On February 1, 2019, the Supreme Court of Canada (SCC) released its highly anticipated decision in the Orphan Well Association, et al. v. Grant Thornton Limited, et al, 2019 SCC 5 (Redwater). The majority of the SCC overturned the Alberta Court of Appeal (ABCA) in Orphan Well Association v Grant Thornton Limited, 2017 ABCA.
This decision has far-reaching implications for all of the stakeholders (including the Crown, Alberta’s Energy Regulator (AER) and Orphan Well Association (OWA), surface rights holders, producers, lenders, receivers and bankruptcy trustees – we will refer to receivers and trustees simply as “trustees”) in the upstream production of oil and gas. This decision may also affect other provinces and industrial sectors as well.
In overturning the Alberta Court of Appeal, the Supreme Court ruled that while trustees will not be personally liable for abandonment and reclamation obligations, the estate will remain liable for such obligations. The most immediate and profound effect of this decision relates to the relative financial priority between the company’s creditors and the cost to reclaim and abandon the wells. Prior to the Supreme Court’s decision, a trustee was entitled to sell economic wells and direct the proceeds to the bankrupt’s creditors (usually, its secured lender) and disclaim uneconomic wells without paying or accounting for the costs required to abandon and reclaim such wells. In short, the Supreme Court of Canada has settled this issue by holding that reclamation and abandonment liabilities must be dealt with before there can be any distribution to the insolvent party’s creditors, including its secured creditors.
The Supreme Court’s Redwater decision represents the law coming full-circle since the 1989 trial decision and 1991 appeal proceedings in the PanAmericana de Bienes y Servicios v.Northern Badger Oil & Gas Limited 1991 ABCA 181 (Northern Badger). Northern Badger stood for the proposition that a court-appointed receiver and manager was personally liable for discharging environmental obligations of an insolvent oil and gas producer including end of life abandonment obligations. Northern Badger granted priority to the costs of remedying environmental conditions over claims of secured creditors.
Given the potential for personal liability, Northern Badger, together with other developments in the law relating to the personal liability of trustees, created a chill over the willingness of trustees to accept appointments as trustees. As a result, in 1992 Parliament enacted (and in 1997 subsequently amended) section 14.06 of the Bankruptcy and Insolvency Act (BIA) to provide a measure of comfort to trustees that they are not personally liable for: (i) pre-bankruptcy environmental conditions or post-bankruptcy environmental conditions unless they caused such conditions either through their gross negligence or through wilful conduct; or (ii) compliance with environmental orders or directives so long as the trustee abandons or releases any interest in the property that is affected by the condition or damage within a prescribed time frame.
For many years in Alberta there was a dynamic tension between the AER and trustees over the obligation of trustees to reclaim and abandon uneconomic well sites. The commodity crash of 2015 led to a significant up-tick in the number of oil and gas insolvencies with the result that the conflict between the AER and trustees approached a full-fevered pitch as the crisis deepened. In the case of Redwater, in July 2015, the receiver appointed for Redwater informed the AER that it was taking possession and control of Redwater’s 17 most productive wells and associated assets, and that it was renouncing to Redwater’s other licensed assets, including 72 wells. In response, the AER issued orders requiring Redwater to complete the reclamation and abandonment obligations associated with the renounced assets. Redwater’s receiver was subsequently appointed as trustee and advised the AER did it did not intend to comply with these orders.
In 2015, in the wake of the demise of Redwater, the AER brought proceedings against Redwater’s trustee. The trustee and Redwater’s secured lender responded to the AER proceedings by successfully arguing in the lower courts that the attempt by the AER to use the statutory power conferred upon it under provincial law conflicted with the scheme of distribution mandated by the BIA. The Alberta Court of Queen’s Bench and the Alberta Court of Appeal decisions can be found in our previous posts here and here.
In a 5-2 majority, the Supreme Court of Canada overturned the Alberta Court of Appeal. The key pronouncements by the Supreme Court include:
- Section 14.06 of the BIA is concerned with the personal liability of trustees, not with the liability of the bankrupt estate. A trustee is fully protected from personal liability for environmental liabilities associated with disclaimed assets (subject to the exceptions in section 14.06) but this release of liability does not extend to the bankrupt estate’s liability.
- The AER can impose conditions on the transfer of a bankrupt’s licenses that require payment or performance of abandonment and reclamation obligations of a debtor, including in respect of wells and other facilities of the bankrupt for which no license transfer is being sought. In doing so, the AER is not asserting a claim in the bankruptcy proceeding and is therefore, not offending the statutory scheme of distribution established in the BIA.
- The Court reserved any guidance on what constitutes “abandoning, disposing of or otherwise releasing real property” for the purpose of section 14.06 for another day.
- With respect to the operational conflict between the BIA and Alberta legislation deeming that a trustee is a “licensee” under the Oil and Gas Conservation Act (OGCA) and the Pipeline Act, the SCC provides comfort to trustees and a warning to the AER. They noted that, in the 20 years since the definition of “licensee” has included a trustee, the AER has never attempted to hold a trustee personally liable. The Court stated that if the AER were to attempt to hold a trustee personally liable under abandonment orders, there would be an operational conflict between the OCGA and the Pipeline Act and section 14.06(2) of the BIA, rendering the OGCA and Pipeline Act inoperative to the extent of such conflict.
- The trustee and secured lender relied on an interpretation of the Supreme Court of Canada’s 2012 Newfoundland and Labrador v AbitibiBowater Inc., 2012 SCC 67 (Abitibi) that the abandonment orders were “intrinsically financial” with the result that requiring compliance with the abandonment orders conflicted with the scheme of distribution in the BIA that mandates that secured claims must be paid before the claims of unsecured creditors. Abitibi established a specific three-prong test to determine whether a regulatory authority is asserting a claim provable in bankruptcy: 1) there must be a debt, liability or obligation to a creditor, 2) the debt must be incurred before the debtor becomes bankrupt, and 3) it must be possible to attach a monetary value to the debt, liability or obligation. In dismissing the trustee and secured lender’s argument, the Court held that the AER was exercising a public duty for the benefit of “their fellow citizens” without the expectation of any financial benefit (which was not the case in Abitibi), with the result that, according to the Court, the AER is not a creditor. In buttressing its holding, the Court also held that the third part of the Abitibi test involved the assessment of the AER’s contingent claim and there was not sufficient certainty that the AER would perform the end-of-life obligations. The result is that the Court held the abandonment orders are not provable claims and do not interfere with the operation of the BIA.
The issue of personal liability of trustees received a thorough canvassing by the majority and the trustee community can take a strong measure of comfort that trustees will not be personally liable for end-of-life obligations even in the face of the legislative provisions that deem them to be licensees other than in the circumstances prescribed in section 14.06 of the BIA. Less certain, however, is the ability of the trustee to utilize estate funds to pay ordinary costs of administration of insolvent estates including post-filing creditors and the fees of the trustee and its counsel in the face of a regulatory directive to comply with end-of-life obligations. The risk presents that trustees will not be eager to accept appointments in cases involving often unquantifiable environmental liabilities absent a policy statement from the AER that the heretofore well understood priority afforded to trustees for its fees and its ability to indemnify itself from estate funds to pay post-bankruptcy creditors will be respected by the AER on a go-forward basis.
More concerning is the impact the decision will have in those circumstances where the end-of-life obligations exceed the expected liquidation value of the bankrupt’s assets. In such cases, there is little, if any, economic incentive for secured lenders to undertake enforcement proceedings. The insolvent borrower, instead, without access to liquidity and working capital, will be cut adrift with no means to safely operate or to deal with end-of-life obligations. Secured lenders will not seek to have court-appointed trustees put in place to deal with the problems. Thus, it appears that a potential unintended consequence of the decision is that there will be a greater increase in orphaned wells than in the landscape that existed prior to the decision. Again, the AER is best-positioned to implement policies that will incentivize secured lenders to deal with their security as opposed to simply walking away.
Similarly, Redwater can be expected to cause increased financial difficulties for junior and intermediate producers in an already challenged credit market. A fundamental requirement for a functioning credit market is the ability of credit providers to have a measure of certainty that they will be able to recover their loan if the borrower becomes insolvent. Affording priority to obligations that by their nature are incapable of quantification at the time credit is advanced will result in constrained credit.
In reaching its decision, the Supreme Court notes that the effect of its decision is to enforce the supremacy of the “polluter-pay principle”; such an objective is at once laudatory and sacrosanct. An unfortunate by-product of the debate surrounding Redwater, however, is that the discourse has taken on a “pro-environment” versus “anti-environment” animus. Such discourse is unfortunate inasmuch as the issue is more complex and nuanced than the simplistic “industry versus the public good” debate that can come into play in environmental matters. The issues in Alberta that led to the troubling increase in orphaned wells is not something that can be solely visited upon the petroleum and natural gas industry and those that provide financing to it. The complex regulatory scheme combined with a generational and unprecedented crash in commodity prices created a perfect storm exacerbating the problem. In particular, attempting to visit the problem upon credit-providers by creating a straw man that lenders knew what they were taking on when they made the decision to lend, not only fails to apprehend the multi-factoral causes of the orphan well crisis, but is antithetical to the admonition from the Supreme Court that “[t]here is no reason why the Regulator and trustees cannot continue to work together collaboratively, as they have for many years, to ensure that obligations are satisfied, while at the same time maximizing recovery for creditors.”
Accordingly, while Redwater provides a clear road map as to what lenders can expect to receive in future insolvency cases involving oil and gas producers whose end-of-life obligations exceed the value of estate, such clarity presents yet another potential roadblock for capital providers to an industry described by the Supreme Court as “a lucrative and important component of Alberta’s and Canada’s economy.” It behoves participants on all sides to work together to find solutions to these issues. It will also be critical for the AER and the Government of Alberta to engage in meaningful discussion with industry and financial institutions to ensure an adequate balance is struck between protecting landowners and tax payers from the burden of the costs associated with abandoning and reclaiming wells and providing adequate regimes for financial institutions to provide the capital critical to ensure a viable oil and gas industry.
We continue to consider the implications of this decision (both in Alberta and elsewhere in the country) and monitor any new directives or bulletins from the AER and other regulatory authorities in Canada. Stay tuned for additional updates as this saga continues to unfold.
By Sean Collins,Walker MacLeod and Kimberly Howard