Canada: Protecting Interests Through Operators' Liens: Priority, Registration And Remedies

Last Updated: April 12 2016
Article by Brendan Sawatsky

Background

An operator's lien is a type of contractual lien that is created by operating agreements in the oil and gas industry. Operator's liens are available in many model form operating procedures, in the context of a joint operating agreement ("JOA"), such as those published by the Canadian Association of Petroleum Landmen ("CAPL"), the Association on International Petroleum Negotiators ("AIPN") and the American Association of Petroleum Landmen. In Canada, the most widely used operating procedure for upstream oil and gas development is the CAPL Operating Procedure (the "Operating Procedure").

There are various versions of the Operating Procedure but all versions since 1981 contain provisions for the creation of an operator's lien. Clause 5.05(a) of the 1990 CAPL Operating Procedure provides an operator with,

...a lien and charge, which is first and prior to any other lien, charge, mortgage or other security interest with respect to the interest of each Joint-Operator in the joint lands, the wells and equipment thereon, the petroleum substances produced therefrom and any production facilities, to secure payment of such Joint-Operator's proportionate share of the cost and expenses incurred by the Operator for the joint account.1

Although the CAPL 1990 Operating Procedure states that the lien will be first and prior to any other interest, this is not always the case. If an operator wishes to take full advantage of its operator's lien, it must understand the type of asset that is the subject of the lien and register the lien under the appropriate legislation. Although operator's liens are registerable in Alberta, few operators actually take advantage of this protection. Operators who choose to forgo registration risk losing priority to secured creditors and to a trustee in bankruptcy in the event that their non-operator counterparts become insolvent or face bankruptcy proceedings. This is particularly significant in the current economic situation in the energy sector.

In general, to determine which party has priority, the following rules apply:

  • priority between two non-registered interests is determined by the date each interest arose, with the earliest having priority;
  • where interests are required to be registered as between an unregistered and a registered interest, the registered interest will prevail; and
  • in the presence of two registered interests, priority will be determined by the appropriate registration legislation, and the interest with the earliest registration will prevail.

Personal Property

The legislation that governs the priority of interests in relation to personal property in Alberta is the Personal Property Security Act2 ("PPSA"). Personal property is valuable as it includes production of oil and gas and the sale of the proceeds of production. The PPSA gives priority to registered interests over unregistered interests.

Unregistered interests of operators' liens are prioritized on the basis of the date of attachment, which is the date the Operating Procedure is executed. 

The PPSA specifies that an unperfected (unregistered) security interest is not effective against a trustee in bankruptcy if the interest is unperfected at the date of bankruptcy. Generally, an interest can be perfected either through possession and/or registration. However, the decisions in Blue Range Resource Corp (Re),3 and Direct Energy Marketing Ltd v Katla Energy Corp,4 have both rejected perfection by possession in the context of an operator's lien. To obtain perfection by possession under the PPSA, the possession must be sufficient to indicate to third parties that a debtor has given a security interest in the collateral to a secured party. As a result of Blue Range and Direct Energy, it is critical that operators register their interests in personal property in order to maintain priority over subsequent secured creditors.

Registration not only gives an operator's lien priority over subsequent secured interests – it also serves to provide notice to third parties of the operator's interest. It has been argued that any creditor dealing with a company in the oil and gas industry has constructive knowledge of an operator's interest, given the wide usage of the Operating Procedure. In some cases, constructive, as opposed to actual notice may be sufficient.5 In the context of joint lands, it is arguable that any potential security holder should have constructive notice of the operator's interest and be aware of the operator's lien. However, registering an operator's lien confirms that third parties have notice, and ensures that an operator's interest will not be ranked behind any subsequent secured interests, unsecured creditors or a trustee in bankruptcy.  

Crown Land & Mineral Interests

In relation to a non-operator's working interest in Crown land and mineral interests, an operator's lien may be registered with the personal property registry pursuant to the Law of Property Act,6 ("LPA") which creates an exception for a charge on land to be registered under the PPSA.  A charge on land is defined as an interest in real property given by a corporation to secure payment or performance of an obligation. While an operator's lien seems to fit this description in cases dealing with Crown land, there have been no court decisions specifying that an operator's lien qualifies as a charge on land as contemplated by the LPA. Like the PPSA, the LPA determines competing interests by the first interest registered. However, if no competing interest is registered, the first interest to have been executed will prevail.

Another registration scheme pertaining to Crown land is found in the Mines and Minerals Act7 ("MMA"). The MMA differs from the LPA by specifically excluding an operator's lien in the definition of a security interest.  Under the MMA, an operator's lien will be viewed as an equitable interest. The MMA is not an all inclusive priority and registration system and does not address priority between registered and unregistered interests. While there is no jurisprudence analyzing the competing interests in this situation, it is likely that the priority rules under the LPA apply. Alternatively, using the common law approach, any subsequent registered legal security holder with constructive or actual notice of a prior equitable interest (the operator's lien) would not have priority over the equitable interest. Registering an operator's lien under the LPA should be sufficient to provide notice under the common law approach.

Freehold Land & Mineral Interests

In terms of freehold land and mineral interests, the Land Titles Act,8 ("LTA") determines the priority of interests. The LTA gives priority to the party that registers first and deals with competing unregistered interests in the same way as the LPA.9

Remedies

The decision in Novalta Resources Ltd v Ortynsky Exploration Ltd,10 upholds an operator's right to place a lien on a non-operator's working interest and to sell all or a portion of that interest when a non-operator fails to pay. However, there are several requirements in the Operating Procedure that the operator must fulfill before this remedy may be employed. Under the Operating Procedure, when a non-operator fails to pay its share of the costs or expenses incurred for the joint account, an operator must give written notice to a non-operator, and wait 30 days from the date notice is given before taking further action. After these requirements are fulfilled, an operator may take possession of all or part of a non-operator's working interest in the joint lands and sell them to recover the costs it is due in accordance with the Operating Procedure.

Another remedy set out in the Operating Procedure is the right to contractual set-off by the operator of the amount a non-operator owes against the non-operator's share of revenue (collected by the operator). The Operating Procedure extends an operator's right to set-off to any other agreement between the operator and non-operator whether it is executed before or after the JOA. This remedy may not be utilized until the operator gives 30 days written notice to the non-operator. An additional difficulty is that the right to set-off is unavailable when the non-operator takes its share production in kind.

Concluding Thoughts

Although registering an operator's lien may be perceived as an administrative burden and an additional expense, it is prudent that operators register an operator's lien to preserve its priority of interest and take advantage of all of the remedies and benefits provided for in the Operating Procedure.

Footnotes

1 See Clause 505(a) CAPL 1990 Operating Procedure (note that the CAPL 2007 Operating Procedure has similar language; the reason the CAPL 1990 Operating Procedure is cited is due to the fact that this operating procedure is more commonly used in the oil and gas industry and has been judicially considered to a greater extent).

2 RSA 2000, c P-7.

3 [1999] AJ No 1165 (ABQB) [Blue Range].

4 [2002] AJ No 463 (ABQB) [Direct Energy].

5 William Corbett, "Priority Issues Affecting Operators' and Suppliers' Liens: The Alberta Perspective" (Paper delivered at the Oil and Gas Sector Conference, 25 April 1996), Toronto: Insight Press, 1996, at 25.

6 RSA 2000, c L-7.

7 RSA 2000, c M-17.

8 RSA 2000, c L-4.

9 Bank v Head West Energy Inc. 2007 ABQB 188.

10 [1994] AJ No 1101 (ABQB).

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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