Accordingly, default on the part of one of them can have serious effects upon one or more of the others. A successful joint venture usually will have at least three distinct stages of operations — exploration, development and operating. Default at each of these stages will, in all likelihood, carry different consequences. During exploration, default will probably not be too serious, being somewhat similar to default under an option, as the amounts of money and committed expenses involved are usually not great and can be honored by the non- defaulting parties. On the other hand, default at or after the feasibility study stage can involve large amounts of money and committed expenses, and the consequences can be truly disastrous.
As with most things involving agreements, the methods of dealing with default are varied and sometimes quite innovative. They are, however, for the most part based on several “traditional” methods. Briefly these are:
* Dilution of the defaulter’s interest in the property as the other parties continue to contribute — The defaulter may or may not have a right to cure its default and return to its former interest (usually upon payment of a fairly hefty premium) or to re-enter at its reduced interest at some specified time or times (usually at no premium). The methods of dilution vary from pro rata to further contributions to a percentage point for the expenditure of a specified amount of further contributions. The endpoint of dilution may be forfeiture at a specified percentage interest or conversion to a carried interest (a very dangerous phrase never to be used in an agreement without a complete definition) — usually a royalty interest. In some cases, a dilution formula based on further contributions may not specify any endpoint so that, in theory, the defaulter will always have an interest in the property, which can cause problems with potential lenders looking for adequate security.
It must also be remembered that dilution under formulae often can be surprisingly slow and that, while a defaulter’s interest is diluting, it is still an interest-holder in the property and, in the absence of very specific provisions in the agreement to the contrary, must be treated as such and will have a right to have a say in any proposed dealings with the property, including mortgaging it to secure financing. If dilution at a set rate of a percentage point for specified further expenditures is used, this may overcome some problems but raise a new one — namely, what is an amount to be used for the set rate that is fair to all parties at the various stages of the joint venture? There probably is not one amount, as no one can forecast how much the parties will have invested in the project when default occurs.
* Immediate dilution to a carried interest — If it is not intended to give a defaulter a right to re-enter, this may be a favored method as it “gets rid of” the defaulter as an interest- holder immediately, leaving the non- defaulters as the property-owners with relative freedom to deal with the property so long as the rights of the defaulter under its carried interest are not jeopardized.
* Some form of right that permits the defaulting party to attempt to dispose of its interest on a fire sale basis such that, if the acquiring party assumes and pays all the defaulting party’s obligations, it may continue as a full participant in the venture — This acknowledges that default may be caused by circumstances, rather than by intention, and offers the defaulting party a chance to recoup something. The provisions are usually quite involved, continuing the applicability of any right of first refusal in favor of the non-defaulting party in the agreement and providing that, if the interest is not disposed of within a specified period of time, forfeiture will occur in favor of the non-defaulting party. Some of the problems to be considered with this method are: the non-defaulting party is left in limbo for a potentially long period of time while disposition is attempted; if the non-defaulting party wishes to continue during the disposition period, it will have to finance the entire project or at least part of the defaulter’s portion; and if the non-defaulting party has a right of first refusal and wishes to exercise it, it will have to raise, in addition to project financing, financing to pay the purchase price (and the latter may have to be raised quite quickly).
* Permit the defaulter to continue as an interest-holder and treat the defaulted payments as loans made by the non-defaulting party and bearing a sub stantial rate of interest — This may be a workable method if the loans and interest are repaid (and this may be a sizeable “if”) but leaves the non- defaulting party with the problem of financing the project and running the risk that it may not see any repayment. In addition, even if the defaulting party repays the loans and interest in full, with a successful project the defaulter will realize its portion of the balance of the profits from the project after repayment without having been at the same risk as the non-defaulting party.
In addition to the actual remedies relating to default, there are many ancillary considerations that are at least worth some passing thought. All of these cannot be addressed here, but a couple are worth mentioning.
From the above it will be noted that a number of remedies for default involve forfeiture. On the face of it, with a successful project this would appear to be favorable to the non- defaulter, and for the profitable project it is. What about the marginal project or the project that turns into a disaster? Or what about a time when the mine has been virtually mined out and there is little left but reclamation and shut-down costs? In these circumstances, it could be advantageous to the defaulter to encourage forfeiture and to leave the non- defaulting party with the ongoing problems. In fact, in the latter example there might even be a race to see who could default first] These types of problems should be anticipated by the draftsman of an agreement calling for forfeiture as, with appropriate provisions, they can be dealt with.
A commonly used provision relating to default requires the non- defaulter to give notice of the alleged default, following which the defaulter is given a period of time to cure the default. If the default is cured, then there is no default under the agreement and things continue as before. As with forfeiture, this appears to be quite fair, but also as with forfeiture it may well not be fair at all. Such a clause can be used by an optionee to gain more time to pay and thereby extend the option or farm-in period — the optionee merely does not pay by the specified date and sits back waiting for the default notice knowing that he has lots of time to pay after its receipt. Payment requirements should be, but rarely are, excluded from such a provision. In addition, there are other matters to consider, such as, does the alleged defaulter actually exist? When is the default “cured?” Is the default curable? What is done if the default is not capable of being cured? All these are interesting questions that can lead to serious disputes and possibly lawsuits.
Although the matter is often ignored in default provisi
ons, there is the question of the materiality of the default in relation to the arrangements between the parties to be considered — it is obviously a much more material breach of covenant to fail to make an option payment under an underlying agreement than it is to be late in delivering a report and, as defaults, they should be treated differently. If the event of default is not material, it may well warrant a slap on the wrist or even ignoring (so long as it does not become a habit) and the agreement can provide for some appropriate encouragement against default. On the other hand, if the event of default is material, then harsh consequences may be called for and should be exercised (the consequences must be kept within reason). If the courts decide the consequences are so severe as to constitute a penalty under the law (at law, the term “penalty” has a meaning and significance that are quite different from the everyday meaning of the word), the provisions calling for such consequences could be held to be not enforceable. The question of legal penalty is complex; but as a generality (which is always dangerous when dealing with the law), if a remedy that is normally used within the industry is used in an agreement, in the absence of out-of-the-ordinary circumst ances, the courts would probably be reluctant to find it to be a penalty. The courts themselves do acknowledge that serious defaults warrant serious consequences. For example, if the court decides that there has been a “material breach of contract” it may, in the case of a joint venture where the operator is the defaulting party, terminate the agreement and turn the property back to the original owner, much as was done in the LAC/Corona case over the Page-Williams mine, in Hemlo, Ont.
In conclusion, it may turn out to be time well spent if the parties take a while to face up to the possibility of default and try to formulate some reasonable consequences that they think are fair and will work. According to Murphy’s Law, to do so surely must be a step in the right direction for long-lasting good relations. Karl J. C. Harries is a graduate mining engineer and partner with the Toronto law firm of Fasken & Calvin. The information in this article is summary and general in nature and is not intended to be taken or acted upon as legal advice.
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