Mining Arbitrations and the Role of Specialised Experts in Valuation and Corruption

Mineral exploration and mining are together seen by financiers and investors as one of the most technically complicated and riskiest sectors. By its nature, a mining project involves defining a resource which may be deep underground, and then designing an approach to mine and process it in a way that is profitable, while minimising technical, economic and environmental risks. The elapsed time between resource discovery and starting production can be 20 years or more.

With few new projects being found in the lower-risk parts of the world, mining companies are increasingly having to invest in countries that are less stable and have corruption issues. These problems often combine, with a new regime blaming the previous one for offering mining licences on a corrupt basis, providing an opportunity to take back licences already issued. Licence revocation has been a problem in recent years particularly in South America and Africa. In Africa, this has extended to the detainment of mining company executives, effectively holding them to ransom on the back of tax demands.

The risks are exacerbated by the sums of money involved. As the grade and quality of mineral resources available to be exploited has diminished, and costs have risen more than commodity prices, the mining companies have had to focus on larger and larger scale assets. This means that multi-billion-dollar projects are being developed in countries which may be fundamentally bankrupt, highly unstable and have a history of corruption.

Local political opposition to large mines can be substantial. This can be from parties who feel that they are insufficiently benefiting from the project to groups with real or perceived environmental concerns.

This cocktail of risk, loss, grievance and potential reward often results in the withdrawal of project rights, as a consequence of legal or illegal actions of the host government. Resolution of such issues often involves international arbitration. Given the complex nature of these projects, expert witnesses are often asked to assist the tribunal by providing an independent and objective opinion on a range of technical and financial disciplines.

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In this article, we highlight two increasingly important issues in mining arbitration that require specialist knowledge in this sector: valuation and allegations of corruption.

Valuation: a deeper dive into risks and underlying assumptions

The term ‘mining project’ may be applied to projects at any point in the lifecycle from discovery, through resource definition drilling, technical studies (Scoping, Pre-Feasibility, then Feasibility), permitting, financing, construction, ramp up and then operation. Most projects will make it through some of these steps, only for management to determine that the project will not be large enough or viable to succeed.

Often, arbitrations concern projects in the early, highly uncertain stages of definition and study. In these stages, project sponsors(developers) remain convinced that they have a viable project which will most certainly make it to production, with a strong stakeholders’ return. It can be expected that if the project is expropriated or returns diminished through government action – such as increases in taxation or export duties – the sponsor will feel that they should be compensated for lost returns.

There are three methods typically applied to the valuation of mining projects. In their simplest form, these are a) costs incurred, b)comparison to other assets where there is a clear valuation (such as market capitalisation), and c) valuation by discounted cashflow of the projections. Each of these have complexities. Costs incurred do not correspond to a valuation of the project or even a confirmation of its viability. Comparable assets are often difficult to find as even projects which look similar on the surface (forgive the pun) can justify very different values and be in different regions of risk. The last method using discounted cashflows, is known as the Income Approach, and is the most commonly used by mining companies for their own assets and for investing in those of others.

Cashflow projections are however far from certain. The earlier the stage of definition a project is in (i.e. nearer to Scoping Study than Feasibility Study), the more speculative the projections are. The further a project is from the point of construction, the more the cost estimates and commodity prices are subject to change. To recognise these risks, project model inputs need to be appropriately adjusted by suitably qualified and experienced specialists. Discount rates also need to reflect the hurdle rates a knowledgeable investor would apply for a project of that nature, in that jurisdiction.

On top of the technical and jurisdictional risks, which need specialist evaluation, there is the additional question of whether the project would attract financing and at what cost. The financing cost will be reflected in the discount rate used. Some projects involving commodities such as diamonds and industrial minerals are difficult/expensive to finance, while others such as thermal coal are now arguably impossible to finance. Of course, a project can be financed by a major sponsor from its own balance sheet without separate project finance, but this reduces the field of potential solutions for the project, or ‘willing buyers’ to use the language of valuation.

Ensuring that these risks are properly evaluated and included in a valuation requires in depth specialist skills and experience, often with experts working together.  

Corruption: building a compelling case from red flags

Despite current uncertainty surrounding enforcement of the US Foreign Corrupt Practices Act, there is still positive momentum when it comes to applying anti-bribery and corruption statutes around the world.

As the volume of disputes between investors and states rises as a result of asset confiscation, we are likely to see a range of allegations of bribery and corruption, conflict of interest and fraud in arbitration proceedings, as states in particular seek to negate the validity of contracts and investment rights.

Arbitral tribunals and national courts in annulment proceedings have often relied on corruption red flags (i.e., circumstantial indicators of corruption) to guide their decision-making. Often these indicia are considered together as a pattern of behaviour, not only as individual occurrences.

Parties raising corruption claims need to be clear about the allegations they intend to make and how best to present them compellingly. Both the party making allegations of corruption and the party facing them should consider the following to pave the way to providing expert witnesses with clear, effective instructions:

• What are the corruption risks most typically associated with the matter at hand?
• What kind of evidence is the best to substantiate the allegation?
• How will the evidence be obtained and reviewed?
• How will it be ultimately synthetised and presented for maximum impact?

When reporting, it is important for experts to keep in mind that their primary role is to help the tribunal understand the key issues by explaining their conclusions and reasoning clearly. Experts looking to provide effective reporting must look to:

• Provide context by stating their instructions, assumptions, methodologies, and evidence sources.
• Disclose any relevant documents that would have been expected to exist but could not be obtained, explaining why these were unavailable. There may be justifiable reasons, such as data quality or statutory document retention periods. However, it may be that absence of data and documents in disclosure raises the prospect that information that is relevant and material to the matter has not been disclosed, and in these circumstances, counsel may consider whether the facts could suggest adverse inference.
• Demonstrate how identified red flags may align with corrupt practices by detailing their nature, the detection process, timeline and summarising the pattern based on experience and similar cases. Remember that not all red flags are created equal, as transaction-specific red flags have more probative value than general red flags (e.g., country risk).
• Carefully choose which issues are relevant enough to present, sometimes excluding extensive but less critical analyses.

Counsel and experts must remember that very rarely will they find a smoking gun that removes all doubts about the existence of corruption. Instead, they should aim to present their findings in a manner that underscores the heightened risk of corruption to a point where it is no longer reasonable for the tribunal to ignore it.

Conclusion: the importance of sector-specific judgement

In mining arbitrations, the value of expert input lies not in broad theories, but in sector-specific judgement, dissecting speculative valuations and connecting red flags to credible patterns. The technical and financial complexity of these projects, layered with the potential for politically motivated expropriation or corruption allegations, means that specialised experts are increasingly important in helping tribunals discern the facts underpinning a dispute.

Authors: FRA Associate Director Jorge Lopes and Rockface Capital CEO George Rogers