Canada: Gross Overriding Royalty As Interest In Land – The Clear Language Conundrum Continues

In 2002 the Supreme Court of Canada, in Bank of Montreal v Dynex Petroleum Ltd, 2002 SCC 7 (Dynex) affirmed that gross overriding royalty interests (GOR) could constitute interest in land provided the parties so intended and that intention was sufficiently evidenced in an agreement. The case-by-case application of Dynex appears to have created a nightmare of uncertainty as courts continue to differ on whether or not magic words expressly create and convey an interest in land, and sufficiency of the language. In an earlier blog post, available here, we analyzed two examples of how courts approach the exercise of determining whether a specific GOR constitutes an interest in land: Walter Energy Canada Holdings Inc., (Re), 2016 BCSC 1746 ("Walter Energy") and Third Eye Capital Corporation v Dianor Resources Inc., 2016 ONSC 6086 ("Dianor"). Dianor was appealed. The Ontario Superior Court had held that the GORs were not interests in land, although the agreements clearly set out the parties' intentions to make them interests in land. It also confirmed the Ontario Court's ability in insolvency proceedings to convey and vest assets free and clear of royalty interests. The Ontario Court of Appeal in Third Eye Capital Corporation v Dianor Resources Inc., 2018 ONCA 253, has reversed the Superior Court on the clear language application and sought further submissions on the jurisdiction of the Court to vest assets free and clear of royalty interests in insolvency proceedings.

Background

The facts of Dianor are set out in an earlier blog post, here. In summary, Dianor Resources Inc. ("DRI") was an insolvent company with interest in mining assets in Ontario (the "Ontario Assets") and Quebec. The receiver wished to sell the Ontario Assets on which 2350614 Ontario Inc. ("235Co") had GORs. 235Co insisted that the assets would be conveyed subject to 235Co's GORs. Third Eye Capital Corporation ("Third Eye") was the winning offer on the Ontario Assets and indicated it would only purchase the Ontario Assets if 235Co's GORs were terminated or significantly reduced. DRI's receiver sought court approval to sell the Ontario Assets. A central issue at the hearing was whether or not 235Co's GORs constituted an interest in land. The relevant agreements contained the following statement:

"It is the intent of the parties hereto that the [GOR] shall constitute a covenant and an interest in land running with the Property and the Mining Claims and all successions thereof or leases or other tenures which may replace them, whether created privately or through governmental action, and including, without limitation, any leasehold interest."

The motions judge concluded that it was not enough for the agreements to simply assert the GORs were interests in land; the agreements had to contain sufficient wording to convey an interest or grant a right in real property. Apart from the lack of specific words, other factors the judge considered included: (a) 235Co did not retain a right to enter the lands to explore and extract minerals; and (b) the GORs were calculated on post-production substances. 235Co appealed. Third Eye cross-applied for an order to quash 235Co's Notice of Appeal on the basis that the appeal was moot as the vesting order operated to extinguish the GORs when it was registered on title.

Issues

Among the issues on appeal were whether: (a) 235Co's GORs were interests in land within the meaning of Dynex; and (b) the motion judge had jurisdiction to vest out the GORs, and if not, the possible remedy for 235Co.

Decision

Reversing the motions judge, the Ontario Court of Appeal held that 235Co's GORs were interests in land. The Court of Appeal noted that the Supreme Court of Canada in Dynex changed common law to permit a GOR to achieve status as an interest in land. Under common law, the right to take resources from another person's land is a profit à prendre and is recognized as an interest in land. However, the right to a payment or to profits alone is not a profit à prendre and was not historically recognized as an interest in land. Because an interest in land could not be granted out of an incorporeal hereditament, the common law posed commercial challenges to holders of working interests who needed to secure financing sources to allow for the exploitation of mining rights. It became industry practice to draft contracts with the intention of granting royalty holders an interest in land because it was commercially and practically expedient to do so. The Court of Appeal noted that key participants often prefer an interest in land rather than a contractual right against the lessee because this allows "investments in a particular piece of property, not in a particular operator or company. ... The investment return on a royalty results from the success of the property regardless of who owns or is working the property." Consequently, for practical and commercial reasons even before Dynex, parties often drafted royalty agreements with the intention of granting the royalty holder an interest in land rather than a contractual right against the lessee.

The Court of Appeal explained that Dynex deliberately changed the common law, in response to these commercial realities and for express policy reasons, to permit a royalty interest including a GOR to become an interest in land, consistent with the industry practice. Thus the law became that a "royalty interest" or an "overriding royalty interest" can be an interest in land if: (a) the language used in describing the interest is sufficiently precise to show that the parties intended the royalty to be a grant of an interest in land, rather than a contractual right to a portion of the oil and gas substances recovered from the land; and (b) the interest, out of which the royalty is carved, is itself an interest in land.

Applying the Dynex principles to this case, the Court of Appeal held that DRI's interests in the claims were working interests or profits à prendre, which the common law unquestionably recognizes as interests in land. Given that the GORs were carved out of DRI's interests, the second element in the Dynex test was plainly met in this case. The Court of Appeal found that the first element was also met because the Crown Land Agreement and the Patented Land Agreement expressly stated that the parties intended the GORs to create an interest in and to run with the land. Considering the surrounding context, apart from the plain language of the Agreements, the Court of Appeal noted that the original GOR-holder took steps to register its royalty rights on title to the patented lands under Ontario's Land Titles Act ("LTA") and on the unpatented mining claims under Ontario's Mining Act. The Court of Appeal concluded that Courts must examine the parties' intentions from the agreement as a whole, along with the surrounding circumstances. The contractual terms are not necessarily determinative of whether an interest in land was intended; the language does not require magic words to demonstrate the parties' intention.

The Court of Appeal held that the motions judge made three errors: (a) he did not examine the parties' intentions from the royalty agreements as a whole, along with the surrounding circumstances; (b) he held that in order to qualify as an interest in land, the royalty agreements had to give the appellant the right to enter the property to explore and extract diamonds or other minerals; and (c) he held that the interest, out of which the royalty is carved, is not an interest in land because it is expressed in the Agreements as only a right to share in revenues produced from diamonds or other minerals extracted from the lands.

Noting that the last two errors resulted from a misapprehension of the Dynex test, the Court of Appeal confirmed that, first, Dynex does not require a royalty rights-holder to have the right to enter the property to explore and extract resources in order to qualify as an interest in land. The purpose of the Supreme Court and the Court of Appeal of Alberta in Dynex was to step away from the requirement that a royalty right had to have the incidents of a working interest or a profit à prendre in order to constitute an interest in land, so that royalty rights could play their useful role in financing the industry and spreading risk. Second, the language in which the calculation of the royalty right is expressed does not affect its characterization as an interest in land, neither does it defeat the clear intention of the parties that the GORs constitute interests in land within the meaning of the law outlined in Dynex.

On the issue of a vesting order, the Court of Appeal considered the motion judge's opinion that the Court would have been authorized to make the vesting order disposing of the royalty rights of 235Co "whether the royalty rights were or were not an interest in land." The core issue was whether the motion judge had jurisdiction, pursuant to sections 100 and 101 of the Courts of Justice Act ("CJA") and section 243 of the Bankruptcy and Insolvency Act ("BIA"), its inherent jurisdiction, or the wording of the vesting order, to approve a sale that vested out 235Co's proprietary interest. The Court of Appeal held that these provisions do not expressly authorize a court to take real property out of the hands of a third party. Considering the Superior Court's inherent jurisdiction, the Court of Appeal held that at equity and common law, a party must have a valid and independent entitlement to possession or ownership in order for a court to issue a vesting order that extinguishes a third party's real property interest. The Courts have consistently held that the inherent jurisdiction of the Superior Courts does not confer the power to take real property from third parties simply because the court considers it equitable to other stakeholders. Rather, it gives courts authority to bring about a transfer of title to a party who is otherwise or independently entitled to it.

The Court adopted the policy reasoning behind the restraint on vesting orders set out by Wilton-Siegel J. in 1565397 Ontario Inc., Re, [2009] O.J. No. 2596, 54 C.B.R. (5th) 262. That Court refused to permit the sale of the property on the grounds that the effect of any such extinguishment amounted to expropriation of the third party's assets in favour of subordinate or unsecured creditors. Further, the third party's interest was not subject to the receivership. Therefore the receiver could not have taken possession of, or otherwise have any interest in, the third party's interests in the property, regardless of the terms of the Receivership Order, because the Order extended only to the assets of the debtor. As such, the receiver had no authority under the Receivership Order to sell the interests of the third party, neither did the Court have the authority to grant such an order in the absence of the appointment of a receiver over the third party's assets.

The Court of Appeal, however, noted and addressed some situations in which courts have considered vesting orders that vest out a third party's proprietary interest including: (a) the "narrow circumstances" exception where doing so would provide added certainty, and there is no evidence of competing proprietary interests; and (b) the "equities" which establishes priorities among interests. Nonetheless, the Court posed a further question, requiring additional arguments by the parties, as to whether and under what circumstances and limitations (including the ones enumerated) a Superior Court judge has jurisdiction to extinguish a third party's interest in land using a vesting order, under s. 100 of the CJA and s. 243 of the BIA, where the following provisions do not apply: ss. 65.13(7), 66(1.1); 84.1 of the BIA and s. 36(6) of the Companies' Creditors Arrangement Act ("CCAA") or s. 11.3 of the CCAA.

On the issue of a remedy, while the parties did not fully address what should be done by way of remedy if the appeal was successful, the Court, noted that 235Co was effectively seeking rectification of the register to reflect the GORs. The Court held that even though registration of the vesting order has effected a conveyance of the mining claims, 235Co is not necessarily without a remedy. Given that 235Co has an interest in land, it could be entitled to rectification of the register under the LTA. However, the Court noted several difficulties that may arise in providing a remedy. First was the lack of evidence on whether an innocent third party acquired an interest from Third Eye after the vesting order was registered, which would debar a remedy. Second was the parties' arguments on the impossibility of varying the vesting order on appeal to remove 235Co's interest from the schedule of claims to be discharged from title and be added to the schedule of permitted encumbrances. The Court concluded that it would not be prudent to exercise authority to rectify title without hearing argument from the parties on remedial issues.

Implications

The appellate decision in Dianor is an important development for GORs for various reasons. First, it favors an application of the Dynex principles, which appears closer to reality and policy considerations, namely that for a valid GOR to exist: (a) royalty rights-holders are not required to have the right to enter the property to explore and extract resources in order to qualify as an interest in land; (b) no "magic words" are necessary to to demonstrate the parties' intention that a GOR constitutes and is being conveyed as an interest in land; and (c) Courts must examine the parties' intentions from the agreement as a whole, along with the surrounding circumstances. Second, it clarified that the CJA and the BIA provisions relied upon do not expressly authorize a court to take real property from a third party, neither does the inherent jurisdiction of the Superior Courts confer the power to do so simply because the court considers it equitable to other stakeholders. Rather, the inherent jurisdiction gives courts authority to bring about a transfer of title to a party who is otherwise or independently entitled to it. These principles, no doubt, ensure that Courts have flexibility to determine when a GOR is an interest in land, and clarifies somewhat the Court's vesting powers in insolvency proceedings.

However, the confusion in the application of Dynex to royalty agreements is far from over. The principle, that the contractual terms are not necessarily determinative of whether an interest in land was intended, makes any hope of attaining consistency in interpretation and certainty in drafting commercial royalty agreements almost impossible. Furthering the confusion is the principle that the language in which the calculation of the royalty right is expressed, does not affect its characterization as an interest in land. Surrounding circumstances will always differ with the facts of each case. In Dianor, for example, the fact that the GOR-holder registered its royalty rights on title to the "patented lands" under the LTA and on the unpatented "mining claims" under the Mining Act was significant for the Court of Appeal's decision. We note that the lack of such registration by a GOR-holder for GORs on Crown lands (unpatented lands) may be an irrelevant consideration in Alberta. Leases and other encumbrances of Crown minerals on Crown lands cannot be registered at the Land Titles under the Alberta Land Titles Act. While the Alberta Mines and Minerals Act expressly recognizes "security interest" for registration there under, there is no such express recognition for royalty interests.

Also of considerable importance to the insolvency practice are the remaining questions as to whether, and under what circumstances and limitations, a Superior Court judge has jurisdiction to extinguish a third party's interest in land using a vesting order, under s. 100 of the CJA and s. 243 of the BIA, where the following provisions do not apply: ss. 65.13(7), 66(1.1); 84.1 of the BIA and s. 36(6) of the CCAA or s. 11.3 of the CCAA, and appropriate remedies if the power is exercised erroneously. BLG will continue to monitor and report on these issues as they unfold.

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