Safeguarding your royalty interest: A primer on strategies

Royalty financing is a well-recognized alternative to traditional types of financing in the mining world. It is an attractive means for companies to obtain capital for projects without share dilution, increasing leverage, or relinquishing operational control. For investors, the returns can be significant, but so can the risks. The question of how best to protect royalty interests from potential downsides is therefore ever-present.

The predominant legal issue concerning royalties, according to Barry Barton, author of “Canadian Law of Mining,” is ensuring the royalty binds subsequent property owners. Royalty holders want their interests to be enforceable against successors of the royalty grantors, increasing the lifespan of the investment and therefore profitability (or its prospect). However, the law has not always been straightforward on what is required to achieve this.

Structuring a royalty interest

Generally, structuring a royalty interest as a property interest rather than a contractual interest increases the likelihood that the royalty and associated obligations will bind successors. At law, an interest in land typically runs with the land through ownership changes, whereas a contractual interest is a personal right enforceable only against the original grantor. This “land interest versus contractual interest” distinction is often at the heart of the dispute in insolvency proceedings involving assets subject to royalties — highlighting the importance of characterization.

Royalty holders in Canadian common law jurisdictions cannot assume that their royalties are, by default, interests in land that will survive property transfers — even if that is the parties’ expectation. When creating such interests, royalty holders must be guided by, among other things, the two-step measure endorsed by the Supreme Court in “Bank of Montreal versus Dynex Petroleum Ltd.” and ensure that: (i) the royalty agreement clearly expresses the participants’ intent that the royalty constitutes a property interest, and (ii) the interest out of which the royalty is carved is an interest in land.

Royalty agreements, according to Barton, should unambiguously incorporate legal provisions that enhance the probability that the royalty will “run” with the land, such as the following: (i) language granting or reserving a royalty interest in the real property; (ii) a complete list and legal description of the properties subject to the royalty; (iii) the right to register a notice of interest on title; and (iv) a prohibition against property transfers unless the transferee expressly assumes the royalty and related obligations.

A caution from the court

The Ontario Superior Court of Justice cautioned in “St. Andrew Goldfields Ltd. versus Newmont Canada Ltd.,” that “royalties and royalty agreements are unique and have to be read with care.” To safeguard one’s royalty interest — regardless of type — the agreement must be thoughtfully crafted, moving beyond the incorporation of some “magic words” and give due regard to, at a minimum, all the facts of the transaction, the type of interest out of which the royalty derives, each party’s intention and objective, potential future disputes, and clarity in drafting. If a litigant later challenges whether the royalty runs with the land, the expressed intention of the contracting parties should at least guide the court in adjudicating the dispute.

Once an agreement is entered into, the royalty holder should, where possible and as soon as practicable, register a notice or caveat of its interest against the relevant properties with the applicable land title office or ministry. This registration will establish the priority of interest in the properties against subsequent interests of third parties, and the act of notifying the public may also be seen as evidence that the royalty is intended to bind new property owners.

Ontario law does not preclude courts from granting vesting orders conveying land to purchasers free and clear of encumbrances such as royalties. However, the Court of Appeal for Ontario said in “Third Eye Capital Corporation versus Dianor Resources Inc.” that “it is difficult to think of circumstances in which a court would vest out a fee simple interest in land.”

In “Dianor,” although the holder’s gross overriding royalties — which were deemed by the Court to be between a property interest and a contractual interest — were extinguished by the motion judge erroneously and not reinstated on appeal, it was primarily owing to the company’s failure to appeal the initial ruling within the legislatively prescribed timeframe. This is another reminder to royalty holders to stay vigilant in safeguarding their interests.

Samantha Weng is an associate; and Simon Grant, Jane Helmstadter, and Ali Naushahi are partners at Bennett Jones LLP in Toronto.

Samantha’s practice centres on the acquisition, disposition, financing, and leasing of commercial properties throughout Ontario. Simon advises on a broad range of financing and lending matters, with an emphasis on complex cross-border financial transactions. Jane advises clients on a full range of domestic and cross-border purchase and sale, property development, financing, asset management, leasing, and JV transactions. Ali practices corporate and securities law, with an emphasis on corporate finance, M&A, and mining.