21 May, 2015
The depressed coal price and limited capacity for miners to further reduce operating costs is presenting buy-side opportunities for savvy investors to pick off mining assets at cyclically low prices. In the current environment, it is becoming more common for mining M&A deals to be done for nominal consideration. However, a purchaser buying a mining operation for nominal consideration should be aware that a ‘bargain’ may come at a cost.
M&A deal protections typically obtained by a purchaser (such as detailed warranties) may be legitimately resisted by the vendor if the sale is for limited consideration. In this scenario, due diligence is key. The real cost of acquiring the mining operation may include a number of liabilities, such as increased rehabilitation obligations and the costs for take or pay contracts entered into by the vendor.
The purchaser needs to balance these considerations against its own drivers for doing the deal. For instance, the purchaser may be able to extract synergies (e.g. through the use of common infrastructure) from buying a mining operation where it already has other mining operations in the same vicinity.
Deal Protection Issues Relating To A Nominal Value Deal
The vendor is likely to want a speedy and 'clean' exit from the mining asset when it is only receiving nominal consideration in order to cut free of costs. As a result, the vendor may only be prepared to offer the purchaser limited, if any, warranties and indemnities in the deal documents. In these circumstances, it is important for prospective purchasers to insist on diligence sufficient to:
- verify beneficial title in the underlying mining tenements,
- clarify the liabilities being assumed (particularly those associated with environmental and rehabilitation obligations), and
- confirm the scope of security interests over the assets being acquired.
If warranties or indemnities are not available to the purchaser’s satisfaction, the purchaser should ensure any risks being assumed are 'priced' into the deal. This could involve 'reverse' consideration being paid by the vendor to the purchaser if the purchaser is inheriting known liabilities.
Where a purchaser obtains meaningful warranties or indemnities from a vendor and has concerns about the financial substance of the vendor, the purchaser may consider seeking security or a guarantee from a third party whose creditworthiness is not in doubt.
Deal Execution Issues Relating To A Nominal Value Deal
Deal execution may be delayed or stymied by counterparties, whose consent is required for the deal. These third parties may seek to use the proposed deal as an opportunity to 're-negotiate' their own deal terms.
Where the mining tenement is subject to a private royalty agreement, the vendor will usually seek to pass on to the purchaser any obligation to pay royalties. The royalty holder may have a veto over a proposed transfer of the mining tenement and may have security over the tenement. This has the potential to complicate and delay deal execution.
Where the mining asset is owned in a joint venture structure, a pre-emption process will usually be triggered as part of a third party sale process. This will typically involve the vendor offering the sale interest to the joint venturers on the same terms as are offered to the purchaser in the absence of obtaining a waiver of pre-emption rights. If the deal value is considered too low, this may create commercial issues for the other joint venture parties (such as asset impairment charges) and this can also complicate deal execution.
Potential Additional Costs
For the purchaser, the real cost of acquiring a mining operation may include a number of liabilities, including rehabilitation costs, environmental liabilities and holding costs.
Costs Of Rehabilitation
The purchaser will need to provide a bond for future mine rehabilitation costs. The purchaser may find that because the existing bond was set some time in the past, the bond is not sufficient to cover the real costs of rehabilitation. Alternatively, the regulator may take the opportunity of the change of owner to revalue the rehabilitation costs and to re-set the bond amount.
The vendor may push for the purchaser to assume pre-completion environmental liabilities (which a purchaser will need to carefully assess prior to accepting the deal). Even if the purchaser only assumes post-completion environmental liabilities, it is often difficult to draw a clear line between a pre-completion liability and a post-completion liability.
Further, as the purchaser usually becomes the holder of the environmental authority upon completion, it assumes liability under environmental legislation for any breach of conditions or environmental harm. Any penalties and fines which result from this, even if they can be proved to be the result of pre-completion actions, may not be legally recoverable under a vendor indemnity.
If the mine being sold is on 'care and maintenance', prospective purchasers will need to consider a number of factors including the following:
- the ongoing holding costs associated with maintaining the mine,
- the impact for the purchaser of the lack of revenue from the mine, and
- the projected cost of getting the mine back into operation at a future date when economics permit.
Take Or Pay Contracts
The vendor may be a party to contracts entered into on a 'take or pay' basis (such as for the use of rail infrastructure). Prospective purchasers should take into account the ongoing costs associated with these contracts, particularly where the mine is not operating and whether capacity provided by such contracts can be re-deployed or put to another third party.
The current market conditions have created financial difficulties for mining companies. Where a vendor is in financial distress, there may also be a voidable transaction risk. If the vendor later enters into liquidation, the liquidator may seek to challenge the purchaser’s acquisition and the assets acquired by the purchaser may be 'clawed back'. If the vendor is already in formal insolvency, the purchaser is likely to be negotiating directly with the liquidator or receiver and manager. This scenario may add a layer of complexity, for instance, a receiver and manager will want to ensure the asset is sold for the best price that is reasonably obtainable in the circumstances.
A sale of a mining operation for a nominal headline price may not be what it seems for either the vendor or the purchaser. Both parties should carefully consider what the underlying deal really is and ensure all risks are appropriately priced. Otherwise, the deal could be too good to be true!
For further information, please contact:
Matthew Fitzgerald, Partner, Herbert Smith Freehills
John Ware, Partner, Herbert Smith Freehills
Mary Boittier, Herbert Smith Freehills