UPDATE:Klondex and Paramount prepare for long fight

The friendly days are long over between Klondex Mines (KDX-T) and Paramount Gold and Silver (PZG-T, PZG-N).

Only a few months ago Paramount was playing the white knight to Klondex, after it was the target of a hostile bid from Silvercorp Metals (SVM-T, SVM-X) at the beginning of June.

While Silvercorp’s all-share offer represented a 60% premium to Klondex’ share price at the time, the company believed it could get more and set out to find a rival bid.

Paramount obliged, and when it tabled an all-share offer of its own which had a 30% premium to the Silvercorp offer, Klondex management endorsed the $80 million deal.

Everything appeared to be sunshine and puppy dogs.

But things turned when Klondex went down to have a look at the main project of the company whose shares it would be acquiring.

Klondex claims that the three geologist sent down to do due diligence on Paramount’s San Miguel project in Mexico’s Chihuahua state quickly learned that two mineralized shoots within the San Miguel mineralized area trended towards a neighbouring property owned by Fresnillo (FRES-L) making some of the resource calculation at the site not on Paramount’s property.

Crying foul, Klondex said the omission of such facts in any public disclosure meant that it could cancel the planned merger and that Paramount would be libel to pay the US$2.85 million reverse break fee and additional damages.

But Paramount’s president, Chris Crupi, says the area in question deals only with projections of where mineralization is trending and has no real relevance to the mineral resource already outlined at the project.

“We’ve drilled 2.64 million gold equivalent ounces. That’s we have,” Crupi says. “Whether or not there are 2, 3, or 6 million ounces on someone else’s property doesn’t matter.”

Still, Paramount went back and issued a revised technical report that took into consideration Klondex’ charges.

The new technical report admits that some of the San Miguel and the La Union deposits fall outside of its boundaries, but says that the amount only makes up between 3% and 5% of the total inferred resource and therefore is immaterial.

The total inferred resource for the two areas is 6.7 million tons with an average grade of 2.24 grams gold at San Miguel and 1.43 grams gold at La Union for a combined total of 406,001 oz of gold. The average silver grade at San Miguel is 98.8 grams silver, while La Union has an average grade of 60.4 grams silver for a combined total of 17 million oz. of silver. The two areas also contain a total of 23,907 tons of lead and 53,086 tons of zinc.

Paramount argues that Klondex had no material reason to pull out of the deal and is therefore liable to pay the US$2.85 million break fee, and damages.

But Klondex’ insists that not only was the resource mis-represented, but that the most gold rich parts of the mineralized zone appear to be trending off of Paramount’s ground and that this fact, “materially limits the prospects for the San Miguel Project.”

To better understand just how much the gold potential is limited by the property boundary, Klondex says it needs to look at the data that was used in the resource calculation, but claims that Paramount has refused to let it see it.

Crupi denies the charge and points out that during Klondex’ due diligence site visit it was given access to all of the drill core and geological information it has.

Klondex had garnered the interest of Silvercorp and Paramount thanks to its flagship Fire Creek project in Nevada. A resource estimate from earlier this year put indicated resources at 5.04 million tonnes averaging 10.11 grams gold for 1.6 million ounces of gold equivalent and an Inferred Mineral Resource Estimated at 1.8 million tonnes grading 8.63 grams gold for 508,799 oz. of gold equivalent.

Paramount argues that the Klondex’ attempt to get out of the merger has to do with management’s desire to entrench itself. Crupi says he feels that Paramount was used to fend off the hostile Silvercorp threat, and once Silvercorp backed off, Paramount too was dropped.

Klondex, however, says it was simply mislead as to the real value of the company that would be acquiring it in all share offer.

It will likely take a long and ugly court battle to sort out a victor.