Due diligence in domestic mining M&A

By Sun Yunzhu and Zhong Ming, East & Concord Partners
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China’s 13th Five-Year Plan pointed out that the central government should support mining enterprises to upgrade technologies, guide the merger and acquisition (M&A) of small mines, and close outdated and environmentally unfriendly mines. In the Development Plan for the Nonferrous Metals Industry (2016-2020), the Ministry of Industry and Information Technology said the regional consolidation of mines should be promoted across the country to expedite large-scale development and intensive use of resources.

Sun Yunzhu, Partner, East & Concord Partners
Sun Yunzhu
Partner
East & Concord Partners

M&A projects in the mining industry are unlike other ones for special core assets (non-renewable mineral resources), requiring high levels of expertise in value evaluation and in evaluating various risks. During the legal due diligence on such M&A projects, attention should be paid to following aspects:

The authenticity of mineral reserves. For mining sector M&A, the mineral reserve is one of the biggest risk factors, apart from market price and conditions for mining and mineral processing. The estimation of mineral reserves involves multiple factors, such as the complexity of an ore body’s geological structure, the control and study of ore deposits, the choice of exploration grid density and engineering techniques, and the choice of estimation methods. When performing legal due diligence on such M&A, lawyers should advise the acquirer to hire experts to examine existing mineral reserves and/or commission evaluation centres where the target mines are located to review exploration reports, on top of reviewing annual inspection reports on resource exploitation, exploration reports, and examination registration reports of target companies, as well as their real production and sales. The purpose is to ensure the authenticity of mineral reserve information provided by target companies.

Legitimacy of the obtainment and disposal of mining rights. For a mining M&A project, whether the transfer of mining rights is legal is key to assessing its feasibility. During legal due diligence, lawyers should examine the following issues: the way the target company obtains the mining rights, as well as the term of validity of the rights and attaching restrictions; whether the mining rights owner has paid fees for exploration rights, fees for exploitation rights, resource taxes, compensation fees for mineral resources, and deposits for environmental restoration in mineral exploitation; whether the exploration rights owner has completed the required minimum exploration and survey input; whether the exploration rights owner has obtained the mineral exploration and survey permit for two years, or whether new mineral resources are found for further exploration and survey, or exploitation within the exploration and survey operations area(s); whether the mining rights are included in consolidation plans by the government; whether it is possible that the mining rights certificates cannot be renewed upon the deal’s completion; and whether the target company, without approval, illegally contracts for or leases mining work, transfers the mining rights, or co-operates with others in mineral exploitation.

Legitimacy of the land for mining M&A projects. As most mineral resources are under the earth, mining M&A projects will inevitably involve target companies’ use of state-owned land. When conducting legal due diligence, lawyers should examine the following issues: whether target companies have obtained the right to use state-owned land; whether the construction projects of target companies have been approved; whether the approved construction projects that need to use state-owned land have legally obtained the approval of land for construction purposes; whether target companies that involve rural collective land have been approved to rent or take over that land for construction purposes, or use farmland for other purposes; whether target companies have been approved to use grassland and forest land for production; and whether target companies have worked out and strictly implemented programmes of land rehabilitation, and water and soil conservation.

Zhong Ming Associate East & Concord Partners
Zhong Ming
Associate
East & Concord Partners

Work safety. According to the Regulation on Work Safety Licences released by the State Council, the state applies a work safety licensing system to enterprises engaged in mining, construction, the production of dangerous chemicals, fireworks and crackers, and blasting equipment for civil use. No enterprises may engage in production activities without work safety licences. Therefore, lawyers should pay attention to the following issues: whether target companies have obtained work safety licences, purchase permits for blasting equipment for civil use, licences for blasting operation organizations, and licences for blasting operators; whether target companies have paid deposits for production risks; whether the construction, operation and closure of tailing ponds, as well as the reuse of closed tailing ponds, comply with the Safety Technical Regulations on Tailing Ponds; whether new mining companies’ projects have safety reports; and whether safety equipment passes the inspection of work safety supervisory authorities.

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Feasibility of M&A plans. After completing the due diligence and assessment of target companies, it is important to work out feasible M&A proposals tailored to the characteristics of target companies and comprehensive information of M&A projects. According to the Measures for the Administration of Transfer of Mineral Exploration Rights and Exploitation Rights, mineral exploration rights owners may, upon fulfillment of the required minimum exploration and survey input and approval in accordance with law, transfer the mineral exploration rights to another person. A mining enterprise having obtained the exploitation rights may, subject to approval, transfer the exploitation rights to another person for exploitation as a result of enterprise amalgamation, separation, engaging in a joint venture or co-operative venture with another person, or as a result of the sale of the enterprise assets as well as other circumstances that change the property rights of the enterprise assets necessitating a change in the main body of the exploitation rights. The acquirer can also gain control over the core assets of target companies through equity financing.

Sun Yunzhu is a partner and Zhong Ming is an associate at East & Concord Partners in Shenzhen

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