Term and volume contracts

McCullough Robertson Lawyers Partner Brad McCosker explores the task of preparing a standard operations mining contract in the second and third parts of this six-part series for Australian Mining.

In part one of this series of papers, some of the special features of a mining venture were outlined, and a range of alternative contract models were explored.

In this paper, the next two parts of the series will be addressed.

I will look at whether the contract should be for a term or a volume, whether any volumes are guaranteed and if not, the impact that this has on the tendering contractor, both in negotiations and then in delivery.

A primary question for a mine owner and then for the draftsperson is whether the arrangement will be a term or a volume contract.

The answer will drive how many of the other variable risks in the project might be managed.

The owner should determine, for instance, what amount of overburden and ore is to be removed and in what time period, what mine planning it has in place and the likelihood of change.

Term vs volume

To assist it in reaching its decision (and making the right decision), questions to be asked and answered include whether the owner requires the volumes moved/allocated over a certain number of years, what its degree of knowledge of the deposit is and the sophistication of the mine planning capability that it has available.

A key commercial ingredient that is often overlooked is if early or over production is of any benefit to the owner, or whether it will only add to its costs e.g. rehandling.

An operational issue arises if the contractor’s over performance affects the mine’s operational ability to handle increased volumes of ore to conveyor, or to otherwise transport the resource to a wash or blending plant or rail or truck load out (transport/truck and materials handling capacities), stockpile capacities and to sell or market increased volumes.

Volume

In a Volume Contract, if the minimum or guaranteed quantities are met before the expiry of the duration of the mining contract, the contract ends.

The contractor can commit and schedule its fleet to secure the best return on capital to it and the minimisation of onsite and offsite overheads. In this scenario, and presuming that the owner is not operationally or financially constrained, whether the contractor fulfils the required volumes before the expiry of the term of the contract, i.e. over performs, may be of little significance. This is, however, very rarely the case and an owner most often wants firm control.

Full volume discretion is rarely given and clauses like this are often used:

The Contractor shall execute and complete the Works.

The Contract will commence on the Contract Date and will continue for the Term.

The Principal requires the removal of and the Contractor agrees to remove during the Term the quantities of waste and ore described in the Production Schedule which are estimated volumes only, are not guaranteed and which quantities may be increased or decreased in accordance with the Contract.

The effect of a clause like this is to make it clear that the contract is a Term Contract.

While it is true that the contractor is required to move indicative volumes within the term, there is no absolute promise made that a certain volume of bcm or m3 need to be moved, nor that the contractor will be required to move them.

The contractor can program its fleet (mobilisation, availability, maintenance) and human resources to meet the volume targets and farm out its overhead allocations to and recoup them in a predetermined timeframe.

The contractor also gets guaranteed workflow and cash flow to assist it in assessing any other opportunities.

Term

In a term contract, the management of the rate at which the contractor provides the volume is critical.

The owner usually requires a certain volume to be moved within particular timeframes.

Express terms can be prepared that without a different agreement, the contractor is not to mine the total volume before the expiry of the term.

An example is as follows:

The Contractor must not, subject to the terms of the contract and without the written agreement of the Owner, perform greater production quantities per monthly period (or per cumulative monthly periods) than is or are described in the Production Schedule or otherwise perform and complete those quantities other than in accordance with the Production Schedule, including completing the quantities prior to the end of the Term.

What a clause like this squarely recognises is that if the monthly quantities are not met or are exceeded within the term of the contract then it will have a significant impact on the owner’s mining operations.

Different contracts deal with these sorts of issues in different ways.

What is common is that if the contractor falls behind, the owner will want the right to require any shortfall to be made up. While this is obvious, what about over performance?

Does the owner also want to be able to ‘slow’ the contractor if it gets ahead of its monthly targets?

A key contractual term is for production to be confined to the volumes (e.g. monthly or quarterly) set out in the mine plan and the production schedule.

One industry model agreement offers a clause that addresses the mine plan and production schedule as follows:

8 Mine Plans and Production Schedules

8.1 Owners Mine Plan

(a) The Owner must provide the Contractor with the Owners Mine Plan. The Owners Mine Plan must provide for quantities of production of Ore within the Production Requirements Range. The Owners initial Mine Plan is annexed as Exhibit #.

(b) The Owner may review and vary the Owners Mine Plan as provided in Schedule #. Any such update or modification must not result in the requirement to mine and extract Ore outside of the Production Requirements Range, unless the Contractor agrees in writing.

8.2 Production Schedule

(a) On or before the commencement of mining under this agreement and thereafter as provided in Schedule #, the Owner must provide the Contractor with a Production Schedule.

(b) The Owner may review and vary the Production Schedule as provided in Schedule #. Any such update or modification must not result in the requirement to mine and extract Ore outside of the Production Requirements Range, unless the Contractor agrees in writing.

While this clause states that the owner is required to provide the contractor with a mine plan and production schedule, it is the Production Requirements Range which is the key negotiating issue.

The owner wants certainty of delivered volumes, one benefit to the contractor is that it can more accurately estimate the resources and equipment required to remove certain volumes and seek to minimise its costs. This means what might be called the Production Requirements Range, or in other contracts be called Tolerances or Production Limits (in all cases both ‘unders or overs’), need to be clearly stated and negotiated.

Ground rules

While objectives are relatively easy to state, all too often the parties are left in some degree of uncertainty over whether the contract is Volume or Term, the role of the various documents making up the contract and what happens in the event of inconsistency between the various documents.

Three basic ‘ground rules’ can help avoid this outcome.

Firstly, state very clearly whether the contract is for a Volume or for a Term.

In my experience parties are for some reason often reluctant to do so. I am yet to fathom why. Surely it is wiser to say it clearly if by doing so the risk of later disputation can be reduced, or better still, avoided.

The second ground rule (which sounds obvious), is to spell out what the Mine Plan and Production Schedule is.

Projects will differ, as will the terminology used, but generally, the Mine Plan states the overall work to be done (e.g. clear and grub, topsoil removal, overburden removal, mining of ore) and gives guidance on things like ramps, stockpile locations, dumping methodologies, sequencing and the dimensions and angles of batters and ramps.

To this extent, the Mine Plan is similar to the Scope of Work in a construction context. It often spells out indicative volumes of waste and ore to be removed for each year during the term.

In contrast, the Production Schedule is a subset of the Mine Plan which gets more closely into the ‘details’.

To this extent, it is not dissimilar to the Specification in the construction context.

The interaction of the Mine Plan and the Production Schedule is most important. The owner will want to be able to change both but usually, at least for the Mine Plan, only after a predetermined period of notice.

The Production Schedule is different, it is often a monthly outlook and more susceptible to change.

My view is to clearly spell out what the role of the Production Schedule is. This is better than just attaching (or worse still, just referring to) a bundle of schedules and numbers in drawings.

The drafting could be something like this:

This Production Schedule describes the Owners requirements in relation to the quantities of material to be mined by the Contractor over the Term as follows:

(a) monthly and annual planned quantities of waste to be removed;

(b) monthly and annual quantities of ore to be mined; and

(c) the proposed stripping sequences, for FY09 to FY12 as better explained in Appendices A to C of this Schedule.

The third ground rule is the ‘holy grail’ of a perfect Mine Plan and Production Schedule. This remains the subject of search.

While the endeavour is worthy, its creation is rare. This means, simply, that a good mining contract must hope for the best and anticipate the worst. It must describe the order of priority of the various documents making up the contract and deal with what is to happen if there is ambiguity between those documents.

What happens if the Mine Plan says something different to what is said in the conditions of contract or if the monthly volumes in the Production Schedule are different to what is detailed in the Mine Plan?

The remedy is simple. Much grief can be overcome by adding a clause like this:

The following documents shall form and be read and construed as making up the Contract:

(a) the General Conditions of Contract and its Annexures A to K;

(b) the details in Schedule 1;

(c) the Production Schedule Schedule 4;

(d) the Mine Plan Schedule 3;

(e) the Schedule of Prices and Rates Schedule 2; and

(f) the Companys Plan of Operations and related Policies and Procedures Schedule 5, and any ambiguity or discrepancy between the documents shall be resolved and interpreted according to the same order of precedence as the documents are listed above, with the documents higher in the list having higher priority.

Summary

In summary, a very important question to be considered when preparing a mining contract (and preferably before the mine owner puts its tender documents together to issue to market) and then by the contractor when looking at the fleet or the mix of fleet that it will need to put together to price its tender, is whether the contract is for a Volume or for a Term.

Once resolved, the contract then needs to address the certainty of that volume and term, its likelihood of change and how such change will be managed.

It is in these latter areas where questions concerning scope adjustment and the treatment of time impacts on the production schedule arise. These questions will be dealt subsequently in this series of papers, but one can rest assured that unless the question of ‘term or volume?’ is first asked and answered, the answers to questions regarding scope and time will be much more difficult to find.

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