The importance of the decision
Ontario’s highest court has created a framework for determining when it is appropriate for courts to approve sales and vest out interests in assets in the context of insolvency proceedings. This has given resource extraction industries and insolvency practitioners some much needed clarity on how to navigate situations when assets subject to encumbrances and other interests are being sold, especially when land subject to a royalty interest is involved.
The Ontario Court of Appeal held in its decision in Third Eye Capital Corporation v. Dianor Resources, 2019 ONCA 508 that third-party interests in land may be extinguished by a vesting order in an insolvency proceeding. While the case confirms that such jurisdiction exists, the principles outlined by the Court of Appeal make it clear that the jurisdiction is unlikely to be exercised in cases where a true ownership or comparable interest, such a royalty interest that is an interest land, is at issue and the holder has not consented to the extinguishment.
In doing so, the court has also confirmed that a vesting order may be granted in a receivership where, unlike a Companies’ Creditors Arrangement Act or Bankruptcy and Insolvency Act restructuring case, there is no express statutory provision that authorizes a sale. This result is particularly noteworthy for holders of royalty interests in mining and energy assets, as it clarifies how their rights may be affected in the event that their counterparty becomes distressed.
Background and context for the decision
Royalty arrangements are a useful financing tool for companies involved in the exploration and production of mineral interests, where there is often substantive investment risk at the outset of development and a corresponding high cost of preliminary capital. To overcome this the party who has the right to exploit the minerals in situ will often grant a fractional interest in the future gross production of its working interest to obtain project investment. The grantor receives its required capital or credit, the grantee receives a return on its investment if and when production occurs and both parties are aligned in seeking a successful project outcome. While the royalty can be an advantageous investment structure, it can also be a burden on the assets if the working interest holder becomes insolvent because potential purchasers will factor the reduced production into their valuation of the minerals. One potential response of the now insolvent grantee or its creditors is to attempt to extinguish or vest the royalty interest in the bankruptcy proceedings, thereby increasing the value of the debtor estate at the expense of the royalty holder.
In the landmark decision of Bank of Montreal v. Dynex Petroleum Ltd, the Supreme Court of Canada held that a gross overriding royalty was capable of constituting an interest in land if the parties evidenced such an intention. While decisions such as Walter Energy and Manitok Energy addressed whether a specific royalty was an interest in land through application of the Dynex Petroleum decision, Dianor provides guidance on the ability of the court to affect a royalty that had previously (through an earlier decision) been determined to constitute an interest in land.
This specific case arose in the context of Dianor’s insolvency proceedings. Dianor’s main assets were a group of mining claims. These mining claims were subject to a gross overriding royalty (the “Royalty”), which was held by 2350614 Ontario Inc. (“235”). Dianor then became insolvent and a receiver was appointed in respect of its assets.
As part of the insolvency proceedings, the receiver obtained offers to purchase the mining claims. Each of the offers it received was conditional upon the lands being unencumbered. The receiver sought approval of the sale of the lands to one of the bidders from the supervising judge, requesting that 235’s Royalty be vested out.
The supervising judge approved the sale and vesting order, and the transaction was completed. 235’s Royalty interest was vested out, and it received $250,000 in compensation.
In reaching its decision, the supervising judge determined that royalty interests are not interests in land. He also determined that the court had jurisdiction to vest out the royalty interest. 235 appealed the decision, but only after the Royalty was struck from the land titles registry and the sale transaction by the receiver to the third party had closed.
The Court of Appeal heard 235’s appeal in two parts. The first part considered whether is the Royalty was an interest in land. In that appeal, analyzed here, the Court of Appeal relied on the Supreme Court of Canada decision in Bank of Montreal v. Dynex Petroleum Ltd., finding that the Royalty constituted an interest in land. The Court of Appeal restated that the court’s role, as it is in all matters of contractual interpretation, is to determine what the intention of the parties was at the time that the agreement was struck. If it is clear and ambiguous that a royalty interest grants an interest in land, the manner of the calculation of the royalty will not displace that intention.
In part two, the Court considered whether the Court has jurisdiction to vest out an interest in land and, if that jurisdiction exists, what the remedy would be in this specific case.
The court develops a framework for determining when to vest out interests in land
The Ontario Court of Appeal began its analysis by recognizing that a “…paradigm shift has occurred in Canadian corporate insolvency practice” over the past decade. While a company may still elect to reorganize through a plan of arrangement approved by each creditor class, going concern sale transactions involving all or substantially all of a debtor’s assets are now frequently the restructuring transaction of choice. The vesting order is the fundamental basis by which such sales are completed, as they provide purchasers with certainty that they are acquiring the assets on a “free and clear” basis and with the benefit of court oversight of the process.
There are numerous examples of sale and vesting orders being granted in insolvency proceedings under the CCAA, and section 36 of the CCAA confirms the ability of the court to provide such relief. Receivership orders are usually focused on liquidation and typically granted under section 100 of the Courts of Justice Act (or comparative legislation in other provinces), section 243 of the BIA or a combination thereof, and this legislation does not provide the same express statutory authority for sales as is found in the CCAA. Justice Peppall, writing for the unanimous Court, offered a lengthy, compelling and detailed rationale as to why section 243(1)(c) of the BIA permits the court to grant a sale order vesting property in a purchaser on application by a receiver. The jurisdiction arises through the broad language of the provision and the expansive and remedial interpretation to be given it, and is not an exercise of “inherent jurisdiction” to fill a legislative gap. Although not specifically decided, the court was careful not to foreclose the possibility of provincial legislation also providing similar authority for cases where the receiver is not operating under an order issued pursuant to section 243 of the BIA.
Having determined that the jurisdiction to grant the vesting order exists under the BIA, the court turns to the appropriate scope of the order itself. This issue is more complicated because of the “…very inconsistent treatment of vesting orders” in the existing jurisprudence. Refreshingly, the court goes to some length to address this through what it describes as a “…rigorous cascade analysis” in deciding whether to grant a vesting order that extinguishes rights. The cascade analysis operates as follows:
- first, the nature and strength of the interest that is proposed to be extinguished is considered;
- second, whether the interest holder has consented to the vesting out of their interest is considered;
- third, and only to the extent that the above-factors prove to be ambiguous or inconclusive, the equities are considered to determine if a vesting is appropriate.
The framework applied to royalty interests
The application of the newly formulated legal test is of obvious importance to royalty holders. The critical point for the court was that the royalty at issue was a true ownership interest and not akin to a fixed monetary interest, such as a mortgage or other type of charge. The reasonable expectation of the holder, like any true owner, was that its interest should continue absent its consent to an alternative arrangement. Given that there was no such consent, the court held that it was not appropriate for the lower court to extinguish the Royalty by way of a vesting order. This conclusion was accepted even though the value of the assets was significantly impaired by the Royalty; the receiver’s position was that there would have been no market for the assets without the vesting of the royalty interest:
The Receiver submits that the realities of commerce and business efficacy in this case are that the mining claims were unsaleable without impairment of the GORs. That may be, but the imperatives of the mining claim owner should not necessarily trump the interest of the owner of the GORs. Given the nature of [the royalty holders] interest and the absence of any agreement that allows for any competing priority, there is no need to resort to a consideration of the equities.
Accordingly, the Court of Appeal found that the motion judge erred in granting an order extinguishing the royalty interest.
Procedural considerations regarding the timing of an appeal
Despite the Court of Appeal determining that the Royalty interest should not be vested out, it was not necessary for it to consider how to remedy the fact that the lands had been sold unencumbered to a third party.
The royalty holder, 235, had ten days to appeal the motion judge’s decision vesting out the Royalty interest. While 235 gave notice to the receiver within the timeframe that it was “considering” an appeal, the receiver waited the requisite ten days to close the transaction. 235 appealed 29 days after the decision. The Court found that the receiver’s conduct was appropriate in the circumstances of the case (i.e., to pursue the efficient administration proceedings).
The Court refused to extend the appeal period nunc pro tunc. There was no evidence that 235 intended to appeal within the ten day appeal period, or evidence to explain its failure to appeal. The royalty holder sat on its rights knowing that the receiver was relying on the motion judge’s decision and did not seek a stay or commence an appeal within the appropriate period.
A welcome decision for resource extraction industries
The Court of Appeal’s decision is welcome clarity for all parties that are investors in in the resource sector, and will almost certainly affect the way that future royalty interests are negotiated and drafted. For royalty holders, clear drafting that establishes an interest in land (and not a mere contractual entitlement) remains important, as does structuring that ensures that the royalty cannot be classified as a security interest. Attention should also be directed at proposed priority and subordination covenants so as to ensure that consent to extinguishment cannot be imposed or implied through their operation. These safeguards will provide as much protection as possible against any effort to extinguish the royalty in an insolvency proceeding.
By James D. Gage and Junior Sirivar
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