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Khan Resources stranded in the bitter Mongolian cold

The remote Dornod uranium project in northeastern Mongolia.

Khan Resources

Underneath the endless brown steppe in the remote northeastern corner of Mongolia, known as Dornod, lies a vast store of uranium.

It's a four-hour drive on a dirt track from Mongolia's capital, Ulan Bator, to what is now just a collection of yurts. Six security guards, employees of Canadian junior miner Khan Resources Inc., are stationed there.

"If you stand on the hill that's right beside the deposit, you look one way, you can see China," said Grant Edey, Khan's chief executive officer. "You look the other way, you see Russia."

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That proximity to Russia has come to haunt Mr. Edey's company. In 2009, Mongolia revoked Khan's mining licences and announced a joint venture with Russian state-owned uranium miner Atomredmetzoloto JSC (ARMZ) to develop the Dornod site. Khan, which says it is has spent up to $40-million since 2005 on feasibility studies and exploration, was left out in the bitter Mongolian cold.

The dispute has sparked legal battles in Ontario and Mongolian courts, and is headed for international arbitration. Legal experts call it a cautionary tale for companies doing business in Mongolia or other developing countries, or with large state-owned enterprises.

Mongolia is a popular place with Canadian mining firms, with scores setting up shop there in recent years and Ivanhoe Mines involved in a massive copper-gold joint venture.

Last September, Khan launched a lawsuit in Ontario against ARMZ, one of the world's largest uranium miners. In a statement of claim for $700-million in damages, Khan alleges that the Russian firm wrongly excluded the Canadian company from the Dornod project and waged a campaign to discredit it.

Earlier this year, Mr. Edey said, ARMZ, as an arm of the Russian government, refused to be served with the Ontario lawsuit, invoking the Hague Convention and calling it an issue of "national security," raising questions about whether such entities can try to use sovereign immunity as a tactic to delay or avoid Canadian courts.

Robert Frank, a Toronto lawyer with McLeod Dixon LLP acting for ARMZ, said he could not comment on the case.

A court date last month to hear the issue was postponed for settlement talks between the two sides in London, but no agreement was reached. Mr. Edey expects a judge to hear the issue some time in June.

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Larry Herman, a former diplomat and a lawyer with Cassels Brock & Blackwell LLP who specializes in international arbitration, said the dispute shows how vulnerable Canadian investors are in countries without an investment-protection treaty with Canada.

Such treaties, similar to a provision in the North American free-trade agreement, allow disputes between investors and foreign countries to be referred to international arbitration directly, without first having to duke it out in the country's local courts. (Canada and Mongolia have such a treaty in the works but it has not been finalized.) "When there is no bilateral investment-protection agreement, companies don't get access to all of the safeguards," said Mr. Herman, who is not involved in the case.

Andrew McDougall, a lawyer and veteran of international arbitration with Ottawa firm Perley-Robertson, Hill & McDougall LLP, said stories such as that of Khan Resources are a warning for Canadian companies operating in developing countries.

More companies need to plan strategically, he said, perhaps by setting up a company in a third country with a strong investment-protection treaty with the country where the investment is going.

"When you're company that's going to invest in these sorts of places in the world, you want to think in advance: How do we set this up to give us the maximum protection if something goes wrong?" said Mr. McDougall, who is not involved in the case.

Mongolia has a long history of Russian, and Chinese, domination. The Dornod project once belonged to Russia, in the 1990s. With uranium prices in the basement, the Russians abandoned it, Mr. Edey said. But they still retained a 21-per-cent interest in the dormant venture. Mongolia also maintained a 21-per-cent interest.

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Uranium prices started to rise as the world began to look again to nuclear power as a cleaner energy source. In 2005, Khan - listed on the Toronto Stock Exchange and set up to develop the site - bought the remaining 58-per-cent stake, and also acquired the property next door.

As a result, Mr. Edey said, his company held about 70 per cent of the estimated uranium believed to be underground, with the total cache worth up to $2.5-billion (U.S.) at today's prices.

The plan was to develop the site as a joint venture. Mr. Edey said the Russians showed little interest until early 2009, when President Dmitry Medvedev paid a visit to the remote site, along with Mongolia's then-prime minister, Sanjaagiin Bayar.

Meanwhile, Mongolia was reconsidering the rules of the game. In 2009, it issued a new nuclear energy law that demanded an up-front, 51-per-cent government stake in most major uranium projects. It also suspended Khan's mining licences and said the company had failed to submit its reserve estimates, which Khan denies. Russia and Mongolia then announced their joint venture to develop Dornod, leaving Khan out of the picture.

In late 2009, ARMZ launched a hostile takeover bid for Khan, whose share price had plummeted because of the uncertainty about the Mongolian project. Khan sought a white-knight investor in the form of CNNC Overseas Uranium Holding Ltd., a Chinese state-owned company, and ARMZ then withdrew its bid.

In its statement of claim, Khan accuses ARMZ of interfering with the Chinese bid and making "misstatements" about the company. The Chinese bid ultimately fell through when the Chinese government failed to approve it.

Mr. Edey said he doesn't believe Khan can ever reclaim the Dornod mine, but he is trying to get some compensation for his shareholders, and has shifted his sights to a stake in a uranium venture in Peru.

He said Khan's trials should be a warning to other Canadian firms and investors: "Political risk is real in a lot of countries. And it is alive and well in Mongolia."

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