Canada: A Producing Royalty As An Interest In Land: The Alberta Court Of Queen's Bench Follows Dianor

Holders of royalties in oil and gas and other minerals should take note of the recent decision of the Alberta Court of Queen's Bench in Manitok Energy Inc. (Re), 2018 ABQB 488 [Manitok], in which the Alberta Court followed the Ontario Court of Appeal's decision in Third Eye Capital Corporation v Dianor Resources Inc., 2018 ONCA 253 [Dianor] and confirmed that a royalty in respect of a fixed quantity of produced substances may constitute an interest in land if the parties' intention to make it so is sufficiently clear.

The receiver of Manitok Energy Inc. ("Manitok"), which took the position that the royalty in question was not an interest in land, recently filed a notice of appeal to appeal the decision in Manitok to the Alberta Court of Appeal.

Dianor

As explained in our recent blog post on the Dianor decision, the Ontario Court of Appeal applied and interpreted the test established in Bank of Montreal v Dynex Resources Ltd., 2002 SCC 7 [Dynex], which is used to determine when a royalty interest constitutes an interest in land. In finding that gross overriding royalty interests in certain mining claims held by an insolvent company were interests in land, the Ontario Court of Appeal rejected two propositions: (i) that a royalty holder must have the right to enter the property to explore and extract resources for the royalty to qualify as an interest in land, and (ii) that the language in which the calculation of the royalty right is expressed affects its characterization as an interest in land.

Manitok

Manitok was engaged in the exploration and development of oil and gas properties. In June 2015, Manitok and Freehold Royalties Partnership ("Freehold") entered into a Production Volume Acquisition Agreement (the "Acquisition Agreement") and a Production Volume Royalty Agreement (the "Royalty Agreement"), under which Freehold provided $25,000,000 in cash consideration to Manitok for the grant of a producing royalty in certain oil and gas properties (the "Producing Royalty"). The Producing Royalty was paid by Manitok to Freehold in cash through to the end of August 2017. After that time, Freehold took the Producing Royalty in kind, until Manitok's assignment into bankruptcy and the appointment of a receiver on February 20, 2018.

The receiver took the position that the Producing Royalty was not an interest in land, and Freehold brought an application for an order declaring that the Producing Royalty was an interest in land and the property of Freehold. At the application, the receiver argued, among other things, that the Producing Royalty was not an interest in land because the Producing Royalty: (i) was in respect of produced substances, regardless of whether Freehold took the royalty in cash or in kind, and (ii) Freehold had no right of entry into the lands, other than upon a default by Manitok.

Justice Horner of the Alberta Court of Queen's Bench undertook a review of both the wording and the context of the Acquisition Agreement and the Royalty Agreement. For instance, she noted that article 1.1(ddd) of the Royalty Agreement and schedule "B" attached to and forming part of the Royalty Agreement together expressly stated that the Producing Royalty is an interest in land that runs with the land and that the parties intended it would be an interest in land.

Further, Justice Horner noted that the contractual scheme of the Royalty Agreement defined the Producing Royalty in terms of production, not in terms of oil or mineral in situ. Justice Horner stated that it was clear from a review of the whole of the Royalty Agreement that the Producing Royalty was an interest in crude oil and condensate recovered from the production lands that was ready to be sold. Justice Horner highlighted the fact that the Producing Royalty was never expressed as a percentage or share of petroleum substances, but instead it was expressed as the first 140 barrels per day produced from the lands.

Justice Horner applied the test set out in Dynex and found that the Acquisition Agreement and the Royalty Agreement were sufficiently clear to show that Manitok and Freehold intended to create an interest in land. In her decision, she also considered the underlying business context of the Acquisition Agreement and the Royalty Agreement and the practical realities of the oil and gas industry in Alberta.

Justice Horner found that the arguments put forth by the receiver could not defeat the clear intention of Manitok and Freehold to create an interest in land. Justice Horner adopted the reasoning of the Ontario Court of Appeal in Dianor. She held that a royalty in respect of produced substances, representing a fixed quantity of production per day, may constitute an interest in land if the parties' intention to make it so is sufficiently clear. She also held that a royalty may constitute an interest in land despite the absence of, or significant limitations on, a right of entry.

Implications

The decision of the Alberta Court of Queen's Bench in Manitok reaffirms the interpretation of Dynex made by the Ontario Court of Appeal in Dianor, and creates more certainty for holders of royalty interests. Manitok also confirms that despite the type of royalty interest, whether it is a royalty granted in respect to mining claims or a royalty granted in respect to volume of oil and gas production, a royalty interest can constitute an interest in land if the parties' intention to make it so is sufficiently clear and that intention is evidenced in an agreement.

In Manitok, the characterization of the Producing Royalty as an interest in land was required for Freehold to assert its proprietary right against Manitok's oil and gas properties and to bind third party purchasers. A finding by the Alberta Court of Queen's Bench that the Producing Royalty did not constitute an interest in land would have reduced Freehold's interest to a mere contractual right enforceable only against Manitok and entitled the receiver to sell Manitok's oil and gas properties free and clear of the Producing Royalty.

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Authors
Alexis E. Teasdale
Isabel Langlois
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