Keeping Your Options Open: Illidge v. Sona Resources Corporation

Mineral exploration option agreements (also known variously as “option agreements”, “earn-in agreements” or “farm-in agreements”) are agreements which have not often been examined by our courts. The recently decided British Columbia Court of Appeal decision in Illidge v. Sona Resources Corporation (“Illidge”) illustrates a number of points to keep in mind when negotiating and drafting these agreements.

The Decision: Illidge v. Sona Resources Corporation 

Illidge concerned two option agreements (the “Agreements”) that were entered into in 2002 between Sona Resources Corporation (“Sona”) and the owners of several mineral properties (the “Owners”). Under the Agreements, the Owners granted Sona options to acquire full ownership of the mineral properties. Sona’s right to exercise the options was subject to the satisfaction of certain conditions, including payment of a yearly advance royalty and completion of a “bankable-quality” feasibility study. Sona paid the advance royalty until 2013 and incurred considerable cost toward producing the feasibility study, but ultimately ran out of funds.

In November 2014, the Owners purported to terminate the Agreements for reasons including that Sona did not satisfy the royalty or feasibility conditions. In December 2014, Sona tendered the advance royalty for 2014. The Owners did not accept Sona’s tender and commenced an action in the British Columbia Supreme Court seeking a declaration that the Agreements were terminated.

The Owners were not successful at trial and Sona retained its option rights. The trial judge identified three main issues with the Agreements:

1. They failed to define a “bankable-quality” feasibility study;
2. They failed to identify a specific time limit for completion of the feasibility study; and
3. They failed to define the timing for payment of the advance royalty payments beyond specifying the date for the first payment and requiring that they be made “per year”.

Issues 2 and 3 were of particular concern. The Court held that absent the parties agreeing in the contract to a specific time-limit, Sona had a “reasonable” period within which to complete the feasibility study. The court found that this period had not lapsed, but that determining its upper limit was not possible. Similarly, the language stipulating payment “per year” was held to be found sufficiently broad that Sona had not made late payment.

The Court of Appeal confirmed that where an option agreement does not stipulate the time available to satisfy a condition, the courts will imply a requirement that the condition must be satisfied in a “reasonable time”. What is “reasonable” must be determined upon the facts of each case. That determination will consider concepts of commercial practicality, including the diligence with which an optionee pursued its obligations and the achievability of the obligations within a certain period of time, as well external factors such as prevailing economic conditions and metal prices. The reality of the undertaking must also be considered, including the exploration results to date and the cost of the work yet to be performed. The Court noted that the determination of a reasonable period of performance must contain a strong element of business sense and the end date for the exercise of the option should not be “remote”.

The Court of Appeal agreed that the reasonable period for the completion of the feasibility study had not passed, but unlike the trial court, held that determination of the period’s upper limit was possible.

As to the royalty payments, the Court held that given the ambiguity of the language in the Agreements and absent further evidence regarding the timing of past events, “per year” meant the calendar year. Accordingly, the 2014 payment was not late. The Court further held that if its interpretation of “per year” is incorrect, relief from forfeiture of Sona’s option rights should nonetheless be granted because time was not made of the essence in the Agreements or via notice provided to Sona.

Ultimately, the appeal was allowed, but only to the extent of determining the upper-limit of the reasonable period of time for completion of the feasibility study. As a result, the parties have the opportunity to address the issue via written submissions to the Court of Appeal.

Practice Points: Negotiating & Drafting Mineral Exploration Agreements

While the decision does not cover new ground, it illustrates some important points to be mindful of in negotiating and drafting mineral exploration option agreements:

1. A “bankable” or “bankable quality” feasibility study is a commonly used industry term, but does not have a defined meaning at law. Such a term should be clearly defined in commercial mining agreements, including option agreements.
2. An option holder must strictly comply with the terms of the grant of option in order to be entitled to exercise the option. For this reason, it is important that the preconditions for exercise of the option be described clearly. In the absence of certainty, courts will make a determination as to the intentions of the parties. This may involve weighing factors the parties did not initially take into consideration.
3. As an example of the concern identified above, failure to clearly specify time periods for satisfaction of option preconditions may result in a court deciding that a reasonable time period should apply, and what length of time constitutes a reasonable period.

The Agreements in this matter were plagued with easily avoidable yet significant errors. Careful drafting will prevent this situation from arising and ensure that parties entering into an option agreement do so with a clear understanding of what is required in order for the option rights to be exercised.