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Stephens Valuation and Consultancy Pty Ltd

 
Roderick Stephens BSc (Hons) MC AAPI (CPV)   

Quarry Lease Terms and Conditions

Introduction

There are many instances were a quarry operation will be leased and the terms and conditions of the lease will determine the rental value or royalty payments required for the lease. Whilst it is recognised that a lease is very often site specific, there are general terms and conditions that apply to most leases and we consider some of these within this paper.

 

This paper is not intended to provide a definitive guide encompassing all circumstances of a lease but to provide some broad guidelines on some of the common terms and conditions involved. We also recommend that any legal document be constructed by a suitably qualified and experienced solicitor.

The Terms and Conditions

The Parties

 
Both the Landlord and Tenant are identified together with details of their company, and company address for serving of notices etc.

 

Execution

 
For a lease to be valid it also needs to be dated and signed by both parties and witnessed. We recognise that there are circumstances which distinguish the difference between a lease and a licence, but these are outside the scope of this paper.
 

The Site

 
The site address, the area of land, and the lot or folio numbers and the deposited plan or crown plan numbers which identify the area of the lease are usually identified.

 

The Term

 
This involves identification of both a commencing and terminating date. Due to the extensive capital costs usually involved within a quarry processing plant operation then it is usual for quarry leases to be agreed over a 20 to 30 year period. However this can vary and much depends upon the extent of the geological resource and the consented life of the quarry. For a short lease you would usually expect the royalty to be higher than the perceived market value (a premium), and conversely for a long lease, then you would expect a discount to the market value. The latter then allows the quarry operator to be more competitive, and generate additional income for the landlord by increasing the quarry output.  

 

Options
   
It is not uncommon for the term to include a relatively short term basis, but with options to renew the tenancy over a longer period. Other options can include the option to purchase or the first choice in purchasing the quarry. It also needs to be noted that a tenancy can continue after a lease has expired often referred to as Holding over or Held Over and many of the existing terms and conditions are relevant, except that the tenancy can be ended by notice given by either party.

 

User Clauses   

 
Many leases specify the intended use of the site, which needs to be looked at carefully to ensure compliance with planning and environmental regulations. However the user clause can restrict the use of the site, which can provide an opportunity to obtain a reduced rental under certain circumstances. So user clauses can be counter productive and need to be carefully worded and thought out.

 

The Royalty and / or Rent

 
The royalty and / or rent is identified either as a rate per tonne usually, but sometimes as a rate per cubic metre, but can also involve a fixed rent, often referred to as a minimum or certain rent, but also a site rent may also be payable.
   
The Theory
 

For example we consider a hypothetical Landlord who wishes to receive a royalty rent of $1,000,000 per annum for a quarry. We assume a range of quarry outputs from 100,000 to 500,000 tonnes per annum and can calculate the royalties by dividing the landlords income or rent by the potential quarry output as set out below.

 

Quarry Output

Royalty

Landlords

Tonnes

 

Income

             100,000

   10.00

 $   1,000,000

             200,000

     5.00

 $   1,000,000

             300,000

     3.33

 $   1,000,000

             400,000

     2.50

 $   1,000,000

             500,000

      2.00

 $   1,000,000

 

 

 
 
 
The theory being that as quarry output increases, then the royalty drops as economies of scale occur. However in the above example the quarry operator or hypothetical tenant, would not be able to successfully sell any products economically if they paid a $10.00 per tonne royalty, but a much reduced royalty may allow them to be competitive and obtain market share. Therefore if the Landlord in this example wishes to obtain his / her $1 million income, then they may have to subsidise the Tenant to allow them to obtain economies of scale which over time may increase the output to a level suitable for the Landlord.

 

The Reality    
 
On the basis that there are competing quarry operators who are paying perhaps an equivalent royalty of $2.00 per tonne, then clearly a smaller operator paying $10.00 per tonne would be uncompetitive. The cut off point for this is usually the optimum point of capacity, which for the above example we have identified as being $4.00 per tonne. The revised quarry royalty curve is as set out below.

 

Quarry Output
Royalty
Landlords
Tonnes
 
Income
             100,000
     4.00
 $      400,000
             200,000
     3.00
 $      600,000
             300,000
     2.50
 $      750,000
             400,000
     2.20
 $      880,000
             500,000
     2.00
 $   1,000,000
  

 .

 
However the reality of the situation is very different. What usually happens is that there is a fixed rent that is paid which reduces the royalty in exchange for an ongoing annual income, often referred to as the minimum or certain rent.

 

The Minimum or Certain Rent

   
In order to alleviate the problems involved with smaller quarry operators being less competitive than larger quarry operators, then it is usual to incorporate a minimum or certain rent, which often includes the rent for the surface lands, and perhaps a site rent for the processing plant area. The theory behind this is that the Landlord would be prepared to accept a lower royalty if he/she is guaranteed a fixed minimum or certain rent, oblivious of whether a quarry deposit is worked or not. The Tenant on the other hand benefits from occupying the quarry lands for a fixed rent and having an incentive to create economies of scale if they exceed the minimum or certain rent equivalent tonnages.
 

 

 
 
 
The inclusion of a minimum or certain rent vastly reduces the risk of income for the landlord, and a low income with low risk, is equivalent to a high income with a high risk, and consequently benefits both Landlords and Tenants. The tenants benefit from converting uncertain variable costs to fixed costs which creates more stability within their pricing structure. In the above chart for example, the tenant pays a fixed rent equivalent to $3.00 per tonne for the first 200,000 tonnes, and if they exceed this tonnage, then they benefit from a reduced royalty, but if they are short of the target level of 200,000 tonnes, then they can off set the shortfall in later years. This is known as under or over workings.

 

Under or Over Workings

 
Where for instance the quarry output for the Minimum or Certain Rent is not reached then the under workings can be accumulated and off set against future outputs. Over workings on the other hand would firstly be off set against any Under workings, and after that would benefit from reduced royalties. This mechanism provides the incentive for the quarry operator to maximise production and sales, whilst in lower output years, provides a subsidy so that prices and costs can be reduced in subsequent years to create a more competitive pricing structure and hence increase output. There should always be provision for under or over workings within a lease.

   

Rent Reviews

   
Virtually all leases should contain rent reviews. The market changes all the time, and rent reviews allow the Landlord an opportunity to capture lost income. It is usual that many leases involve some form of indexation either via the Consumer Price Index (CPI) or inflation, but also there are construction materials Indices, and sand price Indices or other Indices that can be used to alter royalties and rents. Rent Review periods should ideally involve a 3 year basis to ensure that rents and royalties are kept up to date, although older leases, do involve either 5 or 7 year reviews, and these leases can be more valuable to a Tenant. One of the key aspects of triggering a rent review often involves the timing, and time is of the essence which means that if notice is not served by a particular date, then the rent cannot be reviewed until the next review period. The lost revenue for this aspect can be considerable, and additionally it also makes it harder to obtain increases in a following review. So it is often worth obtaining even a nominal increase because the tenant can then factor this into the pricing structure, and their customers absorb these costs. However where reviews are only pursued over longer periods, and involve hefty increases, then this can lose the tenant customers and impact on the landlords income. Additionally where significant increases are involved, then if opposed can incur substantial costs to remedy. Regular nominal reviews can often avoid this scenario.

 

Restoration / Rehabilitation / After Care   

 
There is always an assumption that the Tenant or quarry operator is responsible for restoration / rehabilitation / after care liabilities. These often involve an annual contribution to a restoration bond, depending upon the area worked or the amount extracted. Making a contribution for restoration as working continues is the most cost effective means of covering the costs for this, as otherwise, where no restoration bond is involved then the tenant would have to pay a large capital cost at the end of the lease to pay for the restoration and could easily prefer to liquidate the company instead. Also where old development approvals are in place, then they do not always identify restoration as a planning condition, however, the likelihood of future legislation regulating this anomaly should not be discounted. There are instances where a Landlord may take on the responsibility of carrying out the restoration and under these circumstances then the rent or royalty would need to be adjusted accordingly. Many Local Authorities are now requesting restoration or rehabilitation bonds to be paid before development approvals can be commenced, and this is adding to the costs of any operator and needs to be carefully managed in any lease.

 

Outgoings and Services

 
Most leases are considered to be either net or gross which effectively determines who is responsible for paying the outgoings at the site. It is usual that the Landlord pays for Land Tax, and Council Rates, and sometimes part of the Water Rates. However where a tenant pays the outgoings themselves, then the rent is often adjusted accordingly. Therefore a gross rent would involve the rent including payment of outgoings and services, whilst a net rent involves the rent by itself.

 

Repairs and Maintenance   

 
The tenant is usually responsible for carrying out repairs and maintenance to any buildings on site, but also for the upkeep of fencing, gates, roadways, services etc.

 

Insurances

 
The landlord is often responsible for insuring the premises, but the tenant is responsible for insurance of the contents, but also both parties have public liability insurance, to cover health and safety issues and work place insurance for staff and members of the public visiting the site.

 

Assignment or sub letting
 
The tenant can assign the lease, subject to the Landlords approval, which often cannot be unreasonably with held. An assignment cannot involve any terms outside of the existing agreement, and cannot exceed the term of the lease unless by agreement.

 

Environmental

 
Environmental issues are often contained and regulated within an Environmental Protection Authority Licence issued for a quarry operation. However the Landlord would not wish to have land contaminated or polluted and it is always wise to set out environmental controls and industry best practice pollution and management controls for the site within the lease. The EPA can shut a site down where a pollution incident occurs, and this could seriously undermine the landlords income, as well as creating a clean up liability, which again in the event of a default could incur costs for the landlord.

 

Forfeiture
 
Every lease should contain details of the mechanism for dealing with disputes, or breaches of the agreement and how each party can terminate the lease, or claim for damages etc

 

Other Legal issues

 
There are many other standard terms and conditions which include liability for stamp duty, GST compliance with development approvals and other statutory legislations and regulations and payment of rates and taxes, together with the rights of statutory authorities to carry out works on encumbrances such as easements, restrictions and rights of carriageway, rights of entry for default and other circumstances, flora and fauna preservation restrictions and management, preservation of riparian corridors, covenants for quiet enjoyment, and many others. As stated earlier every lease should reflect the particular circumstances of the site, and no two leases should be the same.

Conclusion

Lease terms and conditions can vary according to the circumstances and objectives of the parties and a range of other factors. Leases can be difficult to construct, as potentially every change to the terms and conditions can impact on the rent and royalty adopted. If royalties are too high, then this can make the lease uneconomical and likely result in a default and loss of income to the Landlord, whereas if royalties are too low then the Landlord could be missing out on additional income. There is a very fine line in order to keep royalties competitive and maximise output so that both parties can fully benefit from a lease.  

 

The opinions expressed in the above paper are the personal views of the author gained from experience and research within the extractive industries. No responsibilities can be held for any person or company who relies on information within this paper or who attempts to take any extracts from this paper. This paper is not to be used or quoted in part or as a whole for commercial use without the express written consent of the author.

 

Stephens Valuation and Consultancy Pty Ltd

 

By Roderick Stephens BSc (Hons) MC AAPI (CPV)

Certified Practising Valuer

Registered Valuer QLD & WA

PO Box 404

Emu Plains

NSW 2750

Tel No:  02 *4704 *8483         

E mail: rodstephens@optusnet.com.au

Mobile 0423 *383 *343

Website: www.quarryvaluations.com which is a Registered Trade Mark
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