Canada: Replacing An Insolvent Operator – Court Upholds Capl "Immediate Replacement" Right

In Bank of Montreal v Bumper Development Corporation Ltd, 2016 ABQB 363 ("Bumper"), the Alberta Court of Queen's Bench enforced the "immediate replacement" provision in the Canadian Association of Petroleum Landmen ("CAPL") 2007 Operating Procedure ("CAPL 2007") for an insolvent operator. This provision provides for immediate replacement of an operator upon the occurrence of certain specified events, including the commencement of insolvency proceedings. Notably, the Court enforced this right notwithstanding the fact that the non-operating party did not act immediately to enforce its rights and prevented conveyance of operatorship with the sale of the operator's assets. Further, the Court acknowledged it would have lifted the stay of proceedings against the insolvent operator to allow the non-operating partner to replace the insolvent operator.

The decision in Bumper addresses a number of items that may be of interest to operators, creditors, working interest and facility partners, and other industry participants:

  • the importance of the wording of the "stay of proceedings" (the "Stay") provisions in a receivership order and its impact on the enforcement of contractual rights such as the "immediate replacement" right contemplated in CAPL 2007;
  • establishing that the replacement of an insolvent operator under CAPL 2007 does not constitute the "enforcement of a right or remedy" for the purposes of a receivership order;
  • illustrating prospective problems that receivers, monitors, debtors and/or secured creditors may face when attempting to convey operatorship along with the associated assets of an insolvent operator; and
  • discussing differences in enforcement of contractual rights between the Bankruptcy and Insolvency Act, RSC 1985, c B-3 (the "BIA") and the Companies' Creditors Arrangement Act, RSC 1985, c C-36 (the "CCAA") as it relates to replacing an insolvent operator under these respective statutes.

Background

Bumper focused on a dispute between Eagle Energy Inc. ("Eagle") and Forent Energy Ltd. ("Forent") regarding the right to operatorship held by Bumper Development Corporation Ltd. ("Bumper") with respect to certain oil and gas producing wells near Twinning, Alberta (the "Wells"). The Court considered whether Eagle could enforce the "immediate replacement" provision in its operating agreement with Bumper subsequent to Bumper being placed into receivership by its primary secured creditor, the Bank of Montreal ("BMO"). BMO successfully obtained a receivership order against Bumper and its wholly-owned subsidiary, Bumper Development Corporation, on February 16, 2016 (the "Receivership Order") pursuant to section 243 of the BIA.

The CAPL Replacement Right

Eagle and Bumper were parties to two agreements which contemplated the ability of a counterparty to replace an insolvent operator: 1) a joint operating agreement relating to the Wells which incorporated CAPL 2007 (the "JOA"); and 2) an agreement for the construction, ownership and operation (the CO&O, and together with the JOA, the "Agreements") of the Twinning 16-20-31-24 W4M Battery (the "Battery", together with the Wells, the "Bumper Assets"). The JOA, incorporated CAPL 2007 to govern certain rights between Bumper, as operator, and Eagle as the non-operating party. CAPL 2007 includes the following provision contemplating the immediate replacement of an operator:

2.02 Replacement of Operator

A. Immediate Replacement – the Parties acknowledge that the Operator's ability to fulfill its duties and obligations for the Parties' benefit is largely dependent on its ongoing financial viability and that the Operator may not seek relief at law, in equity, or under the Regulations to prevent its replacement in accordance with this Subclause. The Operator will be replaced immediately after service of notice from the Non-Operator to the other Parties to such effect if:

(a) the Operator becomes bankrupt or insolvent, commits or suffers any act of bankruptcy or insolvency, is placed in receivership or seeks debtor relief protection under applicable legislation (including the [BIA] and the [CCAA]), and it will be deemed to be insolvent for this purpose if it is unable to pay its debts as they fall due in the usual course of business or if it does not have sufficient assets to justify its cumulative liabilities in full...

The CO&O included a similar clause, which contemplated that Bumper would immediately cease to be operator upon becoming bankrupt or insolvent, committing an act of bankruptcy or insolvency, or being placed in receivership or a receiver/manager being appointing with respect to Bumper's property (Bumper para 6).

Pursuant to the provisions in the Agreements, Eagle provided the Receiver with the required notice of Eagle's intention to assume operatorship of the Bumper Assets. The Receiver responded that, pursuant to the provisions of the Receivership Order, the notices from Eagle were stayed and that Bumper remained the operator of the Bumper Assets. During the process of marketing the Bumper Assets, Eagle made an agreement with the Receiver that the latter would not entertain an offer purporting to convey operatorship of the Bumper Assets to any persons except Eagle. The arrangement between Eagle and the Receiver contemplated that, if Eagle were not the successful bidder, that the purchase and sale agreement for the Bumper Assets would include a condition of closing requiring an electronic transfer of Bumper's operating licence for the Bumper Assets directly from Bumper to Eagle. Forent was the successful bidder for the Bumper Assets, and the Court approved the sale of the Bumper Assets to Forent without prejudice to Eagle's right to challenge operatorship. Eagle's challenge was heard by Macleod J on May 24, 2016.

The Court found that the Agreements clearly entitled Eagle to be the operator of the Bumper Assets upon Bumper becoming insolvent or being placed into receivership (Bumper at para 17). In this respect the Court cited Tri-Star Resources Ltd v JC International Petroleum Ltd. (1986), [1987] 2 WWR 141 (ABQB) where the Court held that the plain language of the operating agreement (which incorporated the a previous versions of CAPL 2007) must govern. In Bumper, Macleod J held that, "had Eagle pursued its right to be Operator at the time of the granting of the [Receivership] Order or soon thereafter, I can think of no reason why this Court would not have acceded to Eagle's request to lift the stay and grant a declaration with respect to both the wells and the battery" (Bumper at para 18). This decision was on the basis that Eagle's right to operate arises under a contract which pre-dates the Receivership Order and, as such, the Court found no reason to interfere with the contractual rights of Eagle under the Agreements which were not subject to the security of Bumper's creditors.

With respect to the question of delay, the Court found that Eagle acted reasonably in light of the receiver's response and negotiated a deal with the receiver to protect Eagle's contractual rights to operatorship under the Agreements. According to that arrangement, the Court found that Eagle believed it would be the operator under the Agreements even if it were not the successful bidder for the underlying assets (Bumper at para 23). Because of that arrangement, the Court found that Forent could not have a reasonable expectation that it was purchasing operatorship of the Bumper Assets. As such, the Court saw it as unfair to deprive Eagle of its clear contractual right to be operator of both the Wells and the Battery: "[t]o do so would be tantamount to appropriating Eagle's right for the benefit of [Bumper's] creditors" (Bumper at para 23).

Exercising a Right or Remedy

Bumper differs from a historical line of cases that restrict contractual counterparties of an insolvent entity from enforcing contractual rights on the basis that doing so constitutes a "right" or "remedy" which is subject to a stay of proceedings (see for e.g. Baytex Energy Ltd v Sterling Eagle Petroleum Corporation, 2012 ABQB 539 ("Baytex") and Re Skyservice Airlines Inc, 2011 ONSC 703 ("Skyservice"). Paragraph 9 of the Receivership Order pertaining to Bumper, titled "No Exercise of Rights or Remedies" provided that: "all rights and remedies (including, without limitation, set-off rights) against [Bumper],the Receiver, or affecting the Property, are hereby stayed and suspended except with the written consent of the Receiver or leave of this Court" (Bumper at para 4).

Although there was similar wording in the receivership orders contemplated in Skyservice and Baytex, the courts both restrained counterparties from enforcing certain contractual provisions on the basis that the questioned actions constituted the enforcement of a "right" or "remedy" that was stayed by those receivership orders. In Skyservice, lessors were attempting to terminate aircraft leases, and in Baytex, an operator of certain oil and gas properties purported to deliver notices of abandonment to a working interest participant once the latter was placed in receivership.

Immediate Replacement under BIA and CCAA Proceedings – Different Outcomes?

The Court specifically distinguished Bumper from Norcen Energy Resources Ltd v Oakwood Petroleums Ltd. (1988), 92 AR 81 (ABQB) ("Norcen"), which was a case in which the operator was subject to the CCAA. This suggests that the outcome of a party attempting to enforce its right under CAPL 2007 (or its successor or predecessor agreements) to replace an insolvent operator may be unsuccessful where the operator is subject to CCAA. In Norcen, the Court rejected a joint operator's attempt under the previous CAPL operating agreement, containing virtually the same wording as Section 2.02 of CAPL 2007, to assert a right to operatorship.

This decision was based on the difference in the legislative purposes of the CCAA as compared to the BIA. While the CCAA is primarily used to attempt to restructure a company's affairs, the BIA mechanisms are used to liquidate and wind-up a company. In Norcen, the Court accepted testimony that removing the insolvent company as operator would be fatal in attempting to restructure its affairs. It is unclear what the Court in Bumper would have done had there been evidence that the removal of the operatorship would have materially and adversely impacted the marketing and sale of Bumper's assets.

Implications

Bumper represents a departure from how courts have previously interpreted actions of contractual counterparties attempting to enforce rights under agreements with an insolvent entity. The decision in Bumper suggests that receivership orders may need to specifically mention actions that the receiver and debtor wish to prevent contractual counterparties from taking in order to successfully have such actions captured by the stay of proceedings. Non-operating parties should be aware of what rights they have to operatorship in the event of insolvency of the operating party and whether such rights are to be transferred on to third parties acquiring the insolvent party's assets. Purchasers of assets out of a receivership process should ensure they are aware of any outstanding claims by non-operators to transfer operatorship, as operatorship may not be something that the receiver can transfer as part of the sale.

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