Canada: Alberta Holds Its Breath: Regulatory And Insolvency Laws Clash In Re Redwater Energy Corporation

CHALLENGING TIMES

At a time of a myriad of challenges facing the oil and gas industry, one of the biggest developments in 2016 is the Court of Queen's Bench decision in Redwater Energy Corporation (Re) (Re Redwater).¹ Adding to an already difficult cycle for producers, Re Redwater enables receivers and trustees to renounce any interest in real property (i.e. insolvent estates' uneconomic wells and facilities) and avoid the associated abandonment and reclamation (A&R) obligations. The Alberta Energy Regulator (AER) is left unable to enforce its regulatory scheme or require security deposits in such instances.

BACKGROUND

The case arose out of the insolvency proceedings of Redwater Energy Corporation (Redwater), a publicly-listed junior oil and gas company. Redwater had credit facilities with the Alberta Treasury Branches (ATB) and owed ATB about five million dollars at the commencement of insolvency proceedings in May of 2015. Grant Thornton Limited was appointed receiver and eventual trustee in bankruptcy for the estate of Redwater (the Receiver).

Following its appointment, the Receiver assessed the economic marketability of Redwater's wells, facilities and pipelines, and renounced any interest in the majority of the assets (the Renounced Assets), pursuant to section 14.06 of the Bankruptcy and Insolvency Act (BIA).² The Renounced Assets were non-producing and had substantial liabilities related to A&R that outweighed any value associated with them. Section 14.06 is a somewhat awkwardly worded provision in the BIA that allows trustees and receivers to renounce any interest in real property where environmental liability exists.³ The Receiver advised the AER that it or the estate of Redwater had no further obligations pertaining to the Renounced Assets.

The AER emphatically disputed this course of action by the Receiver. Under the AER-administered legislation, regulations and directives (the Regulatory Scheme), a receiver and a trustee in bankruptcy are clearly within the definition of "licensee" of the Renounced Assets, and as such, the AER argued that the Receiver must comply with the provincial Regulatory Scheme in its administration of Redwater's estate.⁴ This involves such things as attempting a sales process with the Renounced Assets, using funds from the estate to pay for A&R obligations and paying security deposits to maintain Redwater's Licensee Management Rating (LMR).⁵ Because of the position taken by the Receiver, the AER issued closure and abandonment orders relating to the Renounced Assets (the Orders).

KEYS TO THE CASE

The fundamental issue in Re Redwater was whether the Receiver was able to do as it did with the Renounced Assets. To answer this question, the Court had to resolve several inter-related issues such as:

• whether the federal and provincial laws were truly in conflict in these circumstances or whether it was possible to comply with both – in other words, could the Receiver fulfil its obligations under the BIA and, at the same time, fulfil the obligations under the Regulatory Scheme;
• whether the provincial law, being the Regulatory Scheme, frustrated the purposes of the federal BIA;
• whether the AER's security deposits, the Orders and the A&R costs for the Renounced Assets are provable claims under the BIA; and
• whether the AER can refuse to allow licence transfers associated with the assets retained by the Receiver due to Redwater's LMR or through the Regulatory Scheme in the context of a sales process in bankruptcy.⁶

INSOLVENCY LAWS PREVAIL

The Court ruled in favour of the Receiver and found that the Receiver could properly disclaim any interest in the Renounced Assets before taking possession and control, ending any responsibility with regard to A&R costs. The case turned on the doctrine of paramountcy, which the Court described as being applicable where:

Notwithstanding the high standard of proof generally required to invoke paramountcy successfully, the Court ruled that there was an operational conflict between section 14.06(4) of the BIA and the definition of "licensee" within the Regulatory Scheme. The Court's interpretive approach meant that section 14.06 of the BIA allowed a receiver and trustee to renounce assets and not be responsible for A&R activities, whereas the Regulatory Scheme did not permit the renunciation of licensed assets whatsoever. The Court determined that dual compliance with both sets of laws was not possible and that the position of the Receiver in such a situation was untenable. As such, section 14.06 of the BIA must prevail over the Regulatory Scheme to the extent of the conflict.

The Court also held that there were several instances where the provincial Regulatory Scheme frustrated the legislative purpose of the federal BIA including:

1. The definition of the "licensee" within the Regulatory Scheme frustrated the legislative purpose of section 14.06 of the BIA since requiring licensee (in this case, the Receiver) to pay security deposits or comply with the Orders created a super-priority over any other creditor claims, in violation of the distribution scheme set out in the BIA.
2. Disallowing the renouncement of non-economic assets had the potential of putting the Receiver at personal financial risk, a result which section 14.06 of the BIA specifically disallows.
3. Requiring compliance with the Orders in respect of the Renounced Assets or the payment of security deposits for the AER to approve licence transfer applications frustrated the legislative purpose of section 14.06 of the BIA, which allowed for the disclaimer to all interest in the Renounced Assets.

The Court also found that the Orders were intrinsically monetary in nature and thus provable claims in bankruptcy – this means that the AER ranks as an unsecured creditor. The question here is whether it was "sufficiently certain" that the AER would seek reimbursement for the costs of compliance from the Receiver or Redwater's estate.⁸ The Court ruled that since no other party existed who could carry out the work and it would fall to the AER to do so,⁹ a purposive approach to section 14.06 applied to find that the Orders were provable claims.

In reaching this decision, the Court's analysis has two major takeaways. Section 14.06 of the BIA goes beyond mere protection from personal liability for receivers and trustees. The Court's role, as it interpreted the provision, was to follow Parliament's law by ascertaining its purpose and properly applying it.¹⁰ The other was that in the bankruptcy context, claims from provincial regulators for A&R costs should not receive a super-priority when such priority is not provided in the BIA. To side with the AER in this respect would in essence be replacing the "polluter-pay" principle with a "third-party-pay" principle.¹¹

IMPLICATIONS

This decision, subject to any potential appeal, effectively ends the deadlock between receivers and the AER regarding the sale of assets of an insolvent company. In the insolvency world, this is a welcome decision that will assist receivers and trustees in conducting successful sales processes that, without the need to include non-producing assets and pay security deposits, should significantly increase recoveries for all stakeholders.

In the oil and gas industry, this decision is unlikely to be met with much fanfare. In the continued low-price environment where many small (and even large) producers are teetering on the edge of insolvency, the potential for a significant number of wells to be designated as "orphans" as a result of a bankruptcy or receivership is very real. Since industry is the sole contributor to the fund utilized to deal with the A&R costs when a licensee is unable to fund such costs themselves, it is very possible that the cost to industry will increase substantially due to this decision. During the application, the Canadian Association of Petroleum Producers openly questioned whether producers might balk at such increases in the current economic climate, potentially collapsing the entire orphan well system.¹²

The conflict discussed in this decision between insolvency procedures and holding a party accountable for environmental liabilities has been described as a collision course.¹³ The practical reality in the commercial sphere could be quite a collision indeed. Yet, as with most challenges, the tested parties tend to find solutions.

First published in BD&P Client Bulletin, May 2016

Footnotes

1 Redwater Energy Corporation (Re), 2016 ABQB 278. Materials related to the proceeding are available at Grant Thornton Limited's website.

2 RSC 1985, c B-3. Renunciation effected either through section 14.06(4)(a)(ii) or 14.06(4)(c), both of which the Receiver purported to effect. The provision in-full is available here.

3 See discussion in Re Redwater, at para 124-128.

4 In particular, Oil and Gas Conservation Act, RSA 2000, c O-6, s. l(l)(cc), 24, 27, 29, 30, 106; Pipeline Act, RSA 2000, c P-15, s. l(l)(n), 18, 23, 25, 26, 51; Directive 006: Licensee Liability Rating (LLR) Program and Licence Transfer Process, effective May, 2013 [Directive 006]; Directive 011: Licensee Liability Rating (LLR) Program: Updated Industry Parameters and Liability Costs, effective August 1, 2015. Legislation, regulations and directives are available on the AER's website.

5 The LMR as described in Directive 006 is the ratio of a licensee's "deemed assets" divided by its "deemed liabilities." A ratio of <1.0, meaning greater liabilities than assets, triggers potential restrictions on transfers and requiring security deposits.

6 Re Redwater, at para 85.

7 Re Redwater, at para 95; citing, inter alia, Alberta (AG) v Moloney, 2015 SCC 51, at para 16, 29; Saskatchewan (AG) v Lemare Lake Logging Ltd., 2015 SCC 51, at para 16.

8 Re Redwater, at para 143, citing Newfoundland and Labrador v. AbitibiBowater Inc., 2012 SCC 67; Nortel Networks Corp. (Re), 2013 ONCA 599 at para 31, leave to appeal refused.

9 With the exception of a minority of the Renounced Assets wherein responsibility would fall to the other working interest participants for their proportionate share; See Re Redwater, at para 171.

10 Re Redwater, at para 133.

11 Re Redwater, at para 173.

12 Re Redwater, at para 65.

13 Re Redwater at para 149, citing Tori Crawford, "The 'Collision Course' Continues: Recent Developments in the Intersection Between Insolvency Law and Environmental Law," Insolvency Institute of Canada (May 9, 2014).

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