Are NSR Royalties Enforceable against Mining Properties Located in Québec?
A condensed version of this article was featured in the Canadian Institute of Mining Magazine, Vol. 9, No. 1 (February 2014), the relevant extract of which can be read here (reproduced with permission from CIM Magazine).
Mining royalties are a common feature of mining property transactions. Such royalties frequently form part of the consideration received by vendors in mining property option and/or purchase transactions, usually in combination with one or more other types of consideration, be it cash, shares or work commitment.
A popular type of mining royalty is the Net Smelter Return (“NSR”), through which the holder is typically paid a percentage of the value of production or net proceeds received by the grantor from a smelter or refinery. But are NSRs actually enforceable?
The Quebec Court of Appeal has recently rendered a judgment which provides important guidance to holders of NSRs in mining projects in Quebec. The decision illustrates the complexity of creating enforceable NSR royalties under the civil law of Quebec.
In short, the answer depends on whether the NSR creates a real right or a personal right. A real right establishes a direct right over a thing or property, and as such is enforceable against anyone once the formalities of publication have been satisfied. Real rights attach to and follow the property, conferring upon their holders a right to “pursue” the property. In contrast, a personal right is one against another person for the performance of an obligation. This distinction is critical because it means that a royalty holder with a personal right can only enforce its right against the grantor of the royalty personally. Practically speaking, the result is that if the underlying mining claim is conveyed to a third party or if the grantor becomes insolvent, the royalty will turn out to be unenforceable – and quite possibly worthless.
In the matter of Anglo Pacific Group PLC v. Ernst & Young Inc. (“Anglo Pacific”)1, the Quebec Court of Appeal considered, for the first time, the nature of an NSR royalty granted by the holder of mining claims to a lender and the legal publicity regime applicable to such a royalty. Rendered on August 6, 2013, in the context of the bankruptcy of a mining company, the decision provides that in order to have a real right, the NSR holder must necessarily and inevitably justify a direct right in the property via one or more of attributes of ownership – be it the right to (a) use, (b) enjoy the products from, or (c) dispose of the property – along with the right to pursue the property and the liberty to abandon it2. To put it simply, a royalty will be a real right if it grants a right capable of being exercised directly over the property. If, however, the NSR agreement does not confer one or more of the aforementioned attributes of ownership – but merely a proportion of the profits from the sale of minerals extracted from the subsoil – the NSR will constitute a personal right enforceable against the grantor, but unenforceable against third parties.
The Court of Appeal also clarified the legal publicity regime applicable to mining rights. The Court of Appeal held that real mining rights, such as mining leases, registered in the Mining Register are enforceable against the State only. To be opposable to other third parties, real mining rights that are not subject to an exemption under the Mining Act (including mining royalties where they create such rights) have to be published in the register of real rights of State resource development of the Quebec land register. Care must therefore be given to the registration of mining rights on the appropriate registries.
The Court then applied the law to the facts of the case to determine that the NSRs in the Anglo Pacific case were unenforceable. The relevant facts can be summed up as follows. In 2009, Anglo Pacific Group PLC (“Anglo Pacific”) entered into a senior convertible debenture with Northern Star Mining Corp. and Jake Resources Inc. (the “Debtors”) wherein Anglo Pacific made a loan to Northern Star and required that the Debtors grant it, inter alia, a NSR royalty. Anglo Pacific later registered the debenture deed, containing the NSR agreement, in the public register of real and immovable mining rights (known as the “Mining Register”) maintained by the Ministère des Ressources naturelles et de la Faune (Quebec’s Ministry of Natural Resources). Following the bankruptcy of the Debtors in 2011, the Debtors’ assets were sold by the receiver, Ernst & Young, pursuant to a vesting order authorizing the sale free and clear of all liens and charges.
In the result, the mining property was conveyed to the buyer in the bankruptcy proceedings free and clear of the NSR that was registered against the property, notwithstanding the objections of the holder of the NSR. Anglo Pacific’s NSR was in effect doomed in several ways. First, it did not create a real right and so could not follow the property. This is because despite express wording in the NSR agreement to the effect that the parties wished to “create a direct real property interest in the Products and the Properties in favour of the Holder”, in reality Anglo Pacific was granted a right to receive certain payments upon the sale of the mineral substances and none of the attributes of ownership mentioned above. Second, even if the NSR had created some real right, it could not be set up against a third party given that it had not been properly published in the land register. Lastly, the Court added that even if it had been properly published, the vesting order, as drafted, would have purged the property of the NSR.3
While the Quebec Court of Appeal held that it is possible to create a mining royalty that is a partial ownership right (technically a “dismemberment” of the right of ownership) and provided guidance on how to do so, the practical reality is that royalty agreements are seldom designed to grant the royalty holder with such direct rights in the mining claims, leases and/or extracted mineral substances. Moreover, Anglo Pacific makes clear that the intention of the parties is insufficient, and the grantor will have to grant more than a mere right to receive a percentage of the receipts or profits from the sale of the minerals extracted from the subsoil. The lesson to be learned from Anglo Pacific is that sellers in transactions relating to Quebec mining properties should pay close attention to the drafting of their NSR agreement and obtain professional advice to curtail the risk of having their royalty become a hollow promise of income.
1 2013 QCCA 1323
2 More precisely, abandonment entails relinquishing one’s own real right in the property.
3 The Court held that the operation authorized by the trial judge in Anglo Pacific had the same effect as a sale by judicial authority, discharging the sold assets of all rights charging them to the extent provided by the conclusions of the judge’s order and by article 696 of the Code of Civil Procedure. Since mining royalties as real rights do not fall within the exceptions listed at article 696, such rights cannot survive a judicial sale or a vesting order having the same effect, unless mentioned in the court’s order as being rights which are to survive it. Anglo Pacific’s NSR was not so mentioned in the vesting order.