5. FINANCIAL PROVISIONS AND EQUITY PARTICIPATION

Money is the subject of this section of the SEPA: how much of the mine’s money is to be shared with the Aboriginal community, and how exactly the community will get that share. Many of the terms used in this section may seem foreign and complicated: “Gross RevenuesGross Revenues: money generated by all of a company's operations, before deductions for expenses, sometimes simply called “the Gross.”,” “Annual Net ProfitAnnual Net Profit: calculated by subtracting a company's total expenses from total revenue in a fiscal year, thus showing what the company has earned (or lost) in that year. (Also called “net incomeIncome: money one earns by working or by capitalizing from other people's work.” or “net earnings.”),” “Annual Operating Cash FlowAnnual Operating Cash Flow: a measure of a company's financial health. Equals cash receipts minus cash expenditures over a given period of time; or equivalently, net profit plus amounts charged off for depreciation, depletion, and amortization.,” for example. But a basic understanding of these terms is critical if you are to capture from a SEPA the full range of benefits for your community.

We preface our explanation of this section, therefore, with a brief review of key financial terms. (This reference is reproduced in Appendix 4, p. App-19 if you want to keep it handy.)

Some Accounting Basics

There are four main ways to calculate how much money businesses make in the course of a fiscal year. Each calculation results in a different dollar amount. When negotiating financial provisions with a mining company, you must decide which of these calculations will be the basis for your discussions 

1. Gross Revenues

This is the most simple of the three calculations. Gross Revenues (or “the Gross”) is all the money a business earns from the sale of its products during a fiscal year:

$ Value of goods sold in the fiscal year = Gross Revenues

Gross Revenues is a higher figure than the other three because no money is deducted from it. For that reason, some Aboriginal groups are thinking about negotiating for “a percentage of the Gross.” Mining companies are against using Gross Revenues when negotiating the financial provisions of a SEPA. The Gross does not show how much money it takes to run a business. Mining companies therefore argue that the Gross is an unfair basis for calculating a variable cash payment.

2. Annual Operating Profit

This calculation subtracts from Gross Revenues two types of cost. First come the Variable (or “Direct”) Costs. This is the money the business spent directly on making the product, like wages, fuel, and raw materials.

Second come the Fixed (or “indirect”) costs. This is the money spent on running the business as a whole: management, administration, and leases, for example. One important Fixed Cost is the wearing out of equipment and buildings in the course of the year, or “Annual Depreciation.”

 Unlike other Fixed Costs, Depreciation is not money the business has actually spent in the fiscal year. It is money that the business will spend when the buildings and equipment have to be replaced. In a mine with millions of dollars invested in such assets, Depreciation can be a very big number. By deducting Annual Depreciation from Gross Profit, a business reduces the taxes it has to pay.

3. Annual Net Profit

This third calculation deducts still more of the costs of business: the interest paid on loans, taxes and royalties owed to government, and head office costs. These are called Other Costs.

Net profit is of great interest to shareholders. It indicates how much the value of their investmentInvestment: the purchase of a financial product or other item of value with an expectation of favourable future returns. Generally, “investment” means the deliberate use of money in order to make more money. in the business is growing.

4. Annual Operating Cash Flow

This fourth calculation uses several of the dollar values from the previous three calculations. It starts with the Annual Operating Profit. Annual Depreciation is then added back in (because that money is not actually spent during the year). Finally, the taxes that are payable to government are subtracted.
  

How Important are the Differences Between these Options?

Here is an example of the different look these calculations give to the success of a hypothetical mine in one fiscal year.

Here is the mine’s Annual Operating Cash Flow.

Compare this with the mine’s Annual Net Profit.

Annual Operating Cash Flow is a far higher figure than the Annual Net Profit. Annual Operating Cash Flow is a much more advantageous way for an Aboriginal community’s representatives to calculate the prosperity of a mine when negotiating a SEPA. (See *Case Study #2: Raglan Mine, p. Intro-10.)

These are some basics of business accounting. It is worth the effort to get a firm grasp of this information. For more detailed explanations of each of these key terms, go to www.investorwords.com.

Rationale for Cash Payments

This subsection explains why cash payments are to be made to the Aboriginal community. There may be many reasons:

• To ensure that the Aboriginal community that it will receive direct economic benefits from the project.
• To compensate the Aboriginal community for the foreseen impactsImpacts: the effect or impression of one thing on another such as the impact of a mining project on the life of an Aboriginal community. of the mining project.
• To secure the support of the Aboriginal community for the development and operation of the project.
• To ensure that payments under the agreementAgreement: any explicit, signed document that is negotiated and includes mutual concessions or limitations placed on both sides. Examples are Negotiation AgreementsNegotiation Agreement: an early agreement in the mining process, likely to occur in the Exploration StageExploration Stage: the whole range of activity from searching for and developing mineralMineral: A naturally-occurring, homogeneous substance that has a definite chemical composition and (usually) a crystalline structure. deposits., which would outline the basis of the relationship between the Aboriginal group and the mining company and how the relationship will evolve if the mine moves forward. , Exploration Cooperation Benefit Agreements, Socio-Economic Participation Agreements. can be handled in a specific way when the company pays taxes. (For example, that these payments may be considered as deductions from mining royalties, or from incomeIncome: money one earns by working or by capitalizing from other people's work. tax.)
   

The “Case” Against Financial Compensation

Mining royalties are a type of tax that mining companies pay on the value of the resources that they extract from the ground. Governments in many parts of Canada (including Yukon) have agreed to pass on a portion of mining royalties to Aboriginal communities. In certain parts of the country, there are no such arrangements.

Where such arrangements do exist, mining companies often argue that these royaltyRoyalty: in mining, a royalty is a tax that mining companies pay to government for the extraction of public resources. In Yukon, mining royalties are a percentage of an amount roughly equivalent to a company’s Annual Operating Profit. payments are a kind of financial compensation to Aboriginal communities. Since these communities “already” receive this money, they should expect less financial compensation from a SEPA - or even none at all.

This argument is unsound for two reasons. First, royalty sharing is the result of a government-to-government agreement. It has nothing to do with the mining company. Second, royalties are a tax on the use of public resources. It is a cost that mining companies must pay, whether or not they pay financial compensation to Aboriginal communities.

To use royalty payments as an excuse to reduce or avoid provisions for financial compensation is a very questionable way to conduct SEPA negotiations. The mining company that does so may hope to mislead an ill-informed Aboriginal party. It stands to reason that a mining company should strive to limit its costs and maximize returns to shareholders. That is no excuse for negotiating in bad faith, however.

Fixed Cash Payments

Fixed cash payments are payments that do not rise and fall with the company’s cash flow or profitability, mineralMineral: A naturally-occurring, homogeneous substance that has a definite chemical composition and (usually) a crystalline structure. prices, the quantity of ore extracted, or any other variable. Fixed cash payments may at first appear generous. However, if a mine is successful, fixed cash payments can be extremely small in comparison to the money that the company is making, as the following example shows.

In the case of the Ekati mine (see *Case Study #1: NWT Diamond Mines, p. Intro-10), Lutsel K’e Dene, Dettah, Ndilo,, Deninu Kue and each agreed to receive an annual fixed payment of $250,000.⁵ This fixed payment is tiny compared to what other First Nations have achieved in other settings and to the profits made from mining diamonds in the region.⁶ Lutsel K’e Dene achieved a better financial provision (annual compensation of $804,000) in the Participation Agreement for the Diavik mine. Still, in light of the profit that mine makes annually for Rio Tinto, the fixed payment is very small.

Fixed cash payments are one way to share in the wealth created by a mine. But take care during negotiations not to accept fixed cash payments and to forego variable cash paymentsVariable Cash Payment: a cash payment based on a mathematical formula that contains variables, like costs of production. Consequently, the amount of the cash payment can change as the variables do.. Variable cash payments may offer far greater financial benefits over the long term. Through the combination of fixed and variable cash payments stipulated by the Raglan Agreement, Inuit and Innu communities have captured substantial benefits – far greater than the Lutsel K’e Dene have achieved in any of their IBAs. (See next topic, “Variable Cash Payments.”) It will be interesting to see if the renegotiation of these agreements results in more even-handed financial provisions.

Variable Cash Payments

Variable Cash Payments are payments that do rise and fall over time. This is because they are calculated on the basis of factors that change: a mine’s production rates, its production costs, and/or market conditions. Many agreements have not included variable cash payments. Others have. Variable cash payments can have a big impact on the amount of financial compensation that an Aboriginal community receives.

There are four main options in terms of variable cash payment: Net Smelter ReturnNet Smelter Return: a percentage of the total sales of the mine’s product, minus the costs of transportation to the smelter and the costs of smelting and refining., percentage of Gross Revenues, percentage of Net Profit, and percentage of Annual Operating Cash Flow.

1. Net Smelter Return

Net Smelter Return (NSR) is a percentage of the total sales of the mine’s product, minus the costs of transportation to the smelter, and the costs of smelting and refining. The percentage is generally very small – less than 2.5%. The advantage of the NSR is that it can generate revenue for the Aboriginal community as soon as a mine starts selling its product.

If a mine’s profits were low, an Aboriginal community could realize more revenue through a NSR than through variable cash payments that are profit-based. If a mine’s profits were high, other options for variable cash payment would generate better revenue for the community. To decide which option could generate the best return, consult an industry expert.

In the Yukon, Sherwood Copper Corporation started production at the Minto mine in 2007. In a Cooperation Agreement with Sherwood, Selkirk First Nation negotiated a modest 0.5% Net Smelter Return on mine production. The agreement ensured local employment and contracting opportunities for First Nation businesses. It also committed Sherwood to provide training for construction, mining, and processing plant jobs.⁷

2. Percentage of Gross Revenues

This option for variable cash payment assigns to the Aboriginal community a percentage of the value of the mine’s total product sales. Very recently, a few Aboriginal parties have bargained for a percentage of Gross Revenues. As far as we know, they have not succeeded in making it part of a SEPA. Mining companies argue that a percentage of “the Gross” is unfair, because it takes into account none of the costs of production. (See Appendix 4, p. App-19.)

Mining companies might reconsider this position if they looked at a common practice in the agricultural sector. Farmers often use a percentage of Gross Revenues when renting or leasing their land. They charge the other party a percentage of the value of the yield per acre. When the yield is good, the payment goes up. When the yield is bad, the payment goes down. This is considered fairer than charging a fee based on the acreage leased, which remains fixed despite factors the farmer cannot control (like the weather). In the mining industry, world commodityCommodity: physical substances, such as metalsMetals: one of more than a 100 basic earth elements, grouped under minerals. Includes iron, lead, zinc, and copper., that can be sold or exchanged in a marketplace. prices would be just such an uncontrollable factor.

In SEPA negotiations to date, mining companies have stoutly resisted variable cash payments based on the percentage of Gross Revenues. It will be interesting to see if their minds can be changed by the logic of the example set by the agricultural sector.

3. Percentage of Annual Operating Cash Flow

Unlike the previous option, a percentage of Annual Operating Cash Flow takes into account certain costs of production at a mine, as well as revenues. (See Appendix 4, p. App-19.) It is a type of profit-sharing.

A percentage of Annual Operating Cash Flow was captured by the Aboriginal communities that were party to the Raglan agreement (see *Case Study #2: Raglan Mine, p. Intro-21). The provisions are very innovative, and have generated large financial benefits for the communities.

The company is allowed roughly six years to use its earnings to recoup its costs of exploration and construction. After that, it will share 4.5% of the mine’s Annual Operating Cash Flow with the neighbouring Inuit communities and with Nunavik Region as a whole. As a result, Makivik Corporation received payments of $300,000 in 2005, $9.3 million in 2006, $32.6 million in 2007, and $6.8 million in 2008. A total of $65.4 million has flowed back to Aboriginal interests.⁸

4. Percentage of Annual Net Profit

Another option for variable cash payment is the percentage of Annual Net Profit. This is the profit that the owners (shareholders) of a company draw earnings from, either as a dividend or as an increase in share price. While Annual Net Profit is definitely a legitimate item to negotiate, the Annual Operating Cash Flow is a much better target. It will yield an even higher return to the Aboriginal groups that succeed in negotiating it. (See Appendix 4, p. App-19.)

To have access to a mining company’s Annual Net Profit, you require a share in its ownership, or “equityEquity: the dollar value of what a person or organization owns (as opposed to debt, which indicates what a person or organization owes). A person or organization can have an equity interest in something if they have part or full ownership. interest.” In other words, you must first put cash and other assets of your own at the disposal of the company. (See Module 6, “Factors Affecting the Allocation of Shares,” p. 6-16.) Equity interests in large companies are usually acquired through the purchase of shares on the stock market.

We found no examples of Aboriginal communities that negotiated equity interests in Canadian mines. Nonetheless, equity interests are a possibility. The SEPA that Tr’ondëk Hwëch’in negotiated with Loki Gold/Viceroy awarded the Aboriginal community no equity interest in the Brewery Creek mine. (See *Case Study #3, p. Intro-30.) However, were that mine ever to expand onto Tr’ondëk Hwëch’in’s Category A Settlement LandsCategory A Settlement Lands: in Yukon, lands in which a specified First Nation owns both the surface and the subsurface., things would be different.

Tr’ondëk Hwëch’in’s Due DiligenceDue Diligence: a financial and technical investigation to determine whether an investment is sound. Each party to a business agreement uses Due Diligence to ascertain the actual quantity and quality of the assets which the others claim they can contribute. of the mining company and project revealed that the ore bodyOre Body: a mineralized mass whose characteristics and economic limits have been examined. extended into Category A Lands. Tr’ondëk Hwëch’in therefore negotiated provisions for an equity interest in any expansionExpansion: increasing the area or size of a mine or exploration area. Expansion may trigger a new environmental assessmentEnvironmental Assessment: a written report, compiled prior to a production decision that examines the effects that proposed mining activities will have on the natural surroundings.. of the mine onto those lands. The company would pay for the exploration and for any subsequent Feasibility StudyFeasibility Study: a study of a proposed project’s product or service, market, competition, organization, and finances to determine if it can make a profit.. If the Feasibility Study turned out to be bankable, the company and Tr’ondëk Hwëch’in could then enter into a Joint VentureJoint Venture: commonly, a business to which two or more parties contribute the essential land, capital, and services, in return for a share in its ownership and control. (Note: the Joint Venture is very strictly defined under Canadian law.) agreement. The company would get a 70% equity interest in that mining, and Tr’ondëk Hwëch’in would get 30%.

Compensation Provisions

This subsection stipulates compensation that the company will pay to Aboriginal harvesters or others for losses or expenses they incur as a result of the mine.

The Raglan Agreement (see *Case Study #2: Raglan Mine, p. Intro-21) addresses compensation in two ways.

First, there is compensation for relocation. If Inuit camps and equipment have to move because of the mine, compensation must be discussed and paid. Second, there is compensation for damage from toxic substancesToxic Substances: poisonous matter (either man-made or natural) which causes sickness, disease and/or death to plants or animals.. If the operation of the mine poisons some part of the environment, compensation must be discussed and paid.

Suspension of Payments

This subsection says under certain circumstances fixed and variable payments may stop. For instance, if the mine is not making money or if the market value of the mineral drops, payments may be suspended.

Development and Remedial Fund

The SEPA may establish a fund for specific purposes. It could be used to promote traditional Aboriginal activities or to reduce damage done by mining. Generally money in such a fund is held in trustTrust: a legal arrangement in which an individual (the trustor) gives fiduciary control of property to a person or institution (the trustee) for the benefit of beneficiaries. by the Aboriginal party.

Adjustments for Inflation

This subsection explains how cash payments may change because of inflation.

Tax Implications

This subsection is likely to be included if government is a signatorySignatory: any person or organization who has signed as a signatory to a document or agreement. to the SEPA. The mining company may specify that its cash payments to the Aboriginal party will be deducted from the company’s income tax, for example.

Security Deposit

This subsection specifies the deposit that the mining company must make to ensure there is money for site reclamation and for compensation. Typically, government regulationsRegulations: rules that govern activities that are occurring on the land. require that this deposit be made, however.

Expenses for Administration, Management, and Implementation

This subsection details sources of funding to cover the costs of implementing the SEPA. The company should provide the largest share of the funding. The Aboriginal community may also choose to contribute, if it is able.

Reimbursement of Negotiation Expenses

The costs of negotiation can range widely, from $150,000-$600,000, depending on the size and complexity of the project. If the Aboriginal party does not have the money to negotiate effectively, the quality of the agreement will suffer. That may harm the relationship between the Aboriginal party and the mining company. For that reason, the mining company may agree to reimburse the Aboriginal party’s costs of negotiation. While these up-front costs are substantial, the benefits from a well-negotiated agreement can be much greater. (See *Case Study #2: Raglan Mine, p. Intro-21, and *Case Study #4: Voisey’s Bay Mine, p. Intro-39.)