Canada: Operators May Reduce Annual Compensation Under Surface Lease Agreements

On March 19, 2019, the Alberta Court of Queen's Bench (ABQB) ruled in Karve Energy Inc. v Drylander Ranch Ltd., 2019 ABQB 298 that the Surface Rights Board (Board) does not have the authority to interfere with the amount of compensation determined in a bilateral agreement between a lessor and an operator if that agreement is otherwise not in conflict with the Surface Rights Act, RSA 2000, c S-24. Overturning both the Board's original decision and reconsideration decision, Karve Energy Inc. (Karve) successfully argued that Karve was not in conflict with the Act by exercising a provision under its surface lease agreement to reduce the amount of annual compensation for adverse effect.

Background

In 1994, Karve's predecessor entered into a 25-year surface lease agreement with Drylander Ranch Ltd. (Drylander) to pay compensation for a wellsite and access road. The agreement contained a provision that allowed the operator to reduce its annual compensation payable to Drylander following the completion of its operations. In 2016, Karve notified Drylander that the compensation would be reduced under the agreement. Upon Karve exercising this contractual right, Drylander responded by submitting an application to the Board under section 36 of the Act, which allows a party to apply to the Board to recover unpaid compensation under a surface lease. Drylander argued that Karve had unilaterally changed the compensation in the agreement without consent, contrary to the Act, and that Drylander was owed additional compensation.

The Board agreed with Drylander, finding that a party could only change an annual rent payment through an amended agreement accepted by the parties or through section 27 of the Act, which allows the Board to review annual rental payments and change compensation every five years. Because the clause allowed for the reduction in rental payments "unilaterally", the Board deemed it to be in conflict with the Act. Under section 2 of the Act, where an agreement is in conflict with the Act, the Act prevails.

The Court's Decision

The court overturned both the original decision and reconsideration primarily based on of two reasons. First, Karve relied on a binding bilateral agreement between the parties, which it was entitled to do. The court determined that exercising a contractual right under a binding bilateral surface lease agreement was not a unilateral act. Surface lease agreements, like any other private bilateral contract, allow parties to negotiate compensation for surface rights without going through the Board, as long as they are in accordance with the Act. Drylander had voluntarily consented to a model of compensation that included the possibility of rental reduction at the time of signing the agreement, and Karve was doing nothing more than exercising its contractual rights.

Second, there was no conflict between the surface lease agreement and the Act in this situation. Given that the parties were free to negotiate compensation, it followed that the agreement did not conflict with the Act where contractual rights were exercised and did not specifically violate the Act. The court expressly stated that these kinds of agreements could not undermine orders from the Board fixing, confirming or varying compensation, and that there was no danger in undermining the authority of the Board.

Conclusion

This decision establishes a clear limitation on the Board's ability to interfere with bilateral agreements between parties. While the Board continues to have full discretion to review and award annual compensation under section 27, the Act does not preclude an operator from negotiating terms of compensation within surface leases that change during the lifespan of the agreement.

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