Metals Exploration Bankruptcies

When exploration companies file for bankruptcy, the restructuring goals generally include reducing long-term debt, selling assets, mothballing or decommissioning unprofitable producing mines, eliminating onerous contracts and underutilized equipment, and reducing corporate overhead. In many ways, these are no different than the goals of companies in bankruptcy in any other industry. There are, however, several issues that tend to arise more often in exploration company bankruptcies when compared to other types of companies. The following briefly discusses those issues and others that commonly arise in the mining and exploration context.

Cross-Border Issues

Regardless of where the primary mining operations are located, a large majority of mining exploration companies are publicly traded on Canada's TSX Venture Exchange and are registered with a Canadian address. The TSX-V has capitalization requirements that are favorable to these companies, allowing them easy access to public equity markets for financing. Around 70% of the 2,350 companies listed on the TSX-V are exploration companies.

These exploration companies, which usually are registered in Canada but may have substantial assets in the United States, often simultaneously file insolvency cases in both countries. Determining which country's courts will oversee the main bankruptcy case is an issue that these companies must carefully evaluate with counsel. Companies that decide to file a main case under either Chapter 7 or Chapter 11 in the U.S. will generally also file an ancillary petition in Canada under the Companies' Creditors Arrangement Act (CCAA), and ask the Canadian court to recognize the U.S. case as the main proceeding. The Canadian court will appoint a monitor, who will assist the Canadian court to carefully oversee the debtor but will generally defer to the U.S. court's authority in most instances.

Companies that file a main proceeding under the CCAA will generally also file a Chapter 15 case in the U.S. and ask the U.S. bankruptcy court to recognize the Canadian case as the main proceeding. In these cases, the U.S. court plays a secondary role, recognizing some orders from the Canadian court, but deferring to the Canadian court in most instances. In either case, the company will need to retain both U.S. and Canadian insolvency professionals and must fulfil reporting and other requirements in both cases. Also, the company typically will be delisted from the TSX-V, resulting in a somewhat reduced compliance burden going forward.

Exploration company insolvencies may implicate other cross-border issues as well. For example, the company's cash management system may involve bank accounts on both sides of the border and the court presiding over the main proceeding may impose restrictions on the amount of cash that can be held outside of the country of the main proceeding.

Land and Equipment Leases

Exploration companies tend to have a large number of land and equipment leases. Leases for mining properties are complex compared with other real property leases, and can cover thousands of individual continuous claims. For exploration companies, mining leases are often their most valuable assets. Insolvent companies and their advisers must carefully review all real property leases to understand the rights and obligations of the debtor in bankruptcy and to evaluate whether such leases should be the subject of an assumption or rejection.

These companies also tend to lease a lot of heavy equipment, including bulldozers, digging equipment, fuel trucks, drilling equipment and laboratory equipment. As operations are reduced and assets sold in bankruptcy, it is important that the debtor evaluates all equipment leases for assumption and assignment or rejection. It is also important to review equipment leases to determine if any constitute secured financings rather than true leases.

Mechanics' Liens and Recording Statutes

Exploration companies usually have a number of mechanic's or other statutory liens asserted against them. Mechanics liens can be a powerful tool allowing contractors and others who improve the debtor's property to enforce a lien that in some cases is superior to prior recorded liens that may be held by secured lenders. However, mechanic's liens are governed by state statute and strict compliance with the statute by the purported lien holder is often required. Failing to meet a deadline or correctly record and deliver notice of a lien can result in removal or “expungement.” It is important that insolvent companies evaluate any asserted mechanics liens to determine their validity and the possible implications for the debtor and creditors at various levels of the debtor's capital structure. It should also be noted that mechanic's lien holders are exempt from certain aspects of the automatic stay under section 362(b) of the bankruptcy code.

Rights of First Refusal

Mining exploration is often undertaken by partners, one of which may contribute the mining properties and the other is responsible for exploration and development. These arrangements, such as joint venture exploration, development and mine operating agreements, contemplate earn-in periods during which the party responsible for the actual exploration and development of a mining project can acquire a percentage of ownership in the project by making certain agreed upon levels of expenditures over a period of time. Once the expenditure levels are met and all other contractual requirements are satisfied, the exploration party will acquire a co-ownership interest in the property itself. These agreements frequently provide for a right of first refusal that can be exercised by either party (following the completion of the earn-in period and the acquisition of a property interest by the exploration party) in the event that the other party desires to sell its property or joint venture interest.

Although contractual rights of first refusal are generally enforceable under state law, the rules can change in a Chapter 11 bankruptcy case where the name of the game is maximizing the value of the debtor's assets for the benefit of all creditors and stakeholders. Some courts have declined to enforce contractual rights of first refusal in the context of section 363 sales if enforcement would frustrate or materially interfere with the debtor's ability to maximize value (e.g., where the right of first refusal would chill bidding). The right to ask a bankruptcy court to override a contractual right of first refusal is a powerful tool and should be considered by a debtor as it evaluates available alternatives and devises its restructuring strategy. Conversely, the non-debtor party must be aware of the risk that its bargained-for right of first refusal may be limited or deemed unenforceable at the end of the day.

Sales of Co-Owned Property

Taking the example of an exploration and development joint venture one step further, if a debtor believes that it will be able to maximize value by selling the entirety of the co-owned property rather than just its own interest in the property, it has the right to ask the bankruptcy court for authority to sell 100% of the property pursuant to section 363(h) of the Bankruptcy Code. This is particularly helpful where the debtor owns a minority interest in the property and, thus, ordinarily might expect to suffer a discount in the value of its interest compared to the interest of the controlling joint venture party.

From the non-debtor partner's perspective, it may seem as if the bankruptcy process is completely stacked against it ' not only is it at risk of losing its contractual right of first refusal, but the debtor also has the right to seek authority to force a sale of the entire property over its objection. However, a forced sale under section 363(h) comes along with a powerful right in favor of the non-debtor partner ' a statutory right of first refusal to purchase the entire property under section 363(i) of the Bankruptcy Code that, based on current case law, seems to be strictly enforced even if the ability to maximize value is frustrated.

Royalty Agreements

Another significant issue is the treatment of mining royalty agreements. Depending upon applicable state law, royalty agreements may be considered either non-residential real property leases or executory contracts. This distinction is important as it bears upon whether royalty payments coming due postpetition are required to be paid in the ordinary course. If the agreement is an executory contract, the general rule is that a debtor does not need to timely perform postpetition obligations pending its decision to assume or reject the contract ' such executory contracts being enforceable by, but not against, the debtor. Non-residential real property leases, however, are afforded special treatment under section 365(d) of the Bankruptcy Code such that a debtor is obligated to timely perform all postpetition obligations (subject to certain exceptions) as they arise under non-residential real property leases. Therefore, if a mining royalty agreement is determined to be a real property lease, the debtor will be required to make the postpetition royalty payments as they come due.

Reclamation Bonding

In any mining operation, land is disturbed and operators incur substantial reclamation obligations under environmental laws and regulations. Irrevocable surety bonds are often required to be issued for the benefit of the environmental authorities. These bonds serve as a backstop in the event the mining company fails to satisfy its reclamation obligations. Because of the irrevocable nature of reclamation bonds and the fact that the bond obligates the surety to the environmental authorities (not the debtor), the status of a reclamation surety bond issued prepetition as an executory contract is subject to question.

If the bond is an executory contract, then premiums due postpetition are administrative expenses. But, if the bond is not an executory contract, then such premiums are merely prepetition claims. Moreover, even if the bond is an executory contract, administrative expense status for postpetition premiums may still be subject to challenge because such obligations arguably do not arise as a result of a transaction with the debtor's estate. An irrevocable bond issued prepetition must be performed by the surety as a matter of law regardless of whether premiums are ultimately paid.

Subcontractor Claims

Mining operations also frequently involve the use of a primary mining contractor (known as a contract miner), who in turn may contract with any number of subcontractors to perform different aspects of the mining work. In most cases, the debtor has contractual privity only with the primary contractor and the subs may not be able to assert direct claims against the debtor. Subcontractors, however, often file claims against the debtor and may even seek to assert mechanic's liens. Debtors should consider whether subcontractor claims are legitimate.

Conclusion

The foregoing is a brief, high-level discussion of some of the key issues that arise in the context of mining and exploration cases. Needless to say, each case presents its own complexities and these issues and numerous others will need to be carefully considered by debtors and their advisers.

Elliot Smith and Andrew Simon are senior associates with Squire Patton Boggs US LLP.