|Tom Cumming says that while the inactive well count in Alberta has been increasing, the solution is not to upend federal insolvency law because of regulatory choices made by the province over the years.|
In a landmark appeal decision released yesterday, the majority of the Alberta Court of Appeal dismissed an appeal by the Alberta Energy Regulator and Orphan Well Association of the decision of the Court of Queen’s Bench of Alberta in the Redwater Energy Corporation receivership and bankruptcy proceedings.
In a case closely watched by the insolvency industry and the oil and gas industry, the Alberta Court of Appeal held that Grant Thornton Limited, the receiver and trustee in the Redwater receivership and bankruptcy proceedings, was entitled to disclaim Redwater’s non-producing oil wells and sell its producing ones.
Redwater was a junior oil and gas producer that went into insolvency in the spring of 2015. It owed its bank, ATP Financial, about $5 million.
Upon appointment, the receiver conducted an assessment of Redwater’s assets and advised the AER that of the 91 wells in which Redwater held licences, it would only be taking possession of 20 wells, facilities and associated pipelines.
At issue was whether the provincial regulatory regime under the Oil and Gas Conservation Act and the Pipeline Act conflicted operationally with the federal Bankruptcy and Insolvency Act.
The decision in May 2016 dismissed the application of the AER and Orphan Well Association, which argued that Grant Thornton should have to carry out the abandonment, reclamation and remediation obligations of Redwater’s non-producing wells or perform abandonment orders as issued by the AER, which included paying a security deposit.
Cassels Brock & Blackwell LLP and Gowling WLG served as joint counsel to Grant Thornton on the proceedings and successfully defended it on the appeal.
Arguing the applications on behalf of Grant Thornton were Jeffrey Oliver of Cassels Brock & Blackwell LLP and Tom Cumming of Gowling WLG.
“It’s very unfortunate this issue has come to a head when the industry itself is in a very difficult position, although I think it’s not surprising it would go together because when things are going great people don’t think of the underlying problems that can arise,” says Cumming.
The decision dismissed the appeals of the AER and the OWA, which argued that Chief Justice Neil C. Wittmann erred in finding that Grant Thornton should not have to carry out the abandonment, reclamation and remediation obligations of Redwater’s non-producing wells or perform the abandonment orders as issued by the AER.
Cumming says the issue has evolved out of policy decisions made decades ago.
“There were public policy choices that brought us to this point,” says Cumming. “The AER and OWA — their position was essentially that this problem is caused by the lenders. I don’t think that is realistic and there is the reality that if the lenders can’t recover anything on their security they aren’t going to lend to this industry at all.”
In 1989, there were 20,000 inactive wells in Alberta; 27 years later, there are 81,000 inactive wells and Cumming says that, by the AER’s own numbers, only two per cent of those wells will ever be reactivated.
Not all the companies that hold those 81,000 wells are going to become insolvent, but changes to the legislation in the 1990s essentially permitted big producers that drill the wells and then develop them to later sell the wells to smaller cap producers and then have no further liability. It was thought the policy would encourage drilling of wells and development of the oilpatch.
“There was a policy choice not to put a specific timeline on when companies had to carry out abandonment and remediation work with respect to inactive wells,” says Cumming.
The companies have to make the wells safe and turn the valves off within a year of being inactive, but in terms of full abandonment and reclaiming the site, that can — unless ordered otherwise by the AER — be deferred for “decades and decades.”
The result of that is that rather than decreasing from 1989, the number of inactive wells became four times worse.
Most environmental legislation in Canada says if you were in management and control of a well you are stuck with that obligation.
“If you contrast it with other jurisdictions, there are timelines when you have to carry out abandonment and reclamation work,” says Cumming.
“There is the reality that it is the secured creditors who are appointing the receivers, typically. If the secured creditor simply stopped lending to an insolvent producer and walked away, it would mean instead of it at least being the inactive wells going into the orphan well funds, it will be all of the wells. Even if the AER’s vision of the priorities was correct, it still would be a drop in the bucket in terms of the real risk to the orphan well fund as a result of the way the economy has gone.”
The majority of the Court of Appeal held that:
• By attempting to extract security deposits or the performance of abandonment obligations on a transfer of AER licenses, the AER was in effect transferring the proprietary value in the bankrupt estate from the underlying real property assets of Redwater (which were interests in its oil and gas properties) to the AER licenses, contrary to the scheme of distribution contemplated under the Bankruptcy and Insolvency Act.
• A trustee and receiver is entitled to abandon or renounce oil and gas assets encumbered with environmental obligations.
• The AER’s requirement that security be posted for abandonment obligations, or diverting value from the bankrupt estate to ensure that remediation is performed, is sufficient to classify the claims of the AER as financial in nature, making them a “creditor” whose claims are subject to the priorities prescribed by the BIA.
• The AER cannot indirectly interfere with the value of assets in a bankruptcy by placing financial preconditions on the transfer of AER licences.
• Based on the doctrine of federal paramountcy, the obligations of trustees and receivers under both the Oil and Gas Conservation Act and the Pipeline Act to abandon oil wells and pipelines; pay the costs of remediation performed by other persons; and to obey any order of the AER is in operational conflict with section 14.06 of the BIA. Section 14.06 of the BIA exempts a receiver or a trustee from personal liability, allows a trustee and receiver to disclaim assets, and prescribes the priority of environmental remediation costs.
• The applicable sections of the OGCA and PA frustrate the federal purpose of the BIA of managing the winding up of insolvent corporations and settling the priority of claims against them. The majority of the Court of Appeal therefore confirmed that such obligations of the AER are unenforceable as against the Receiver and Trustee.
Cumming says that while the inactive well count has been increasing, the solution is not to upend federal insolvency law because of regulatory choices made by the Alberta government over the years.
“That’s a tough argument to put forward and I don’t agree with it,” says Cumming.
“If you want a functioning credit system for oil and gas producers, you have to respect the federal rules with respect to priorities,” Cumming says. “The AER was doing everything possible to avoid those rules.”