What a 2% net smelter return royalty actually pays

A 2% net smelter return royalty is not 2% of a mine. It is 2% of a cheque — the one the smelter sends the operator — less the smelter’s own charges, for as long as the mine ships concentrate and not one day longer. If you option your claims to a listed junior, hand over 100% of the ground three years later and keep a 2% NSR, you have traded a property for a formula. Whether the formula ever produces money depends on a mine being built, which most properties never see, and on roughly a dozen definitions that most people sign without reading.

The money in the sector makes the formula worth reading. Natural Resources Canada puts Canadian exploration and deposit-appraisal spending at $4.4 billion for 2025 on preliminary figures, with junior companies accounting for about half of it in 2024 (NRCan Canadian Mineral Exploration Information Bulletin), and almost every junior dollar goes into ground that somebody else optioned to them and kept a royalty on.

What “net smelter return” means — and what it never deducts

The word doing the work is net (the glossary has the one-line version). Gross proceeds are what the smelter, refinery or buyer pays for the concentrate, doré or ore. From that, a well-drafted NSR lets the operator deduct only the costs incurred after the product leaves the mine: smelter and refinery treatment charges, refining charges, penalties for deleterious elements like arsenic or mercury, the cost of trucking or shipping the product to the smelter, insurance in transit, and — in some agreements — independent assay and umpire charges. The percentage applies to what is left.

What comes off is short. What does not come off is the entire mine: drilling, blasting, hauling, crushing, milling, tailings, reclamation, head office, debt service and depreciation all stay with the operator. That is the whole point of the instrument. You have no say in the mine plan, so you should not be exposed to the operator’s cost discipline, and an NSR is the royalty that achieves that.

The two neighbouring instruments show the boundaries. A gross overriding royalty allows no deductions at all — it is a percentage of gross proceeds, and it is the oil-and-gas default that occasionally migrates into mining deals. A net profits interest sits at the other end: the holder is paid a share of profit after the operator has recovered capital and operating costs, which means the holder is paid last, is paid only if the accountants say there is a profit, and needs audit rights it will actually use.

How big an NSR is, and what the buyback does to it

On grassroots and early-stage Canadian properties the vendor-retained royalty runs from 0.5% to 3%, and 2% is the number you will see most often. Eagle Plains Resources, a project generator that has built a business on optioning ground and keeping royalties, describes most of its portfolio as 2% NSRs with a right for the optionee to buy back 1% for $1 million (Eagle Plains, Royalty Generation). That structure — 2% retained, half of it repurchasable for a fixed sum — is close to a market convention.

The buyback is where you, as vendor, give up the most without noticing. A fixed buyback price is set when the property is moose pasture and exercised when the operator has a feasibility study in hand and knows exactly what the 1% is worth. If that number is $1 million on a deposit that will produce $200 million a year in net smelter returns, the operator is buying a $2-million-a-year income stream for six months of it. Once you see this, you ask for one of three things: a buyback window that closes before a production decision, a price that escalates with a milestone (a resource estimate, a feasibility study, first production), or no buyback at all and a right of first refusal on any sale of the royalty instead.

The definitions that decide whether an NSR pays

The disputes in NSR agreements rarely concern the percentage. They concern six or seven definitions, and the drafting on each is settled enough that leaving one out is a choice.

Metal that is never sold. An operator that keeps refined gold in a vault, delivers it to a lender, or ships it to an affiliate has not received a smelter payment. The agreement needs a deemed sale: a price fixed by reference to a published benchmark (the LBMA gold price, the LME cash settlement price for copper) on a stated date, usually the date the product leaves the refinery or the end of the month.

Affiliate sales. Product sold to a trader or smelter related to the operator is priced as if it had been sold at arm’s length, and the marketing or off-take charge of an affiliate is not a permitted deduction. This is the clause that generates the most heat, because it is the one an integrated operator has the most room to use.

Commingling. If ore from the royalty ground is blended with ore from adjoining claims before it reaches the mill, the royalty holder needs an obligation to weigh, sample and assay each stream before commingling and to allocate proceeds on that basis. Without it you are arguing over a mill feed you cannot separate.

Hedging. The operator’s forward sales, options and streaming arrangements are its own business. The standard clause excludes hedging gains and losses from the calculation entirely, so the holder is paid on physical sales at the price actually received or deemed.

A cap on deductions. An NSR is only as net as the operator’s smelter contract makes it. Some vendors negotiate a ceiling — deductions may not exceed a stated percentage of gross proceeds — so a bad off-take contract cannot swallow the royalty.

Audit and records. The holder gets quarterly statements showing the calculation, an annual audit right at its own cost, and a shift of that cost to the operator where the audit finds an underpayment above a threshold (3% to 5% is usual). A royalty without an audit right is a royalty the operator calculates for you, at its own pace.

Minimum advance royalty. Where the vendor wants the operator to keep moving, an annual advance payment starts on a set date or once a resource is defined, and is credited against royalties once production begins. It is the only cash you will see on a property that never becomes a mine.

Does a net smelter return royalty survive a sale of the property?

Your NSR is a contract between you and the optionee. Five years later the optionee sells the claims, goes into receivership, or merges them into a larger land package, and the person now holding the ground never signed anything with you. Whether the royalty binds that person depends on a question Canadian courts have been answering since 2002: is the royalty an interest in land, or a personal right to be paid?

The Supreme Court settled the framework in Bank of Montreal v. Dynex Petroleum Ltd., 2002 SCC 7: a royalty can be an interest in land where the language of the grant shows the parties intended it to be one, and where the interest out of which it is carved — the mineral claims or lease — is itself an interest in land. Intention is found in the words. A royalty described as “an interest in land running with the property” that binds “successors and assigns” and survives any transfer of the claims is one thing; a covenant to pay a percentage of proceeds is another, and it evaporates when the covenantor does.

The Ontario Court of Appeal applied that test to mining royalties in Third Eye Capital Corporation v. Ressources Dianor Inc., 2019 ONCA 508, and the facts are the ones you should worry about. A secured lender had the royalty-burdened claims sold through a receivership and asked the court for a vesting order that would strip the gross overriding royalties off title. The Court held the royalties were interests in land — ownership in the product of the claims, not a fixed monetary obligation. It then set out the test a court must apply before vesting such an interest out: the nature of the interest first, then whether the holder consented, and only then the equities. An ownership interest in land, the Court said, cannot be extinguished without the holder’s consent absent unusual circumstances. The royalty holder still lost. It had appealed the vesting order outside the ten-day period under the Bankruptcy and Insolvency Act, and the Court declined to extend the time. The law was on its side and the calendar was not.

The Alberta Court of King’s Bench added the most recent word in Durham Creek Energy Ltd. v. Chimera Management Group Ltd., 2025 ABKB 246. A royalty does not need “magic words” to be an interest in land; the court reads the parties’ objective intention against the commercial context. That helps you if your royalty was loosely drafted. It does not help you if you would rather not litigate the question in a receivership.

Recording the royalty against the claims

Drafting the royalty as an interest in land is half the protection. The other half is putting it on the public record, so the purchaser or lender who comes later takes with notice of you.

In British Columbia, Mineral Titles Online accepts net smelter royalty agreements and option agreements for registration against mineral claims, with the recorded holder’s consent unless the holder is a party to the document. The province is careful to say registration is “for public record only” — the Chief Gold Commissioner does not adjudicate the royalty’s validity — but public record is exactly what a royalty holder needs. In Ontario, claim transfers run through the Mining Lands Administration System online, while agreements, debentures and liens are still filed against the claim abstract on paper, at $15 per claim; I covered the mechanics in the companion piece on mining option and earn-in agreements. When claims are converted, merged or replaced by a lease, the royalty agreement should oblige the operator to re-register against whatever tenure now covers the ground — the encumbrance provisions of the Mining Act carry recorded interests forward to converted cell claims, but a royalty over some of the legacy claims that were merged into one cell is a priority argument waiting to happen.

What to do, on each side of the table

If you are the vendor keeping the royalty, put it in a standalone royalty agreement rather than a schedule to the option, grant it expressly as an interest in land that runs with the claims and any successor tenure, require registration on exercise of the option and on every transfer, and treat the buyback as a real negotiation rather than boilerplate. Ask for a right of first refusal on any sale of the royalty ground.

If you are the optionee or operator, the royalty is a permanent cost on a project you may spend $50 million defining. Get the deduction list wide enough to reflect a real smelter contract, keep the buyback and make it exercisable at any time, define the property precisely so the royalty does not creep onto adjoining ground through an area-of-interest clause, and make the vendor’s audit right a right and not an ongoing conversation. Most of that is a morning’s work when the option is being papered and a lawsuit when it is not, which is why it sits in the standard scope of my work as Canadian counsel to mining and resource companies.

The royalty that ends up in a dispute is almost never the one with an unusual percentage. It is the ordinary 2% NSR, drafted in twenty minutes at the end of an option agreement, that nobody registered.