On April 21, 2023, the Court of King's Bench of Alberta (Court) released its decision in Terra Energy Corp (Re). In this decision, the Court rejected the Government of Alberta's attempt to recover oil and gas royalty arrears, owed by Terra Energy Corp. (Terra), from Enercapita Energy Ltd. (Enercapita). Terra is a bankrupt oil and gas company, and Enercapita is a company that had purchased Crown oil and gas leases from Terra prior to its bankruptcy. The decision establishes that a purchaser's liability for royalty arrears under Crown mineral leases does not necessarily include liability for such arrears discovered by audit conducted after the purchase closes.
Background
In Alberta, royalties on Crown-owned oil and gas leases are
calculated based on the net proceeds of sale, pursuant to formulas
set out in regulations made under the Mines and Minerals Act (MMA). For natural
gas (other than solution gas), lessees are allowed to deduct
certain costs that they incur and must provide annual reports to
Alberta Energy setting out the details of those costs. Alberta
Energy then has the authority to audit that information.
In September 2015, Enercapita purchased certain Crown-owned oil and
gas leases from Terra. Terra later became bankrupt in November
2016.
After Terra became bankrupt, Alberta Energy audited Terra's
royalty filings for 2011 to 2014. Specifically, Alberta Energy
requested that Terra provide supporting documentation for cost
allowances it claimed in calculating its natural gas royalty
obligations for those years. The majority of these cost allowances
related to gas from wells that Enercapita did not acquire.
Neither Terra nor its trustee in bankruptcy provided the requested
information. Accordingly, Alberta Energy amended Terra's
allowable expenditures for 2011 to 2014 to zero, resulting in Terra
owing royalty arrears of approximately C$3.2-million.
Alberta Energy then demanded payment of approximately C$2.8-million
of these arrears from Enercapita. Alberta Energy relied on section
91.1 of the MMA, which provides that a transferee of a Crown
mineral lease may be liable for certain liabilities of the
transferor. At the time, Alberta Energy owed Enercapita
approximately C$1.2-million in royalty overpayments, and the
ministry sought to retain this amount by setting it off against
Terra's arrears under subsection 46(4) of the MMA.
Over the following three years, Enercapita engaged extensively with
Alberta Energy to obtain and provide supporting documentation for
Terra's natural gas cost allowances, even though Enercapita had
no connection to Terra other than as a purchaser of some of
Terra's leases.
Alberta Energy did not accept this documentation. After Alberta
Energy issued a final refusal to refund Enercapita's
overpayment in December 2020, Enercapita applied to the Court for
relief.
Decision
The Court decided in favour of Enercapita on all issues. The
Court found that Alberta Energy could not rely on either section
91.1 or subsection 46(4) of the MMA.
The Court interpreted section 91.1 narrowly and found that it
applies only to liabilities existing at the time a Crown mineral
lease is transferred. The Court found that at the time of the
transfer of the leases from Terra to Enercapita, the possibility
that Terra might have royalty arrears discovered in the audit
process was a contingent liability, and that such a contingent
liability did not come within the scope of section 91.1.
The Court found that even if section 91.1 allowed Alberta Energy to
recover Terra's royalty arrears from Enercapita, Alberta Energy
had not established a right to set off those arrears against
Enercapita's overpayment under subsection 46(4). The Court held
that section 91.1 did not support Alberta Energy's approach of
allocating Terra's arrears to Enercapita even though the
majority of the arrears related to gas were from wells that
Enercapita did not acquire. Further, because Enercapita had
provided supporting documentation for the natural gas cost
allowances claimed by Terra, the Court was not convinced that Terra
owed any arrears at all. Therefore, the Court found that Alberta
Energy had not established that Enercapita owed a debt.
Accordingly, the Court ordered Alberta Energy to refund
Enercapita's royalty overpayment.
Alberta Energy has not appealed the Court's decision and the
deadline for doing so has passed, meaning that the decision is now
final.
Takeaway
This decision provides comfort to purchasers of Crown oil and gas leases that their potential liability for a vendor's royalty arrears is narrow. Based on the Court's interpretation of section 91.1 of the MMA, a purchaser will only be liable for arrears that Alberta Energy has identified prior to closing. If Alberta Energy conducts an audit of the vendor's royalty account after closing and alleges additional amounts owing, it will likely only be able to recover these amounts from the vendor, and not the purchaser.
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