Quasar Resources v APG: Court of Appeal refines understanding in relation to NSR royalties

In Quasar Resources Pty Ltd v APG Aus No 3 Pty Ltd^[1], the Court of Appeal of the Supreme Court of Western Australia considered the meaning of “refining” in the context of the deductible costs for the calculation of a net smelter return royalty. The decision is particularly important for parties negotiating a net smelter return royalty.

Court of Appeal’s decision

The background to the decision is simply stated. There was an agreement entered into in 2002 under which a seller sold mining tenements to a buyer. Under that agreement, the consideration payable by the buyer for the mining tenements included the payment to the seller of a net smelter return royalty as calculated in accordance with the agreement.

While there is no generally accepted meaning of a net smelter return royalty, it is commonly understood as being a royalty based on the relevant percentage of the gross revenue received for the product concerned less smelting and refining costs and penalties and other associated costs (such as transportation, insurance and marketing costs).

APG Aus No 3 Pty Ltd (APG) was the successor to the seller, and Quasar Resources Pty Ltd (Quasar) was the successor to the buyer, under the relevant agreement. As such, APG was entitled to be paid, and Quasar was obliged to pay, the net smelter return royalty.

As typical, the calculation of the net smelter return royalty under the agreement allowed for the deduction of specified costs, including “[c]harges, costs and penalties, if any, for smelting (which does not include crushing), refining and marketing”.

In the proceedings, APG contended that the reference to “refining” should be construed narrowly in accordance with its technical meaning and therefore mean “the final processing of metal bearing products by which impurities are physically separated from the metallic intermediate product, resulting in a pure or nearly pure metal final product”. This construction meant that purification processes preceding the final stage of metal processing would not constitute “refining”.^[2]

Conversely, Quasar contended that the reference to “refining” should be construed broadly in accordance with its ordinary meaning and therefore mean the purification and upgrading of a commodity from an impure state. This construction meant all processing operations directed to purifying or upgrading the relevant commodity, including those preceding the final processing stage, constituted “refining”.^[3]

The Court of Appeal found that the reference to “refining” in the context of an agreement for the sale of mining tenements meant that “refining” should be given the meaning which it was commonly understood to have in the Australian mining industry at the relevant time.^[4] In doing so, the Court of Appeal endorsed the technical meaning of “refining” set out above.

What can be learnt?

While each contract must be construed by reference to its particular text, context and purpose, the Court of Appeal’s decision is nevertheless instructive to parties negotiating a net smelter return royalty. Put simply, if the description of the deductible costs in the relevant contract for the purposes of the calculation of the net smelter return royalty only refers to costs of refining (and not the costs of milling, beneficiation, upgrading or concentrating), then there is a real risk that costs related to the milling, beneficiation, upgrading or concentrating of the relevant product will not be deductible.

Where parties are negotiating a net smelter return royalty on the basis of the Energy & Resources Law Association (formerly AMPLA) model mineral royalty deed, the Court of Appeal’s decision is less relevant, as the pro forma definition of “Allowable Deductions” in the model deed expressly makes clear that the “Allowable Deductions” include costs of refining but do not include costs paid or incurred in milling or other initial processing. The pro forma definition of “Allowable Deductions” under the model deed reflects the common commercial position in Australia in relation to the deductible costs for a net smelter return royalty.

If parties are negotiating a net smelter return royalty on the basis of the model deed and they intend for the costs of milling, beneficiation, upgrading or concentrating to be an “Allowable Deduction”, then that definition will need to be specifically amended to include the relevant costs.