Julia Parent and Graham Haynes

In the long-awaited decision in the case of Orphan Well Association v Grant Thornton Ltd, the Supreme Court of Canada held that end-of-life environmental cleanup obligations imposed by Alberta’s provincial regulatory scheme on bankrupt oil and gas companies take priority over all bankruptcy claims, including secured creditor claims.

The trustee’s disclaimer of a number of oil wells without value to the bankrupt estate did not allow the bankrupt estate to abandon its environmental cleanup obligations imposed under Alberta’s regulatory scheme with respect to those orphaned wells. In so finding, the majority of the Supreme Court held that the environmental obligations with respect to the orphaned wells were not provable claims, and as such there was no conflict between the provincial regulatory scheme and the provisions of the Bankruptcy and Insolvency Act (“BIA”).

While this decision is highly fact-specific, the result may have a significant impact on lending in resource sectors. In particular, where the regulatory environment imposes ongoing liabilities that may take on a “super-priority” status in the administration of bankrupt estates.

Background

Redwater Energy Corporation was an Alberta-based public energy exploration company whose principal assets were 127 oil and gas wells, pipelines and facilities as well as the licenses to operate same. Under Alberta legislation, license holders are obligated to assume the end-of-life responsibilities for their oil and gas facilities and particularly the plugging and capping of oil wells (“abandonment”) and the dismantling of structures and restoring of lands to their previous condition (“reclamation”). The relevant energy and environmental legislation is administered by the Alberta Energy Regulator (“Regulator”).

In 2014, Redwater started experiencing financial difficulties and, in early 2015, Grant Thornton Limited (“GT”) was appointed as its receiver. Upon being advised of the receivership, the Regulator notified GT that Redwater was obligated to fulfill its abandonment and reclamation obligations before GT could distribute any funds and that the Regulator would not approve the transfer of any of the licenses associated with the Redwater assets until the regulatory obligations were fulfilled.

Unfortunately, many of the Redwater assets were not productive and the cost of abandonment and reclamation of the unproductive sites would have been greater than the sale proceeds of the remaining productive assets. Based on this assessment, GT informed the Regulator that it would only be taking possession of 17 of Redwater’s wells, 3 associated facilities and 12 associated pipelines. GT disclaimed the remaining assets (“Renounced Assets”).

The Regulator responded by issuing orders to abandon the Renounced Assets (“Orders”) and filed an application for a declaration that GT’s renunciation was void and seeking orders that GT comply with the Regulator’s Orders.

A bankruptcy order was issued and GT was appointed as trustee, allowing GT to rely on section 14.06(4)(a)(ii) of the BIA with respect to its disclaimer of the orphaned wells.¹

The chambers judge and a majority of the Alberta Court of Appeal held that the Regulator’s use of its statutory powers under the Orders conflicted with the BIA in two ways: (1) by imposing on GT the licensee’s obligations despite section 14.06(4) of the BIA; and (2) by upending the priority scheme set out in the BIA by vaulting statutory obligations to a super-priority status. Due to this conflict, the chambers judge and majority of the Court of Appeal held that portion of the provincial regulatory regime was inoperative to the extent of the conflict by virtue of the doctrine of federal paramountcy (i.e. where an unresolvable conflict arises between provincial law and federal law, federal law prevails).

Majority decision of the Supreme Court of Canada

In a 5-2 decision, the majority of the Supreme Court of Canada (“SCC”) reversed the decision of the Alberta Court of Appeal and held the Regulator’s use of its statutory powers did not conflict with the BIA as described by the lower courts because: (1) section 14.06(4) of the BIA only permits a trustee to protect itself from personal liability, it does not empower the estate it is administering to walk away from the estate’s environmental liabilities; and (2) the priority scheme set out by the BIA is not upended because the Regulator is not asserting a “provable claim” under the bankruptcy regime.

On the first point, the SCC held that section 14.06(4) protects a trustee from personal liability when it disclaims the bankrupt’s property but that the ongoing liability of the bankrupt in relation to the disclaimed property is unaffected. Said another way, while the trustee might have been personally protected from not complying with the Orders, the environmental liabilities to which the Orders related were still valid.

On the second point, the SCC held the end-of-life obligations of Redwater under the Orders were not a claim provable in bankruptcy. To do this, the SCC had to revisit the test from Newfoundland and Labrador v AbitibiBowater Inc.² which had held a particular regulatory obligation is a provable claim in bankruptcy if:

1. There is a debt, liability or obligation to a creditor;
2. That debt, liability or obligation was incurred before the debtor was bankrupt; and
3. It is possible to attach a monetary value to this debt, liability or obligation.

The SCC held that the first part of this test should not be interpreted as standing for the proposition that a regulator is always properly characterized as a creditor when exercising statutory enforcement powers against a debtor. The SCC held that the Regulator, in its enforcement of the Orders, was enforcing a public duty and thus was not a creditor of Redwater per se. Although this was sufficient to deal with the appeal, the SCC also held that while the Orphan Well Association had the right to be reimbursed for the abandonment and reclamation activities it generally would undertake following disclaimer, this was not sufficiently certain to ground a provable claim either.

In conclusion, the SCC held that the environmental legislation in Alberta did not conflict with the federal BIA and thus the doctrine of paramountcy did not come into play.  In result, the obligations on Redwater for abandonment and reclamation remained operative.

Dissent

Justices Moldaver and Côté, in dissent, would have dismissed the Regulator’s appeal and agreed with the majority of the Alberta Court of Appeal’s finding that there was a genuine inconsistency between federal and provincial laws under the paramountcy test.

The Justices reasoned there was an inconsistency between the provincial and federal legislation because Alberta’s statutory regime and the Orders did not recognize or contemplate valid disclaimers by trustees of assets encumbered by environmental liabilities. The dissent stated that section 14.06(4) of the BIA permits a trustee to disclaim the bankrupt’s property as well as the liabilities which attach to such property until the estate is fully administered (at which point the disclaimed property reverts to the estate). This premise is in keeping with the fundamental objective of trustees, which is the maximization of recovery for creditors by realizing an estate’s most valuable assets.

The dissenting Justices further reasoned that the Regulator’s claim was a “provable claim” and that the Regulator was a creditor of the bankrupt estate. The dissenting Justices noted that the majority’s interpretation permitted a government entity to “systematically evade the priority requirements of federal bankruptcy legislation under the guise of enforcing public duties.” In doing so, the dissenting Justices found that the majority inappropriately narrowed the definition of “creditor” in the first branch of the Abitibi test above. The dissent also attacked the majority’s alternative conclusion that the claim was not sufficiently certain to ground a provable claim.

What this means for you

Operators and secured lenders in regulated industries beware.  The SCC’s decision has, at the very least, created a new priority claim for regulatory authorities in the Alberta oil and gas sector. While the broader scope of this decision remains to be seen, the SCC’s decision will likely have a considerable impact on how regulatory authorities interact with insolvency professionals and how property affected by regulatory claims is dealt with during the course of the administration of bankrupt estates going forward.

Further information

This update is intended for general information only. If you have questions about the above information, and how it applies to your specific situation, please contact a member of the Stewart McKelvey Bankruptcy, Receivership & Insolvency or Energy, Environmental & Natural Resources group.

¹ Of note is the fact that the Regulator had already set up an independent non-profit entity known as the Orphan Well Association (“OWA”) to abandon and reclaim oil and gas assets left behind by companies.

² 2012 SCC 67.