Canadian Update - Redwater Cases

Redwater Decisions and Outcomes in Alberta, Canada

In Orphan Well Assn. v. Grant Thornton Ltd., 2017 ABCA 124, 2017 CarswellAlta 695, the Alberta Court of Appeal (the “ABCA”) recently handed down its highly anticipated decision involving the Alberta Energy Regulator (the “AER”) and Redwater Energy Corporation (“Redwater”). In doing so, the ABCA affirmed the determination by the Alberta Court of Queen Bench (the “ABQB”) in Grant Thornton Ltd. v. Alberta Energy Regulator, 2016 ABQB 278, 2016 CarswellAlta 994 that receivers and trustees (together “Trustees” or a “Trustee”) have the legal authority to disclaim uneconomic oil and gas assets in order to satisfy creditors and cannot be prevented from doing so on the basis of provincial legislation. This case summary will consider each decision as well as their practical consequences.

Background

The AER is the provincial authority in Canada responsible for the issuance, maintenance and transfer of any oil and gas license in the province of Alberta. Two crucial facets of this system are the AER’s Licensee Liability Rating Program (“LLR”) and Liability Management Ratio (“LMR”).

The primary purpose of the LLR and the license transfer process is to prevent the costs to suspend, abandon, remediate, and reclaim a well, facility, or pipeline in the LLR Program from being borne by the public of Alberta should a licensee become defunct. Importantly, the LLR applies to all licensed operators of AER-licensed wells, facilities, and pipelines, and, until the Redwater decisions, the provincial Oil and Gas Conservation Act (the “OGCA”) and Pipeline Act (the “PA”) classified Trustees of AER-licensed assets as licensees. In other words, prior to the Redwater cases, Trustees would assume all the same statutory and regulatory obligations owed to the AER as any oil and gas company operating under the AER regime.

The LMR is the ratio given to each AER licensee, calculated by dividing the licensee’s deemed assets by its deemed liabilities. Previously, if its LMR fell below 1.0, the licensee would be required to post a security deposit with the AER equal to the difference between the licensee’s deemed liabilities and deemed assets. If this security was not posted, the licensee would be subject to abandonment orders demanding that the licensee close some or all of its wells, facilities, or pipelines and remediate the land. Failure to do so could result in the AER refusing to transfer the licenses for any of the licensee’s oil and gas properties in the province of Alberta.

Alberta Court of Queen’s Bench Decision

In 2015, Redwater, a junior oil and gas company that owned dozens of AER-licensed wells, became insolvent. Its secured lender, Alberta Treasury Branches (“ATB”), made an application to have a receiver appointed. The application was granted and Grant Thornton Limited (“GTL”) was appointed first as receiver under the federal Bankruptcy and Insolvency Act (the “BIA”) and then eventually trustee in bankruptcy as well. GTL proceeded to disclaim its interest in all but 20 of Redwater’s 127 AER-licensed properties on the grounds that they were uneconomic, as Trustees are entitled to under s. 14.04(4) of the BIA. The AER responded by issuing abandonment orders for the disclaimed assets, which insisted that GTL post either payment or security sufficient to remediate the wells. When GTL failed to comply with the orders, the AER refused to transfer the licenses for any of the Redwater properties, including the non-disclaimed wells. This prevented GTL from selling those assets to satisfy Redwater’s creditors.

The main question for the ABQB to decide was whether the AER could legally impede a Trustee from transferring compliant AER-licensed assets until the Trustee fulfilled provincial environmental obligations pursuant to other renounced oil and gas assets. In its May 2016 decision, the court determined that the AER had no such authority because the OGCA and PA, under which the AER had issued its abandonment orders, violated the doctrine of federal paramountcy. The obligations imposed on Trustees by this provincial legislation were in operational conflict with the federal BIA by, in effect, ranking payment of, or the posting of security for, the abandonment costs for disclaimed assets in priority to all other creditors. This frustrated the BIA’s federal purposes of winding up insolvent corporations and settling the priority of creditor claims. In its concluding remarks, the Court stated that a Trustee is not a licensee of disclaimed assets, does not assume any liabilities, and is not bound by any abandonment order relating to disclaimed assets. In other words, the AER cannot attempt to impose on the Trustee the obligation to remediate the renounced property by performance or posting security.

Alberta Court of Appeal Decision

The ABCA affirmed the lower court’s decision on April 24, 2017. Among other things, the Court made the following important statements:

    • Trustees are not personally liable for environmental liabilities, meaning that the obligation to remedy that type of damage is limited to the assets available in the bankrupt estate itself.
    • Trustees can abandon or renounce assets encumbered with environmental obligations. They can disregard assets incapable of realization and must turn them back to the bankrupt.
    • Section 14.06 of the BIA states that this federal legislation applies “notwithstanding any provincial law”. The fact that the OGCA and PA define Trustees as “licensees” had no impact on this appeal. Trustees do not have to "step into the regulatory shoes" of the bankrupt, and do not have to take assets with "warts".
    • Provincial legislation does not change the basic priority regime in bankruptcy. The order of payment of claims in bankruptcy under s. 136 of the BIA is still subject to the rights of secured parties. Parliament did not (as it could have) provide that provable claims are to be paid subject to environmental claims, and next subject to the rights of secured creditors.

Consequences of the Redwater Decisions

On November 9, 2017, the Supreme Court of Canada (the “SCC”) granted leave to hear an appeal of the ABCA Redwater decision.  A date for the hearing has yet to be scheduled, but the average time for the SCC to hear an appeal is approximately seven months, and an additional five months to render a decision. In the meantime, the AER has taken the interim measure of making it significantly more difficult to transfer oil and gas assets by increasing the LMR required for the transfer of an oil and gas license from 1.0 to 2.0. Thus, while trustees and receivers are no longer prevented from disclaiming uneconomic oil and gas properties and selling viable AER-licensed assets in order to satisfy creditors, this change to the LMR requirements will likely have severe effects on their ability to transfer those non-disclaimed assets. For instance, it will logically reduce the pool of available purchasers for assets, as any purchaser whose LMR is less than 2.0 but greater than 1.0 after a transaction will now be required to post additional credit. This necessarily gives the advantage to purchasers whose LMR is high, but also potentially reduces the number of purchasers and thus could reduce purchase prices. Further, the new LMR requirements may lead to a larger pool of renounced assets in the case of an insolvency. Any receiver would, one would expect, be selling a suite of assets whose effective LMR is greater than 2.0, rather than 1.0, to ensure that the pool of purchasers is as great as possible. Therefore more marginal or suspended assets would logically be renounced.

Recent accounts support this theory that the Redwater decisions will result in more disclaimed oil and gas assets. Since the May 2016 ABQB Redwater decision, receivers of 12 defunct oil and gas companies have renounced 1,628 AER-licensed oil and gas sites exceeding $100 million in liabilities. The responsibility for remediation of these properties now falls on the Orphan Well Association (the “OWA”) – and potentially the Alberta taxpayers to foot the bill for the cleanup costs. This burden could also increase drastically in the near future. In February 2017, the AER forced bankrupt Lexin Resources Ltd. (“Lexin”) into receivership, leaving its more than 1,600 wells, pipelines, and facilities to be sold off or remediated. Depending on how many of these properties are disclaimed by GTL, Lexin’s Trustee, the OWA could potentially assume tens of millions of dollars in additional remediation costs for this company alone. The OWA has already spent over $2 million maintaining the Lexin sites since the company went in receivership in February, 2017.

One final note to make on the changes to the LMR requirements mentioned earlier is that the ABCA seems to have dismissed the potential to challenge these new requirements on the basis of federal paramountcy. By increasing the LMR threshold from 1.0 to 2.0, the AER has arguably frustrated the intention of the federal BIA. The increase will reduce the pool of purchasers qualified to hold those assets, which will likely result in more disclaimed properties and thus less revenue to pay towards creditors. However, the ABCA seems to have exclaimed the province’s sovereignty over this system by stating the AER can control the transfer of AER licenses by bankrupt companies—not by placing financial conditions on transfer that disrupt the priorities under the BIA, but by limiting transfers to qualified transferees.