Canada: All Wells May Not End Well: Alberta Court Of Appeal Rules That Receivers And Trustees Can Orphan "Bad" Wells

In a much anticipated decision, a 2-1 majority of the Alberta Court of Appeal (the ABCA) has upheld the Alberta Court of Queen's Bench (ABQB) decision in Re Redwater Energy Corporation, 2016 ABQB 278. The ABCA found in favour of receivers, trustees and secured creditors on the basis that the Bankruptcy and Insolvency Act (the BIA) takes precedence over the provincial oil and gas regulatory schemes, making such schemes inoperative to the extent that they purport to require trustees and receivers to comply with abandonment, reclamation and remediation requirements of disclaimed assets. This decision will continue to prevent the Alberta Energy Regulator (the AER) from refusing to transfer licensed assets in an insolvency process unless ongoing environmental obligations tied to disclaimed licensed assets are met. The ABCA's split decision also likely signals a period of continued uncertainty as it is reasonable to expect that the AER and the Orphan Well Association (the OWA) will be seeking leave to appeal this decision to Canada's top court. Moreover, whatever happens in Alberta will impact policy in the other western Canadian provinces.

Background and ABQB Decision

In 2015, Grant Thornton Limited (GTL) was appointed as receiver (the Receiver) of the assets of Redwater Energy Corporation (Redwater). The Receiver advised the AER that it took possession and control of only 20 of the 127 AER-licensed assets belonging to Redwater. In fact, the Receiver took possession of the most valuable assets and disclaimed the remainder. In response, the AER issued abandonment and closure orders regarding the licensed assets of which the Receiver indicated it did not assume possession. GTL later disclaimed the remaining 107 AER-licensed assets in its capacity as Redwater's trustee in bankruptcy, informing the AER that it did not intend to comply with the abandonment and closure orders as it had legitimately renounced those properties.

Pursuant to Alberta's Oil and Gas Conservation Act (OGCA) and the Pipeline Act (PA), trustees and receiver-managers are "licensees", and are therefore subject to the statutory and regulatory obligations imposed by the AER, including reclamation and remediation requirements. On the other hand, section 14.06 of the BIA permits a receiver or trustee to renounce and not be liable for environmental liabilities. GTL and Alberta Treasury Branches, which was Redwater's primary secured lender, argued that the federal BIA was paramount to, and rendered inoperative, the applicable provisions of the provincial OGCA and PA to the extent of any conflict.

Chief Justice Neil Wittman of the ABQB agreed that so long as a trustee or receiver renounces assets in accordance with section 14.06 of the BIA, the AER cannot impose on them the obligation to remediate the renounced property by either performance or the posting of security. He held that Parliament intended for priority of creditors over environmental remediation under section 14.06. As such, the OGCA and PA were inoperative, to the extent of any conflict with section 14.06, because dual compliance with both the provincial and federal statutory regimes was not possible and, additionally, the provincial regime frustrated the BIA.

ABCA Majority Decision

Writing for the majority of the ABCA, Mr. Justice Slatter upheld the ABQB decision on the grounds of paramountcy. On appeal, the AER had argued that section 14.06 of the BIA was only applicable where the trustee faced personal liability, such that the trustee still had to meet the remediation obligations of Redwater until Redwater's assets were exhausted before the rights of renunciation found in section 14.06 would come into play. The majority disagreed, noting that the BIA assumes a trustee has the right to disclaim assets and that section 14.06 of the BIA contemplates that a trustee may consider the economic viability of the assets, which, to be meaningful, must go beyond a trustee's personal liability.

In argument, the AER tried to distinguish between Redwater's real property and the licenses to show that regulating licenses did not interfere with the property rights of Redwater. However, the majority found that the AER's policy on the sale of assets of a bankrupt had the effect of artificially transferring the value of the assets to the AER licenses, which would create a super priority for quantifiable environmental claims and upset the BIA's scheme of priorities. Thus, if the AER were successful, it could redistribute value from producing wells to non-producing wells in order to enforce the environmental obligations attaching to the latter. The majority confirmed that the AER cannot sidestep the BIA by trying to establish a parallel process to collect claims by masking them as managing obligations, concluding that the AER cannot insist a trustee devote substantial parts of a bankrupt estate in satisfaction of its environmental claims in priority to the claims of secured creditors.

In concluding remarks, the majority rejected any argument that public policy considerations such as provincial public duties and fairness of outcome should override the plain wording of the BIA. The majority stated that Parliament considered all of these competing policies and "undoubtedly was concerned that giving environmental claims a super priority would drive away lenders, and deprive highly leveraged industries (like the oil and gas industry) of necessary financing".

ABCA Dissenting Decision

Madam Justice Martin dissented on the basis that she viewed the OGCA and PA as creating generally applicable public legal duties which were outside the scope of bankruptcy claims. Justice Martin concluded that a trustee cannot disclaim end of life license obligations, which, in her view, are not real property and therefore fall outside section 14.06 of the BIA. In addition, she stated that section 14.06 of the BIA protects trustees from personal liability but does not go so far as to provide them the ability to disregard and renounce provincial legal obligations. In the result, Justice Martin found that the provincial regime was not in conflict with the BIA, nor did it frustrate its purpose, such that there was no issue of paramountcy. Rather, she noted the province "is enforcing laws and licence conditions designed to protect the public interest, the environment, and the rights of third-party landowners affected directly by this distinctive resource and regulatory regime".

Commentary

In the wake of the ABCA's decision in Redwater, secured creditors in the oil and gas sector will be relieved as the decision results in their priority being maintained over the secured assets of a bankrupt. Industry may now find itself with more willing lenders both for drilling programs and for acquisitions. In addition, many companies that have been treading water in order to see how the ABCA would rule may now seek receivership and bankruptcy proceedings that will result in the sale of their producing assets and the renunciation of their non-producing assets. The burden of these orphaned wells may, in the short term, fall to the OWA, but it and the AER have already signaled they may seek leave to appeal. All eyes will be on whether leave to appeal to the Supreme Court of Canada is sought and granted, which might lead to a definitive decision within 18 to 24 months if leave is granted. In our view, Justice Martin's discussion of public interest issues signals a case that is ripe for consideration by Canada's highest court.

In addition, a spokesperson for the Minister of Energy has indicated the ABCA's decision may result in a "thorough review of the oil and gas liability management system". In the months to come, industry may see revisions to the manner of calculating licensee liability ratings and associated AER security requirements. Orphan well fund levies could also be significantly increased to ensure that the province remains well-positioned to meet impending environmental liabilities that have become so pronounced in the current downturn. While bringing certainty to secured creditors and ensuring access to credit is fundamental for the industry, a balance may have to be struck. That difficult balance will have to ensure that environmental liabilities can be met at a cost that does not disincentivize investment in Alberta or result in remediation obligations being met by the public purse. Continued uncertainty comes at a cost and addressing these issues in earnest will benefit all interested parties. Unfortunately, industry may have to continue to navigate ill-defined half measures (such as the AER's increasing of liability management ratio requirements to 2.0 for transferees) until the matter is further adjudicated.

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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