Canada: Freehold Lease Terminations: Summary Judgment Efforts Falter

In the April 4, 2013 edition of Energy @ Gowlings,  we reported on two rulings made by judges of the Alberta Court of Queen's Bench, each of them granting summary judgment against the lessee under a freehold petroleum and natural gas lease.  One of those decisions, dealing with cessations in production, has been overturned by the Alberta Court of Appeal.  The other decision has not been overturned, but in a case similar to it, also involving the offset well and default clauses, the chambers judge came to the opposite conclusion and refused summary judgment.  These most recent decisions provide a sobering lesson to mineral owners thinking of summary judgment as a relatively cheap and expeditious way to obtain a final court ruling in freehold lease disputes.

Locke, Stock & Barrel Company Ltd.: No Production and No Working Operations

In P. Burns Resources Limited v. Locke Stock & Barrel Company Limited, 2014 ABQB 13 (January 30, 2014), the Alberta Court of Appeal reversed a decision of Bensler, J. (2013 ABQB 129) in which she had granted a "partial" summary judgment terminating the lease held by Locke Stock & Barrel Company Limited ("LSB"). 

The lease followed a common industry form.  After the primary term, any cessation in the production of leased substances would result in termination of the lease, subject to certain saving provisions.  Under one of these saving provisions, the lease would continue in force during the period of non-production if drilling or working operations were started and prosecuted with no cessation of more than 90 days.  Furthermore, time would not count against LSB in either of two further circumstances:

  1. If drilling or working operations were interrupted as a result of any cause beyond LSB's reasonable control; or
  2. If a well was shut in or suspended or otherwise not produced for any cause whatsoever which was in accordance with good oil field practice.

As the case was heard on a summary judgment application, both the chambers judge (Justice Bensler) and the Court of Appeal only had affidavit evidence (as opposed to oral) before them to help them decide whether these conditions had been satisfied.  As is clear from the Court of Appeal's Reasons, LSB had submitted more complete affidavit evidence than is apparent from a reading of Bensler, J's reasons.

Affidavits had been sworn by LSB's field operator and by an expert retained by LSB, who had given his opinion on what constituted "good oilfield practice" in operating low productivity wells such as the well in question.

The chambers judge had described the work done by the field operator, Ferner, as "minimal and not directed at the production of oil".  She therefore found that his efforts did not qualify as "working operations".  As for the expert witness, Mr. Anderson, she found his opinion on "good oilfield practices" to be "generalized and not directed to the particular operations carried out by Mr. Ferner on the Well".

The Court of Appeal noted that LSB's affidavit evidence described the high concentrations of acetate and wax in the producing zone, the tendency of those substances to plug the pump and the various strategies adopted by LSB to attempt to dislodge the acetate and wax.

Evidence showed that the pump had been pulled and repaired in July 2007. This was not a well that was just shut-in and forgotten.  Ferner, the pumper, was present at the site of the well on almost a daily basis.  He ... contacted experts for advice, followed that advice, shut down and started up the pump for the Well occasionally, poured diesel down the pump, and tapped the pump. (para. 18)

The Court of Appeal quoted at length from Anderson's written opinion about the steps that a prudent operator should take at the low productivity stage of a well, and in cases where the oil is waxy and susceptible to "scaling".  It rejected the lessor's efforts to support the chambers judge's decision on the basis that the expert had not been present at the site.

The fact that Anderson had not been to the site, and did not know exactly what the pumper did at the Well-site, does not mean that his opinion as to proper oil field practices was not highly relevant here. He is entitled to opine on hypothetical facts put to him, and his opinion is not diminished because he does not know if those steps were carried out. (para. 22)

The Court of Appeal emphasized that it was not making a judgment on the final outcome of the trial.  However, it is worth noting that the Court understood that the appropriate strategy for an operator to adopt will depend on the conditions pertaining to the particular well and the type of oil that is being produced.  What is good operating practice will be different from well to well.

Laird v. Sword Energy Inc.: Offset Wells and Default Notices

The default clause in many standard-form P & NG leases contains a potential trap for the lessee. It requires the lessee to do one of two things within 30 days of receipt of a default notice.  The lessee must either:

(i)         remedy the alleged breach; or

(ii)        "commence and diligently pursue proceedings for a judicial determination as to whether the alleged acts or omissions constitute a breach or breaches on the part of the Lessee".

If the lessee fails to respond appropriately to a default notice, it may lose its lease or have to pay substantial damages to the lessor, or both.  This can happen whether or not there was any default in the first place.

In Laird v. Sword Energy Inc., [2014] A.J. No. 13 (January 7, 2014), Manderscheid, J. dismissed an application by a lessor for summary judgment based on an alleged failure to make a timely response to a default notice complaining about a supposed breach of the offset well clause.  In an earlier decision involving the same oil company defendant and the same form of lease, 1301905 Alberta Ltd. v. Sword Energy Inc., [2013] A.J. No. 190 (February 19, 2013), another judge, Lee, J. had ruled that the lessee, Sword Energy Inc. had failed to make an effective response to a similar default notice.  In a follow-up decision ([2013] A.J. No. 840), that judge had assessed damages based on the offset royalty that would have been payable.

Both cases arose out of an alleged breach by Sword of the offset well clause.  That clause places an onus on the lessee to take steps to prevent the lessor's reserves from being drained by an offset well – a well drilled on a spacing unit adjoining the leased lands – or else to compensate the lessor by paying an offset royalty.

In the earlier case (1301905 Alberta Ltd.), Sword had sent a reply to the default notice denying that it had breached the offset well clause.  In the more recent case, Sword (or more precisely, its 50% partner, Alberta Clipper Energy Inc.) had responded that, as the lessee "has no future plans for these lands, the lease will be allowed to expire on its own terms".  In terms of substance, it is difficult to see a great deal of difference between these two responses.

In the earlier case, Justice Lee had taken a literal approach to the default clause.  He held that the lease had been "cancelled" as a result of Sword's failure either to do anything to "remedy the breach" or else to commence legal proceedings, within 30 days of receiving the notice.  The only issue left for trial was the amount of damages payable by Sword.

In the Laird case, Justice Manderscheid distinguished the earlier case on the basis that, while in that case Sword had effectively admitted its breach of the default clause, in the Laird case it had made a timely response to the default notice by which it had arguably remedied the breach.

Several years earlier Sword had drilled a well on the Laird lands.  Tests showed the well to be incapable of commercial production from the relevant formation.  The default notice stated that Sword "has the obligation to make every reasonable effort to produce this well".  The judge found it unclear exactly what this meant.

Furthermore, Justice Manderscheid found a triable issue as to whether Sword was entitled to "surrender a Well [sic] that it has determined to be incapable of production without going through the additional expense of commencing a judicial proceeding".  He found that the lease was silent on the question of what might constitute adequate steps to remedy the breach in those circumstances.  Might an offer to surrender the lease be a sufficient step to "remedy the alleged breach"?

The judge's disinclination to grant a summary judgment is understandable, especially given the apparent futility (according to the evidence before him) of the type of steps demanded in the default notice.

Additional grounds for finding against the lessor in this case suggest themselves.  The offset clause is triggered by commercial production from a well on an adjacent parcel, but the lessee's obligation to act is subject to the proviso: "unless ... a well has been or is being drilled" on the relevant spacing unit within the lands. (emphasis added)  Did the fact that the earlier well had been drilled not engage this proviso?

Finally, given the harsh consequences being sought by the lessor, the court might also have considered exercising its equitable power to relieve against forfeiture.

Summary & Implications

As these two recent decisions show, while summary proceedings are available to terminate an oil and gas lease or to obtain a declaration of default on the part of the lessee, an application for summary judgment should only be pursued in the clearest of cases.

The result of the Court of Appeal's decision in the Locke Stock & Barrel case is reminiscent of what happened in Desoto Resources Ltd. v. EnCana Corp., [2011] A.J. No. 355.  In that case, a master granted summary judgment in favour of the lessor, holding that a P&NG lease had terminated.  As in Locke Stock & Barrel, the master's decision was upheld by a judge in chambers.  Also as in Locke Stock & Barrel, the Court of Appeal then reversed the judge's decision, holding that there were unresolved issues of fact that required a trial.  In both Desoto and Locke Stock & Barrel, the lessor's decision to proceed by way of summary judgment ultimately backfired, despite its initial successes.

In the final analysis, the facts of any case involving a problematic freehold lease will dictate which type of procedure is the most appropriate.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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