are the net smelter returns royalty (NSR), the net profits interest royalty (NPI), and the gross overriding royalty (GOR).
A net smelter returns royalty is calculated on the proceeds of the sale of the mineral product to the treatment facility and may be payable in cash or in-kind. There may be deductions for costs incurred before the sale of the product and after the product leaves the mining property, such as the cost of: transportation, insurance or security, penalties, sampling and assaying, refining and smelting and marketing[1].
A royalty based on net profits is calculated by using a fixed percentage of the income from a mine-mill complex less expenses incurred to produce the income. Often, the NPI is not payable until the operator has recouped its capital investment in the project and all pre-production costs[2].
A gross overriding royalty entitles the owner to a share of the market price of the mined product as at the time they are available to be taken less any costs incurred by the operator to bring the product to the point of sale. These deductions include the cost of making the products saleable and delivering them to market.
When a mining royalty is not an interest in land it is a contractual royalty. A contractual royalty is negotiated between parties and is limited to those involved in the contract. It grants the holder of the royalty rights against the contracting parties and no other person or entity. Once ownership of the mine changes hands, the royalty holder no longer has an interest in the property unless the interest is properly transferred or assigned upon the sale of the property. Therefore, there is risk associated with such an interest from the royalty holder’s perspective.
On their face, contractual royalty interests may appear straight-forward, however, disputes can arise upon a transfer of ownership in a mining property with a royalty interest. If a mining royalty is determined to have an interest in land, then the holder is entitled to enforce their rights in perpetuity against the property owner. If a royalty interest does not have an interest in land, then the rights are only contractual and cannot be enforced against anyone who isn’t a party to the contract. Furthermore, insolvency and bankruptcy events can nullify a contractual royalty much like any other contractual obligation.
Therefore, royalty holders are always interested in securing the royalty as an interest in the land. Canadian courts have given consideration to the matter in two recent decisions, one from the Ontario Court of Appeal and the other from the Alberta Court of Queen’s Bench. These decisions have provided business owners with some clarity on when a mining royalty develops an interest in land.
In 2002, the Supreme Court of Canada recognized the commercial reality of mining royalties running with the land and updated the common law to reflect contemporary business practice. Prior to the Supreme Court of Canada’s decision in Dynex[3], a royalty could not be an interest in land if it was not attached to the right to take resources from the land. Dynex shifted the common law in Canada to allow interests in land to be granted without a possessory right to the property’s resources. The Court stated than an interest in land may be created if that is the intention of the parties. In Third Eye Capital[4], the Ontario Court of Appeal interpreted and applied the Supreme Court’s test for when a royalty constituted an interest in land. To determine whether a royalty is an interest in land: (1) the contract must use precise language to show that the parties intended the royalty to be a grant of interest in land; and (2) the object of the royalty itself must be an interest in land[5]. The second part of the test is rarely in dispute because it is often plain and obvious when the property or claims to the minerals on the property constitute an interest in land. Whether an interest in land has been established will depend on whether the parties can prove their intention to create an interest in land. The Ontario Court of Appeal held that the language in the contract was sufficient to demonstrate their intention to grant an interest in land by stating: “It is the intent of the parties hereto that the GOR shall constitute a covenant and an interest in land running with the Property and the Mining Claims and all successions thereof…”[6]
This decision was followed by the Alberta Court of Queen’s Bench in Manitok Energy[7] in 2018 and more recently in Accel Canada[8] in 2020. In both decisions, the Court of Queen’s Bench adopted the reasoning in Third Eye Capital. For there to ben an interest in land, the parties must have met the criteria established in Dynex. In Manitok, the Court held that the contract’s language demonstrated the intention of the parties to create an interest in land. The Royalty Agreement: “preserve[d] the existence of the Producing Royalty until such time as the Documents of Title expire…”[9] In Accel, the Court did not find an interest in land to exist. Accel failed to prove that the parties intended the royalty to be an interest in land, and found instead that it was a security interest.
When drafting your royalty agreement and associated documents, there are no magic words that will show a clear intention to create an interest in land. Rather, a court will look at the agreement as a whole along with the surrounding circumstances to determine the parties’ intent. There are steps royalty holders can take to ensure their interest in land is clearly marked in the contract. The contract should expressly state that the royalty is intended to be an interest in land. The royalty owner should be given rights under the agreement that would allow them to act as an owner, such as the right to consent to the abandonment of property. Finally, if you are the holder of a royalty that is an interest in land, registration practices vary by provincial and Federal jurisdictions, and due care and attention should be paid to ensure valid registration to protect your interest.
[1] BJ Barton, Canadian Law of Mining (Calgary: Institute of Resources Law, 1993) at 461.
[2] BJ Barton, Canadian Law of Mining (Calgary: Institute of Resources Law, 1993) at 462.
[3] Bank of Montreal v Dynex Petroleum Ltd, 2002 SCC 7.
[4] Third Eye Capital Corporation v Dianor Resources Inc, 2018 ONCA 253.
[5] Ibid.
[6] Ibid.
[7] Manitok Energy Inc Re, 2018 ABQB 488 (Manitok).
[8] Accel Canada Holdings Limited Re, 2020 ABQB 182.
[9] Manitok supra.
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