TORONTO (miningweekly.com) – Coal producer SouthGobi Resources continues to seek an amicable resolution of its tax dispute with the Mongolian government, failing which, a court sanctioned financial penalty could trigger events of default with a Chinese funding partner and eventual bankruptcy.

SouthGobi, a subsidiary of Rio Tinto-owned Turquoise Hill Resources, had in January been found financially liable as a ‘civil defendant’ for a penalty of about $18-million, following a criminal tax investigation case.

A panel of appointed judges from the Second District Criminal Court of Justice found three of the company's former employees guilty of tax evasion and sentenced them to imprisonment, ranging from five-and-a-half years to five years and ten months, in the correctional facilities of strict regimen in Mongolia.

Despite the company’s subsidiary, SouthGobi Sands (SGS), not being a party to the criminal proceedings, the court declared it to be financially liable.

Following an unsuccessful appeal to the Second District Criminal Court of Justice, on April 22, SGS filed an appeal with the Supreme Court against the decision of the 10th Appeal Court of Mongolia, upholding the tax verdict against SGS. The subsidiary said the Supreme Court had refused to hear the tax case on appeal and, as such, the tax verdict had come into force.

However, SouthGobi alleged that the tax verdict was not immediately payable, nor enforceable against SGS, as the subsidiary had not yet received a copy of the bailiff's resolution on execution of the verdict, as required under Mongolian law.

SouthGobi still believed that there was a lack of evidence to support the tax verdict and that the verdict and the subsequent decisions of the higher courts on appeal were substantively and procedurally in error under the laws of Mongolia.

The company was attempting to resolve the dispute amicably with the Mongolian authorities.

Should the verdict be enforced, it could result in an event of default under the China Investment Corporation (CIC) convertible debenture and CIC would have the right to declare the full principal and accrued interest owing thereunder immediately due and payable.

CIC had, in July, agreed to defer an interest payment of $7.9-million for a second time to November 19, to allow SouthGobi to execute a funding plan.

The company, together with its new strategic partner and significant shareholder, Novel Sunrise, had developed a funding plan to pay the interest due under the CIC convertible debenture, meet the company's obligations as they fell due and achieve its business objectives in 2015 and beyond. However, there was no guarantee that SouthGobi would be able to implement the proposed funding plan or secure other sources of financing.

“Such an event of default under the CIC convertible debenture or the company's inability to pay the penalty could result in voluntary or involuntary proceedings involving the company (including bankruptcy),” SouthGobi explained.

The deal that would have allowed Canada's Turquoise Hill Resources to sell its remaining stake in the Mongolian coal miner, which was once worth more than C$3-billion, had fallen through in May.

The slower Chinese economy, falling coal prices, accounting problems and funding troubles had hit SouthGobi hard over the past several quarters.

For the three months ended June, the company sold 190 000 t of its coal products after resuming mining operations on March 30 and, since then, had produced 620 000 t of coal from its flagship Ovoot Tolgoi mine. The company had hoped that the stockpile would help it capture new offtake contracts, as well as cater to its existing obligations.

SouthGob's TSX-listed shares peaked at C$21.99 in 2008. The stock fell as low as C$0.34 in February and was trading at C$0.50 a share on Friday.