Canada: Key Right Of First Refusal Provision “Ambiguous”: Case Sent Back For More Evidence

Copyright 2008, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Energy - Oil & Gas/Litigation, August 2008

On August 5, 2008, the Alberta Court of Appeal issued a decision of significance and concern to the oil and gas industry in Canada. The decision of the majority in Canadian Natural Resources Ltd. v. EnCana Oil and Gas Partnership was written by Madam Justice Conrad, and concurred in by Mr. Justice Costigan. Mr. Justice Berger dissented.

The decision is interesting at many levels, particularly (a) the majority's finding that the Right of First Refusal (ROFR) clause in the 1990 CAPL Procedure, widely in use in the oil and gas industry, is ambiguous, and (b) the very different views of the majority and Mr. Justice Berger with respect to the role of the appellate court as to whether it should decide cases based on the evidentiary record before it.

AMBIGUITY OF THE ROFR

The primary issue before the court was the triggering date for the ROFR under the 1990 CAPL Operating Procedure.

Background Facts

CNRL and EnCana had entered into a pooling agreement incorporating clause 2401B of the 1990 CAPL Operating Procedure, which provides that a party to such a pooling agreement cannot dispose of any of its working interest by, among other things, farmout, unless it provides the other party with notice of its intention and an option to exercise an ROFR.

On October 24, 2005, EnCana entered into a farmout agreement with Marauder Resources West Coast Inc. (Marauder) covering 15 parcels of land, two of which were the pooled lands in issue. EnCana did not provide written notice to CNRL in 2005 when it entered into the farmout agreement, but only on December 6, 2006, after Marauder had selected for its 2007 drilling program three test wellsites within the pooled lands.

On January 5, 2007, CNRL elected "to exercise its preferential right of first refusal to acquire the subject interest on the same terms and conditions offered to Marauder." CNRL subsequently advised EnCana that it intended to drill one test well in a location identified by Marauder, and two test wells at locations that differed from those identified by Marauder. CNRL also requested additional time to complete the test wells, as it could not drill, complete, equip, and tie-in the test wells by April 30, 2007, as required by the farmout agreement.

CNRL did not drill the test wells within the time limits set out in the farmout agreement. EnCana gave written notice of default and sought to enforce at the Alberta Court of Queen's Bench a liquidated damages clause entitling EnCana to C$300,000 for each test well not drilled. In turn, CNRL sought a declaration that it was entitled to select the wellsites and extend the spudding date.

Decision

The court considered, as a foundational question, when the ROFR was triggered; in particular, whether that occurred once EnCana decided to enter into the farmout agreement with Marauder or instead at the time Marauder selected the wellsites for the 2007 drilling season.

CNRL submitted that the ROFR was triggered once EnCana intended to farmout its working interest, because the farmout agreement provided that an interest could be earned on the pooled lands. CNRL argued that it did not matter whether Marauder did, in fact, earn such an interest. CNRL further argued that the provisions could not be interpreted otherwise, as CNRL had an entitlement, if it triggered the ROFR, to the same terms as offered in the contemplated farmout. Under this interpretation, CNRL would have had the opportunity to select test wellsites or plan a drilling program, seasons in advance. EnCana, on the other hand, argued that a farmout agreement is not necessarily a disposition, and that the disposition triggering the ROFR does not occur until the farmee selects a test wellsite on the pooled lands. In other words, it argued, CNRL's "ROFR with respect to the Pooled Lands does not arise until earning is imminent."

The Alberta Court of Appeal observed that "a right of first refusal is an important contractual right" and "the triggering event for the ROFR provided by the CAPL Operating Procedure is an issue of some significance to the oil and gas industry. The precedent created by a decision on this issue could have far reaching effects on other agreements incorporating Article XXIV of the CAPL Operating Procedure, and the conduct of the parties under those agreements." Unfortunately, however, after referencing broad use of the CAPL Operating Procedure, and the critical nature of this issue to those in the industry, the Alberta Court of Appeal provided no guidance with respect to its interpretation.

In its conclusion, the majority found that both CNRL's and EnCana's interpretations were reasonable. It found that "this means that the language is ambiguous and that a proper interpretation may benefit from extrinsic evidence, including evidence of industry practice." The matter was therefore sent back for a full trial on the issues.

ROLE OF AN APPELLATE COURT

Clearly, Madam Justice Conrad, for the majority, was focused on the fact that the matter had come before the Alberta Court of Queen's Bench pursuant to an Originating Notice, and therefore on more limited evidence than would likely have been presented in a full trial procedure. The majority expressed concern about resolving a matter of great consequence for the industry without the more fulsome evidentiary record that often results from trial to assist it in resolving the ambiguity it found in the contractual wording.

In his dissent, Mr. Justice Berger disagreed fundamentally on the question of whether the contractual language was ambiguous. He also noted that "the complexity of an issue on appeal can sometimes benefit from a more robust evidentiary matrix", but noted that this did not necessarily mean that the record was deficient. In that same vein, he noted that the factual underpinnings of a dispute are not always fully disclosed and the context is not always known to the court. For their own reasons, strategic or otherwise, counsel for parties may choose not to call expert or other evidence. Nonetheless, in Mr. Justice Berger's view, the Alberta Court of Appeal ought not to hesitate to provide its assistance to resolve a dispute between parties when those parties have sought the court's direction.

Further, Mr. Justice Berger noted that, notwithstanding the record that the appellate court might wish to see, it could not force parties to call expert or any other evidence in support of their cases at trial. As he observed, "in other words, when the matter comes back to this Court, as it most likely will, the record may be no more fulsome than it already is."

This disagreement between the majority and minority decisions highlights the tension between the role of the court as an arbiter of disputes between individual parties – who in this case both sought the court's assistance by way of Originating Notice and summary procedure – and its recognition that such decisions may, depending on their scope and how they are worded, cause a ripple effect in the corporate/commercial world.

CONCLUSION

While use of ROFRs in the industry has generally declined since 1990, they remain in use and of significant value in the right circumstances. This decision is of significance to the oil and gas industry in that the Alberta Court of Appeal has now pronounced the ROFR in the 1990 CAPL to be ambiguous, and in this respect the 1990 CAPL Operating Procedure is similar to its 1981 predecessor. This finding will undoubtedly concern industry participants, as it introduces a level of uncertainty that the courts are unlikely to resolve for some time at best. Moreover, if CNRL and EnCana reach a settlement, and resolve their dispute before a trial is heard and a further decision rendered by the Alberta Court of Queen's Bench, then this uncertainty may be extended indefinitely.

Amendments to the CAPL Operating Procedure in 2007 introduced a new clause 2401B(d), stating that, if a proposed disposition of a working interest (including an option to earn that working interest) is granted pursuant to an Earning Agreement, the disposing party will offer the other party

(a) an "opportunity to assume the entire obligations of the proposed assignee" if the Earning Agreement includes only joint lands, or (b) where the earning agreement includes both joint lands and other lands, providing either its bona fide estimate of the value of the consideration, for the working interest proposed for disposition in the joint lands, or offering the other party the opportunity to assume the entire obligations of the proposed assignee as it relates to both joint lands and the other lands subject thereto.

In light of the Alberta Court of Appeal's determination that the 1990 language is ambiguous, the language in the 2007 CAPL Operating Procedure provides a practical resolution of the problem and an example of language that could be used. If parties are currently governed by the 1990 version, however, they would be well served in light of this decision by amending their agreement to incorporate the 2007 CAPL language. Whether both, or all, of the parties decide it is in their interest to do so will, of course, depend on the circumstances and whether the parties think they are equally likely to be on either side of the ROFR.

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