On January 31, 2019, the Supreme Court of Canada (SCC) released its decision in Orphan Well Association, et al v. Grant Thornton Limited, et al, 2019 SCC 5 (Redwater), overturning the decisions of the majority of the Alberta Court of Appeal and Court of Queen's Bench. The Redwater case is of critical importance to both the oil and gas industry, and to lenders, particularly in the environmental and economic circumstances the industry currently finds itself. On one hand, there has been increasing concern by governments, environmental groups, industry and other stakeholders as to the responsibility for end-of-life environmental liabilities of oil and gas assets, and the desire to recognize the "polluter pays" principle. On the other hand, there is concern that if these environmental obligations rise in priority above that of a secured creditor, it may restrict the ability for a lender to recover from secured assets and accordingly, will further restrict the availability of capital to the industry.

Until today, the law in Alberta permitted receivers and trustees to limit their possession to valuable estate assets, and renounce possession of wells, pipelines, facilities, and other assets on the basis of environmental liabilities associated with such assets (Undesired Assets). The proceeds of saleable assets were distributed in accordance with the priority structure of the Bankruptcy and Insolvency Act, RSC 1985 c B-3, typically resulting in payments to creditors. In Redwater, the SCC found that the Alberta Energy Regulator (AER) was not a creditor when it issued abandonment orders and enforced LMR requirements, and instead recognized its first charge on real property affected by an environmental condition, or damage in order to fund remediation. In other words, these environmental obligations shape the parameters of the debtor's estate, which is then available for distribution to creditors. Receivers and trustees in bankruptcy are not entitled to walk away from the abandonment and reclamation liabilities of a debtor's estate. Accordingly, the SCC's decision fundamentally changes the application of the law by receivers and trustees.

The impact on receivers and bankruptcy trustees

  • Sales processes will likely become more complex and costly as the ability to successfully sell a debtor's assets will be impacted by the liability associated with the Undesired Assets.
  • May result in a significant number of more assets being turned over to the Orphan Well Association (including valuable and/or producing assets) if packages become too unattractive with the inclusion of Undesired Assets.   
  • The AER may require the receiver or trustee to hold all sale proceeds pending resolution of the estate's abandonment and reclamation obligations rather than distribute such proceeds to secured lenders to ensure the environmental liabilities of the debtor's estate are properly accounted for before distribution. In Redwater, the SCC ordered the proceeds of the sale of the debtor's valuable assets, previously held in trust, be used to address end-of-life obligations associated with the remaining assets. 
  • The ability of receivers and trustees to satisfy their fees from estate assets may be impaired, and as such receivers and trustees may be more cautious in taking appointments.

The impact on secured lenders

  • Will result in an overall increased cost of capital to take into account increased realization risk and may result in renegotiation of existing facilities or renewal on stricter terms.
  • May result in the recalculation of debt ratios based on the present value of a borrower's asset retirement obligations (ARO).
  • Because lenders will become, at best a second lien debt, subject to the risk of compliance by borrowers with their reclamation obligations, lenders will spend more time and effort on monitoring and managing this risk:
    • Lending agreements will require increased representations and covenants regarding remediation liabilities and the tightening of covenants related to ARO as well as increased scrutiny of the reclamation practices and overall financial wherewithal of the borrower;
    • Will see increased monitoring by secured lenders of operational and regulatory matters of the borrower. In particular, secured lenders may want to receive reports submitted or generated with respect to the borrower's compliance with certain AER programs, including: (i) the Inactive Well Compliance Program; (ii) the monthly (and transfer related) LMR calculations; (iii) the Remediation Certificate Amendment Regulation; (iv) Directive 013 obligations; (v) the borrower's licensee eligibility status pursuant to Directive 067; and (vi) any licensee specific to AER remediation, or compliance plans or orders.
    • Lenders may begin imposing their own cash reserve requirements for future reclamation obligations.
  • Secured lenders seeking to appoint receivers and trustees may face requests to provide indemnification for the fees of receivers and trustees, given the increased uncertainty with realization of estate assets.
  • Lending community likely to further retrench on lending to this sector until the impact of the decision is better understood.  

The impact on potential purchasers

  • Increased opportunity to acquire inexpensive assets for potential purchasers who are comfortable with the cost of end-of-life obligations associated with other packaged assets.
  • Will continue to be subject to regulatory requirements placed by the AER regarding the transfers, which may also involve less leniency with respect to discretionary waiver of the LMR 2.0 post-closing requirement.

The impact on producers/operators

  • Will continue to be subject to regulatory requirements, including conditions on transfers. The AER may impose further pre-closing requirements and take a stricter position on partial license transfers in order to monitor ongoing abandonment and reclamation liabilities. 
  • Potential for the reduction in access to capital, as well as higher rates of interest, stricter borrowing conditions, and increased monitoring by lenders.
  • Terms of current banking facilities may come under scrutiny on a more expedient basis in order for lenders to manage their risk prior to insolvency occurring.
  • Although not expressly addressed by the AER at this time, the AER may impose timing requirements with respect to abandonment and reclamation work in order reduce the number of un-reclaimed but non-producing assets in Alberta. The imposition of timing requirements will significantly impact how a company accounts for its ARO.

The impact on the AER

  • The AER may take a more active role in monitoring all potential asset transactions in insolvency proceedings to ensure that (i) transfer applications qualify on an LMR basis; (ii) the cost of the abandonment and reclamation activities associated with the estate are accounted for; and (iii) where such costs are not satisfactorily accounted for at the time of sale, funds are held in trust subject to a determination of their proper distribution.
  • The AER may be called upon to provide a clarity and consistency in its liability management program, the costs of abandonment and reclamation, and any new or relevant regulations impacting ARO.

Redwater will have an impact on all participants in insolvency proceedings and in particular, an immediate effect on clients involved in the oil and gas industry. The fall out of this decision is expected to continue in the near term as provincial regulators and stakeholders in the oil and gas industry and other industries grapple with the practical implications of the decision. In Alberta, within a few hours of the release of Redwater, the AER released its initial response, wherein the AER indicated it would continue to "build a new liability management framework". We expect that Redwater will heavily influence this new framework and the frameworks of other regulators, and accordingly, await the reverberations that will compound the impacts set out above.

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