Canada: Update: Court Of Appeal Affirms Unconstitutionality Of Alberta's Oil And Gas Licensing Regime

On April 24, 2017, in Orphan Well Association v. Grant Thornton Limited, the Alberta Court of Appeal (Court) upheld Chief Justice N. Wittmann's decision (Chief Justice) in Redwater Energy Corporation (Re) (Chambers Decision) by finding that certain sections of the Oil and Gas Conservation Act (OGCA) and Pipeline Act (PA) are inoperative to the extent that they are used by the Alberta Energy Regulator (AER) to prevent the abandonment or renunciation of an insolvent debtor's assets by a court-appointed receiver or trustee, and require the trustee to satisfy certain environmental claims outside of the scheme of distribution set out in the Bankruptcy and Insolvency Act (BIA).

HISTORY OF PROCEEDINGS

Redwater Energy Corp. (Redwater) was a publicly listed junior oil and gas producer in Alberta that held a number of properties licensed under the OGCA and the PA. In May 2015, after Redwater's inability to consummate an out-of-court sale of its assets in order to repay its lender in full, Grant Thornton Limited (GTL) was appointed receiver over Redwater's assets pursuant to section 243 of the BIA. In October 2015, Justice B. Romaine granted an order assigning Redwater into bankruptcy and GTL was named trustee of Redwater's estate.

Upon appointment, GTL conducted an assessment of Redwater's licensed assets and advised the AER that it would only be taking control of approximately 20 of the 127 Redwater wells, facilities and associated pipelines. Shortly thereafter, the AER issued closure and abandonment orders (AER Orders) in respect of the licensed assets renounced by GTL (Renounced Assets) and filed an application to compel GTL to comply with the closure and abandonment orders and to fulfill all of Redwater's statutory obligations in relation to abandonment, reclamation and remediation of the licensed assets.

GTL brought a cross-application seeking the approval of a sales process that excluded the Renounced Assets and sought a determination of the constitutionality of AER's licensing regime under the OGCA and the PA to the extent that it prevented GTL from abandoning the Renounced Assets and imposed an obligation on GTL to expend funds to comply with the AER Orders as a condition precedent to the AER approving a transfer of Redwater's AER licences.

The Chief Justice dismissed the AER's application and granted GTL's application to commence a sales process to dispose of Redwater's assets. The AER and the Orphan Well Association (Appellants) both appealed the Chambers Decision (collectively, the Appeals) shortly thereafter.

APPEALS

The majority of the Court dismissed the Appeals on the basis that the Chambers Decision disclosed no errors and was consistent with the majority decision of the Supreme Court of Canada (SCC) in Newfoundland and Labrador v. AbitibiBowater Inc. (AbitibiBowater). Further, the majority of the Court found that the AER's position in respect of end-of-life obligations both engaged the doctrine of paramountcy and frustrated the BIA's purpose.

Environmental Claims

One of the primary questions addressed in the Chambers Decision was whether the AER Orders were provable claims capable of being compromised under the BIA. The primary environmental provisions in the BIA are contained in section 14.06, which assumes that the general bankruptcy regime applies to environmental claims other than those covered by the exceptions contained therein. In effect, the Court found that section 14.06 was Parliament's attempt to incorporate environmental claims into the general bankruptcy regime.

Whether an environmental claim will be subject to compromise under the BIA depends on the circumstances. If the environmental obligation is framed in monetary terms, it will qualify as a provable claim. If it is not framed in monetary terms, it must be examined to see whether it will "ripen into a financial liability", having regard to the "factual matrix and the applicable statutory framework". In AbitibiBowater, the SCC set out a three-part test to assist with this determination:

  1. There must be a debt, liability or obligation to a creditor
  2. The debt, liability or obligation must be incurred at the relevant time in relation to the insolvency
  3. It must be possible to attach a monetary value to the debt, liability or obligation

The Court noted four specific points in support of the Chief Justice's determination that the AER Orders were provable claims:

  1. An examination of the substance of the regulatory regime indicated that it was irrelevant whether Redwater's obligation to remediate the wells arose directly or indirectly, as the AER's policy on transfers resulted in the stripping away of value from the bankrupt estate to meet the outstanding environmental obligations.
  1. It did not matter which public body actually does the remediation, as in any case, there is a "creditor" with a provable claim in bankruptcy operating under the government's authority.
  1. The determination of whether it is sufficiently "certain" that the remediation work will be done depends on the factual context, but the AER cannot manage the timing of its intervention in order to escape the insolvency regime.
  1. The effect of the AER's policy on the sale of assets was to artificially transfer the value of the oil and gas assets to the AER licence, which itself has no intrinsic value. As a result, the Court found that the regulatory technique of placing financial conditions on a transfer of AER licences provided sufficient "certainty" in that it both fixed a monetary value on the obligations and made it certain that the funds will be set aside to perform the remediation.

Constitutional Questions

In addition to agreeing that the AER Orders were provable claims under the BIA, the majority of the Court also found that the current regulatory regime engaged the doctrine of paramountcy to the extent that it required GTL to devote substantial parts of the bankrupt estate in satisfaction of the environmental claims in priority to the claims of the secured creditor.

After careful review, the Court found that the current regime governing the transfer of AER licences is premised on the assumption that there is an obligation outstanding, with the obligation being the actual or potential cost of abandoning the well. For a number of years, the AER has been hindering the disposition of assets in bankruptcy by placing financial preconditions on the transfer of permissive AER licences, thereby requiring payment of environmental obligations ahead of the claims of secured creditors and disrupting the scheme of distribution under the BIA.

The Court agreed with the Chief Justice that the AER's licensing scheme was in violation of the "single proceeding" model and also that the obligations that the AER sought to impose on receivers and trustees were in operational conflict with the provisions of the BIA that: exempt a trustee or receiver from personal liability, allow a trustee or receiver to disclaim assets, and govern the priority of remediation costs. Additionally, the Court found that the regime frustrated the federal purpose of managing the winding up of insolvent corporations.

However, the determination of unconstitutionality was limited to those provisions that conflict or frustrate the BIA's purpose. The Court clearly expressed that the AER remains able to control the transfer of AER licences of bankrupt companies, as long as its actions do not disrupt the priority of environmental claims under the BIA (including further limiting transfers to qualified transferees).

One justice dissented on these points and held that the OGCA and PA did not create an operational conflict or frustrate the BIA's purpose. She found that the current regime was not aimed at the subversion of the scheme of distribution under the BIA and that any incidentally effect on distribution was permissible.

COMMENTARY

The Court correctly recognized that the Appellants sought to replace the "polluter pay" system set out in AbitibiBowater with a "third-party pay" system, placing the costs of environmental obligations squarely on the shoulders of Redwater's creditors. The Court was cognizant of the purpose of section 14.06 and held that if Parliament had intended that the debtor always satisfy all remediation costs, it would have granted the Crown a priority with respect to the totality of the debtor's assets. This express affirmation of the scheme of distribution under the BIA and the general law of priority of claims provides certainty that Alberta courts will continue to recognize the rights of secured lenders with properly registered security. Finding otherwise would have the effect of limiting the influx of capital into an industry attempting to recover from an extended downturn.

Of particular note to lenders, the Court found that the industry practice of accounting for outstanding environmental obligations when evaluating the creditworthiness of a potential borrower will not prejudice or result in the subordination of their security in liquidation proceedings under the BIA.

The AER has indicated that it will seek leave to appeal the Court's decision to the SCC. However, it is unclear what measures the AER will take in the interim to address the effects of the Court's decision, as the AER's response to the Chambers Decision had unintended consequences that significantly disrupted industry (see AER Bulletin 2016-21).

If you would like to discuss the decision or its possible effects on your business, please contact the authors.

Blakes acted for Alberta Treasury Branches, Redwater's principal secured lender, in this matter.

Please also see our May 2016 Blakes Bulletins: Alberta's Oil and Gas Licensing Regime Found to be Unconstitutional and AER Seeks to Hold Directors, Officers Personally Liable for Obligations of Insolvent Corporate Licensees, our June 2014 Blakes Update: Alberta Licensee Liability Rating Program Imposes Financial Challenges for Junior Oil & Gas Companies and our September 2013 Blakes Bulletin: Increases to Alberta Licensee Liability Rating Program.

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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