February 14, 2019

Environmental Liabilities Now Enjoy Super-Priority in Canada

Tom Cumming, Caireen E. Hanert

On January 31, 2019, the Supreme Court of Canada released its decision in Orphan Well Association et al v Grant Thornton Limited et al, which was an appeal by the Alberta Energy Regulator (AER) and the Orphan Well Association (OWA) arising from the receivership and bankruptcy of Redwater Energy Corp. (Redwater), a small publicly traded oil and gas producer in Alberta.  The decision addresses the treatment of environmental regulatory obligations in insolvency proceedings and has significant implications for Canada’s natural resources and financial services sectors.  In several important respects, it marks a new and less certain direction for insolvency law and what has been referred to as its untidy intersection with regulatory law.

From an insolvency perspective, at issue was the ability of receivers and trustees (Court Officers) to realize upon the valuable wells, facilities and pipelines (PNG Assets) of insolvent oil and gas producers and to distribute the proceeds amongst the secured and unsecured creditors in accordance with the priorities regime in federal Bankruptcy and Insolvency Act (BIA).  The Province of Alberta’s regulatory regime for the oil and gas sector required that Court Officers perform the remediation obligations of insolvent producers, to the extent of any value in the estate, prior to licensed assets being sold or distributions to creditors being made.

The Bankruptcy and Insolvency Act and the Regulation of the Oil and Gas Industry in Alberta

Under the Constitution Act, the federal government has exclusive jurisdiction over bankruptcy and insolvency, the provincial governments have exclusive jurisdiction over the non-renewable natural resources, and jurisdiction over the environment is shared.  Where otherwise valid federal and provincial legislation conflict, either because of an operational conflict where the two laws impose conflicting requirements, or because the effect of the provincial law frustrates the purpose of the federal law, then the provincial law is inoperative to the extent of the conflict under the constitutional doctrine of federal paramountcy.  The application of the paramountcy doctrine depends on a “proper” interpretation of the effect of the provincial and federal laws at issue in light of the principle of cooperative federalism, which requires courts to take a restrained approach that favours interpretations permitting federal and provincial laws to operate harmoniously over interpretations that result in incompatibility. 

Section 14.06 of the BIA, which governs the treatment of federal and provincial environmental remediation obligations in insolvency proceedings, provides that: (i) receivers and trustees (Court Officers) are not personally liable for environmental obligations of the debtor arising before the proceedings, or arising after unless resulting from the Court Officer’s gross negligence or wilful misconduct; (ii) if a remediation order is issued, a Court Officer that disclaims the affected property within certain time frames is not personally liable for failing to remediate or comply; (iii) costs of remediating disclaimed property do not rank as costs of administration of the estate; and (iv) costs incurred by the federal or provincial governments to remediate land constitute first ranking security against that land and any contiguous land related to the activity that caused the environmental condition or damage.

The AER is the regulator under Alberta’s oil and gas regulatory regime (Regulatory Regime). Producers are required to obtain licences for each of their PNG Assets from the AER and to be qualified under those laws to hold such licenses.  Licences can only be transferred with the prior written consent of the AER, which consent can be conditioned on the transferor and transferee complying with various obligations under the Regulatory Regime.  Licensees and parties having an interest in the PNG Assets are responsible for suspending, abandoning, reclaiming and remediating their PNG Assets, which requires their safe shut down and dismantling and the restoration of the land on which they are situate (for ease of reference, we will refer to these actions as remediating).

Each licensee is required to report to the AER on a monthly basis with respect to the status and production from its PNG Assets.  Based on these reports, the AER calculates a liability management rating for each licensee based on a comparison of the aggregate value of its PNG Assets (based roughly on 12 months’ trailing production) to the AER’s estimate of its aggregate remediation liabilities.  Where the aggregate liabilities exceed the aggregate value, the AER will require the licensee to either reduce its liabilities by remediating PNG Assets, or provide a security deposit to increase the value.  This calculation is performed by the AER on a monthly basis, and whenever a licensee applies to the AER for the approval of a licence transfer.

The Regulatory Regime also provided for an orphan well system, under which the OWA, funded by industry levies imposed and collected by the AER, would exercise the AER’s powers to remediate PNG Assets where the licensee was insolvent or defunct and there was no other party responsible for performing the remediation work.

The proceedings were triggered by the fact that the Regulatory Regime deems a Court Officer to be licensee, responsible for all of the debtor licensee’s regulatory obligations, and does not recognize any right of a Court Officer to disclaim assets under the BIA.  Further, where the aggregate remediation obligations of an insolvent licensee exceeds the aggregate value of the PNG Assets, the AER will not permit its licenses to be transferred in a sale by the Court Officer of PNG Assets unless a security deposit is posted for the amount by which the excess of liabilities over asset values increases.  Since a Court Officer can generally only sell the valuable producing PNG Assets, this generally has the practical effect of requiring that all proceeds of sale be posted as security for remediation obligations.

Background

Redwater’s PNG Assets consisted of 127 wells, facilities and pipelines, of which only 19 were producing wells and 3 were operating facilities. The remaining PNG Assets were burdened with significant environmental remediation obligations and had no realizable value.  Redwater was struggling financially as a result of low commodity prices and inadequate capitalization, and after conducting a failed sale process its secured lender applied to the Court of Queen’s Bench of Alberta for an order appointing a receiver.  The Court appointed Grant Thornton Limited (GTL) as receiver in May of 2015 and trustee in bankruptcy in October 2015.  GTL quickly determined that it would only be able to sell the 22 producing and operating PNG Assets and therefore disclaimed the remaining assets in July of 2015. 

The AER, which regulates the oil and gas sector in Alberta, issued remediation orders against Redwater and applied to the Court for an order setting aside the disclaimer and directing GTL to remediate the disclaimed PNG Assets.  GTL applied for an order confirming its right to disclaim PNG Assets and sell the PNG Assets it had retained.

The Court determined that GTL was entitled under section 14.06 to disclaim PNG Assets, as a result of such disclaimer was not responsible for the remediation obligations relating to the disclaimed assets, and that such remediation obligations were provable claims subject to the BIA’s priority regime.  To the extent that the Regulatory Regime did not permit disclaimer, required that remediation obligations be performed or secured by security deposits before any distributions are made to creditors, and conditioned transfers of licences on such performance or payment, the Regulatory Regime was inoperative under the paramountcy doctrine.  The appeal by the AER and OWA to the Alberta Court of Appeal was dismissed, and the AER and OWA appealed to the Supreme Court of Canada.

The Supreme Court Decision

In a five to two decision written by Chief Justice Wagner, the majority of the Court found that there was no conflict giving rise to the application of the paramountcy doctrine.  Wagner C.J. narrowly interpreted the effect of a disclaimer under section 14.06, and limited the circumstances in which a regulatory obligation will be characterized as a provable claim subject to the priority regime in the BIA.

Wagner C.J. focused narrowly on two subsections of section 14.06 to conclude that the provisions were only concerned with protecting Court Officers from personal liability for environmental remediation obligations.  Further, he found that Parliament included the reference to disclaimer in the provision in order to confirm that even if Court Officers disclaimed property, they could not “walk away” from the obligation to remediate that property.  Because the AER was not seeking to impose personal liability on GTL, but rather limited GTL’s obligations to the extent of value in the estate, there was no conflict for the purposes of the paramountcy doctrine.  Justice Côté, in dissenting reasons, wrote that the majority reasons did not apply the correct rule of statutory interpretation, which required that the words of provisions must be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme and object of the statute and intention of Parliament.  Côté J. found that based on the majority’s interpretation, there would be no purpose to a disclaimer and that the majority ignored subsections of 14.06, and the Parliamentary record, that contradicted their interpretation.

Wagner C.J. acknowledged that if the remediation obligations were provable claims for the purposes of the BIA, then to the extent they had to be satisfied before any distribution to creditors, there could be a conflict for paramountcy purposes.  However, Wagner C.J. changed a three-part test for determining when a regulatory obligation was a provable claim subject to the BIA’s priority regime.  That test had previously been set out in the Supreme Court’s 2012 decision in Newfoundland and Labrador v. AbitibiBowater Inc. (Abitibi) and provided that: (1) there must be a debt, a liability or an obligation to a creditor; (2) the debt, liability or obligation must be incurred as of a specific time; and (3) it must be possible to attach a monetary value to the debt, liability or obligation.  The third prong tests whether it is sufficiently certain that the regulatory body will carry out the remediation work and thereby have a monetary claim against the debtor.

The Supreme Court in Abitibi held said that under the first prong of the test a regulatory body was a creditor when it exercised enforcement power against a debtor.  Wagner C.J., however, held that a regulatory body could only be a creditor where it was not acting in the public interest and for the public good, and was not seeking a financial benefit or engaging in a colourable attempt to recover a debt.  Applying this revised criteria, Wagner C.J. found that in ordering Redwater to remediate the disclaimed PNG Assets and requiring GTL to satisfy the associated remediation obligations as a condition to license transfers, the AER was acting in its regulatory capacity for the benefit of the public, and was not acting as a creditor seeking a financial benefit or making a colourable attempt to recover a debt.  Wagner C.J. wrote that the first prong of the test had to be applied in this manner because otherwise a regulatory body would satisfy the test whenever it exercised enforcement power.  However, , although it was not explained why the third prong, which was intended to limit the application of the BIA rules to regulatory obligations that were in substance provable debt claims, was not sufficient for those purposes.  In her dissenting reasons, Côté J. wrote that there was insufficient reason to change the first prong of the Abitibi test, and that under the revised application of the first prong, a regulatory body would almost never be found to be a creditor.

Wagner C.J. also determined that the third prong of the test was not satisfied because: (1) it was not certain that the AER would in fact abandon the disclaimed PNG Assets; (2) the OWA, which would otherwise abandon them, was distinct from the AER; (3) the OWA only did so over an extended time period (exceeding a decade) and one could never know what would happen in such a period; and (4) the AER was unlikely to file a claim for the remediation costs in the insolvency proceedings.  Côté J., on the other hand, found that the factual findings of the Court of Queen’s Bench should be given deference on appeal.  Based on those findings, Côté J. held that it was reasonable for the Court to conclude that it was sufficiently certain that either the AER, or its delegate the OWA, would carry out the remediation work and have a claim for the costs.

Finally, Wagner C.J. found that the AER’s license transfer conditions, which required the payment or performance of remediation costs of disclaimed PNG Assets before the AER approved a transfer, reflected the inherent value of the PNG Assets and did not disrupt the federal insolvency priority regime.  Côté J., by contrast, concluded that because they have the effect of requiring the payment of remediation obligations before distributions to prior-ranking creditors, the licence transfer conditions conflict with the BIA’s priority regime.

Impact of the Supreme Court Decision

The majority decision signals what some have termed a sea change in how insolvencies of regulated companies will be handled going forward.  This may limit capital availability for regulated sectors, such as the natural resources extraction industry, and the ability of the insolvency system to effectively restructure or liquidate such industries.  Ultimately, it remains to be seen what the actual consequences of the decision will be, but the following are some of the concerns:

1. Regulatory Obligations generally not subject to Bankruptcy Rules.  Regulatory obligations, even where monetized, will only be treated as provable claims subject to BIA priorities in limited circumstances.  It is unclear when regulatory bodies will be found to be not acting in the public interest and for the public good, and what constitutes a pecuniary benefit that will result in a court concluding that the regulatory body is acting as a creditor.  Further, even if a regulatory body was found to be a creditor, it is unclear in what circumstances the delegation by a regulatory body of remediation work to statutory bodies or even third party contractors, would result in a court not finding those remediation obligations to be provable claims.  Given this uncertainty, it is unclear how lenders and potential Court Officers will be able to determine whether regulatory obligations are provable claims that are subject to the BIA’s priority regime.

2.  Super-Priority for Regulatory Obligations.  Where, as a result of the re-cast Abitibi test, regulatory obligations are not provable claims subject to the BIA priority regime, those claims must be satisfied before any distributions may be made to secured and unsecured creditors.  Effectively, abandonment and other regulatory obligations are super-priority claims.

3. Quantification of Environmental Obligations.  Although the AER calculates licensees’ remediation obligations on a monthly basis, those calculations are generally perceived to be less than actual remediation costs.  Without conducting extensive due diligence, lenders and Court Officers will have difficulty quantifying remediation obligations for the purposes of determining loan availability.  Further, it is unclear how Court Officers will quantify such obligations for the purposes of determining whether distributions can be made to creditors.  The BIA does have mechanisms for proving and quantifying claims, but these do not apply to regulatory obligations that are not in substance provable debt obligations. 

4. Protection of Court Officers.  To the extent that the provincial Regulatory Regime seeks to impose personal liability on Court Officers for environmental obligations, section 14.06 would render those provisions inoperative.

5. Priority of Costs of Administration versus Costs of Environmental Obligations.  Wagner C.J. did not address whether the fees and costs of the Court Officer and the other costs of administration can be paid before regulatory obligations are paid or performed.  Unless there is certainty on this point, Court Officers will likely either refuse appointments or require indemnities before accepting appointments.  If the quantum of the regulatory obligations exceeds the realizable value of the assets in the estate, it is unlikely that a secured creditor would initiate insolvency proceedings or provide an indemnity to the Court Officer.  Since, however, the majority decision requires Court Officers to pay or perform remediation obligations, it would be reasonable for future courts to conclude that the majority intended that the fees and costs of the Court Officer and other administration costs could be satisfied before remediation costs.

6. Efficacy of a Disclaimer.  Since Court Officers are protected from personal liability without disclaiming properties affected by environmental conditions, and remain responsible for remediating any disclaimed properties to the extent that there are assets in the estate, a disclaimer will only benefit the estate to the extent that limits non-regulatory obligations. Wagner C.J. did not address how a Court Officer may remediate disclaimed property, when subsection 14.06(6) provides that the costs of remediating disclaimed properties cannot be costs of administration.

7. Loan Value Redeterminations.  Over the coming months, lenders will re-determine the amounts available to oil and gas producers.  In calculating loan availability, lenders typically margin super-priority claims against the value of the borrower’s assets.  In the oil and gas industry, lenders have complex methodologies for calculating the value of a borrower’s oil and gas reserves and for margining various prior ranking obligations and costs to determine loan availability.  Because environmental remediation and other types of regulatory obligations will now have to be treated as super-priority obligations, there is concern that credit availability for producers will be reduced.  A reduction in capital availability for producers could reduce revenues for the service industry that is dependent on them.  In the current market conditions, the availability and cost of capital from other sources is uncertain. 

8. Chilling Effect on Insolvencies.  Reduced capital availability often triggers insolvency. However, if lenders determine that the prior ranking remediation obligations exceed the value of a borrower’s assets, they may conclude there is no economic benefit to providing further credit or to commencing insolvency proceedings.  In such event, unless arrangements can be made with the AER, the borrower’s business may simply shut down, and it is unclear what would happen to its assets. 

9.  Enhanced Environmental Risk.  Where a producer simply shuts down because its lenders will not provide further credit, it is unclear how its PNG Assets would be safely secured and shut down.  This can pose a real risk to the public and environment.  The AER would likely have little alternative, in such circumstances, to transfer all of the borrower’s PNG Assets, including ones that are productive and sellable, to the orphan well fund and the OWA would end up doing the remediation work.  This would have exactly the opposite effect intended by the AER and OWA in pursuing the appeal. 

Overall, these issues are significant and will not be resolved without the participation of the AER, the provincial and federal governments, the lending community, the oil and gas industry and insolvency professionals.  Practical solutions will have to be crafted to address remediation obligations, preserve the access of producers to capital, and permit insolvency proceedings where producers have become insolvent.

    Tom Cumming and Caireen E. Hanert

    Tom Cumming and Caireen E. Hanert are partners in the Restructuring and Insolvency group in Gowling WLG’s Calgary office. Gowling WLG served as co-counsel to Grant Thornton Limited, the Receiver and Trustee in the Redwater Energy Corporation receivership and bankruptcy proceedings.