Canada: Put Skin In The Game – "Klemke Mining Corporation v. Shell Canada Limited Blair McGeough"

Last Updated: November 12 2007

Article by Blair McGeough, © 2007, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Energy - Oil & Gas, October 2007

Introduction

On March 14, 2007, the Court of Queen's Bench of Alberta released its decision in Klemke Mining Corporation v. Shell Canada Limited, 2007 ABQB 176 (Klemke). In Klemke, Madam Justice Smith oversaw a case where the plaintiff, Klemke Mining Corporation (KMC), alleged that the defendants Shell Canada Limited (Shell), Chevron Resources Limited (Chevron) and Western Oil Sands Inc. (Western) along with Albian Sands Energy Inc. (Albian), a company resulting from the joint venture between Shell, Chevron and Western, orally agreed to grant KMC mining and consulting work in relation to an oil sands project in the Athabasca Oil Sands.

Klemke is a fact-driven case with the plaintiff's evidence often contrary to the evidence given by the defendants and thus credibility was a paramount consideration for Justice Smith. In the end, the plaintiff's witnesses had a better recollection of important facets of the case and had more detailed notes on crucial events. This helped establish the plaintiff's credibility and led to a favourable decision for KMC.

Shell owned the rights to a Bituminous Sands Lease granted by the Province of Alberta (Lease 13) dating back to the 1970s. KMC originally contacted Shell regarding the development of Lease 13 in 1994 and was introduced to Mr. Camarta, a Vice President of oil sands at Shell. By the mid 1990's Shell began to explore various strategies to develop Lease 13 and obtained a permit in 1999 to develop the area. They had performed several feasibility studies in which KMC was involved either for their advice or to provide budget and cost estimates for the project in order to benchmark formal contract bidding which was to happen at a later point in time.

Shell became interested in the expertise and local knowledge that KMC had to offer and KMC began to consider certain investment options to become involved in the project. KMC considered investing in a joint venture partner to the project, specifically in a company that would later become Western. Initially, Shell expected KMC to become a joint venture partner, however this stance changed. Justice Smith found that Shell was more interested in KMC for its knowledge in mining oil sands than for its investment potential and, in a pivotal meeting on June 25, 1999, Shell encouraged KMC to "put skin in the game" to align KMC's interests with Shell through the investment by KMC into one of the joint venture partners. At the June 25 meeting, Mr. Camarta offered KMC a contract whereby KMC would participate in the project using benchmarking as a pricing mechanism for the mining work. The contract offered by Mr. Camarta did have two conditions precedent: a) KMC would have to "put skin in the game" through an investment, and b) a project had to exist. On June 29, 1999, Mr. Klemke sent a letter to Mr. Camarta advising of KMC's intention to put "skin in the game" through an investment in the company that later become Western, effectively meeting the first condition precedent.

Meetings continued throughout 1999 and on December 6, 1999, the project came into being. On December 10, 1999, a letter and term sheet were sent to KMC from Mr. Barber, a representative in charge of finalizing the contract with KMC. The parties took very different views on the binding aspects of the cover letter and term sheet, however, Justice Smith accepted the plaintiff's assertion that the cover letter and term sheet represented a memorialization of the agreement reached on June 25. The term sheet contained various points of agreement between the parties. The term sheet stated that "It is intended that KMC will perform mine development and contract mining work" and also provided that the scope and duration of the project would be agreed upon. The cover letter contained a standard clause recognizing the acknowledgment from Albian and KMC of the agreement of terms contained in the documents.

Mr. Klemke signed the cover letter and forwarded them to Mr. Barber. The cover letter was never signed by the defendants.

In early 2000, the defendants were dissatisfied with KMC's performance under another contract. In the end, the defendants decided not to use KMC for the initial mining work and decided to use a different company for the project. As a result KMC brought an action for breach of contract against the defendants.

Legal Analysis

Klemke details the many different meetings and discussions through which a contract was formed between the parties despite the lack of a formal signed contract. In the June 25 meeting the Court found that an offer was made to KMC and that the offer was accepted. What the ultimate question in Klemke became was whether a legally enforceable contract was formed between the parties.

Justice Smith invoked the legal principle of consensus ad item or whether there was a "meeting of the minds" between the parties so as to create an enforceable contract. Relying on an Alberta case Ron Ghitter Property Consultants Ltd. v. Beaver Lumber Co., 2003 ABCA 221, the Court used a two part test to uncover whether there was a meeting of the minds. The test contains two parts, a) the parties must be objectively seen to have intended to contract with each other, and b) the terms of such contract must be sufficiently clear so as to suggest that the parties actually came to an agreement.

a) Intention To Contract. The defendants maintained that the lack of a drafted and signed formal contract answered the question of whether the parties intended to contract. In making its determination, the Court used an "objective standard of whether the outward expressions of the parties would lead a reasonable and dispassionate observer to conclude that they intended to be contractually bound" (at para. 163). Justice Smith found that KMC made their intention clear on both an objective and subjective basis and that the intention was that KMC would only invest in the project if they were given an opportunity to participate in the initial mine development work. On the other hand, the defendants needed KMC's oil sands expertise and knew this expertise and KMC's willingness to invest in the project were inextricably linked to a grant of the contract mining work. The defendants' intention to contract first came into being when the offer was made by Mr. Camarta on June 25. This initial intention to contract with KMC to participate in the project was subject to the conditions precedent of putting "skin in the game" and whether a project existed. Mr. Camarta failed to deny his initial offer and the Court concluded that Shell tried to honour the original agreement during the entire negotiation process until a contract was deemed to exist.

The June 25 meeting followed by the preparation of documents on June 29 based on the discussions from the earlier meeting and culminating with a cover letter and term sheet based on the prior negotiations all amounted to a binding contract. This binding contract was not simply an 'agreement to agree' but a clear, focused intention from Mr. Camarta to bind KMC and the future negotiations and discussions were the manifestation of that original intent. The cover letter and term sheet reflected the essential terms of the contract and recorded the oral agreement. It served as the roadmap for a formal contract that would follow, but the contemplation of a future formal contract was not a problem because all of the essential contractual terms were already decided upon. Furthermore, the intention remained clear because the cover letter and term sheet contained no language making the documents subject to a formal contract.

b) Clear, Unambiguous And Complete Terms. Another hurdle to deciding whether there was a meeting of the minds is that where the terms of a contract are vague, ambiguous or incomplete, there is no contract between the parties. Justice Smith recognized that the parties did not come to an agreement regarding the final price, which is usually an essential contractual term, but did decide that a mechanism for determining pricing was agreed upon. Having a price mechanism in place made the terms of the contract certain according to industry practice. The nature of the oil and gas industry is that the final price is often a moving target and is usually unknown until work actually begins. The final price can vary dramatically from original expectations and greatly depends on many factors. As a result, pricing mechanisms are a necessity and, in this particular case, benchmarking was the agreed upon pricing mechanism which is commonly used in the industry. Justice Smith admitted that the pricing mechanism was refined during negotiations but that the refinement could not be characterized as a lack of agreement on price.

Commentary

Courts are usually loathe to impose an agreement upon parties, however, this case shows that courts will do so but only if the parties intention is clear and the terms are unambiguous. The defendants' conduct in this case showed they had a clear intention to contract with KMC and fell short of ever repudiating the contract which was a major factor in the Court imposing the agreement on the defendants. The defendants failed to make decisions about the mining contract until it was too late. This case demonstrates that clear communication is a necessity when dealing with large projects coupled with a clear sense of a project's direction in terms of who should and should not be involved from an internal and external point of view.

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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