Canada: Alberta Court Of Appeal Finds Mistake In Dispute Over Unit Agreement

Copyright 2009, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Litigation, January 2009

Introduction

On December 22, 2008, the Alberta Court of Appeal released its decision in Signalta Resources Limited v. Dominion Exploration Canada, 2008 ABCA 437. This case examined the ownership of natural gas rights in the Glauconite formation, a gas-bearing zone. The appellant and plaintiff in the original action, Signalta Resources Limited (Signalta), claimed that the respondent, Dominion Exploration Canada Ltd. (Dominion) (represented by Blakes) was producing and taking natural gas belonging to the West Viking Gas Unit No. 1 (the Unit), a gas unit operated by Signalta. It was the position of Signalta at trial (Signalta Resources Limited v. Dominion Exploration Canada Ltd. 2007 ABQB 636) and on appeal that the Glauconite formation had been a unitized zone since the inception of the Unit, and that production from the Glauconite formation therefore belonged to the Unit. Dominion, on the other hand, argued that while the Viking formation formed part of the Unit, the Glauconite formation, which is below the Viking formation, was never unitized and production thus belonged to Dominion.

The decisions at trial and on appeal are significant for exploration and production companies in highlighting the importance of thorough title review and underlining the fact that transactional documents, such as unit agreements, cannot always be relied upon by producers in fully determining their rights to oil and gas substances. Rather, a detailed review of historical title documents is necessary to determine ownership of mine and mineral rights and the rights to production. The case is of further significance in confirming the roles and responsibilities of working interest owners and royalty holders, including the interaction of these rights where a unit is involved. Finally, the case is significant for litigation counsel in confirming the ability to rely upon extrinsic evidence to interpret agreements relating to mine and mineral rights in certain circumstances, such as where this evidence is necessary to prove mistake by the parties to the agreement, to resolve ambiguity in the agreement, or to determine the capacity or role in which a party executed the document.

Background

In December 1973, Siebens Oil & Gas Ltd. (Siebens) was the registered owner of an estate in fee simple in mines and minerals upon or under Section 8, Township 49, Range 13, W4M (the Section 8 Lands), subject to a caveat filed by Hudson's Bay Oil and Gas Company Ltd. (HBOG), wherein HBOG protected its rights to secure a petroleum and natural gas lease from Siebens.

In April 1974, HBOG entered into a Farmout Agreement with Dyco Petroleum Corporation (Dyco) as Farmee. The Farmout Agreement provided that Dyco was to drill 26 test wells on the lands, and that Dyco would be entitled to a lease on production to the depth of the test wells drilled on each parcel. If wells were not drilled on a particular parcel, then Dyco would be entitled to a sub-lease to the contractual depth set out in the Farmout Agreement. This contractual depth entitled Dyco to an interest to the base of the Viking formation in the Section 8 Lands.

In February 1974, Voyager Petroleums Ltd. (Voyager) issued a notice to various petroleum companies who held interests in the West Viking area of Alberta indicating its interest in establishing a gas unit. The Section 8 Lands were within this area. From February to August 1974, various proposals for the Unit were considered. Finally, in August 1974, a meeting of all working interest owners of the proposed Unit was held. Importantly, at that time Exhibit "A" to the Unit Agreement – the exhibit setting out tract participation – was unanimously approved for the purpose of determining unit participation. At the time of the meeting, Dyco had not yet earned its interest in the Section 8 Lands, and consequently HBOG attended the meeting as working interest owner of those lands. At that time, the Glauconite formation was set out as an excepted formation and was not included in the proposed Unit.

On December 2, 1974, by letter to the unit operator, HBOG advised that it had farmed its interest in the proposed Unit to Dyco. At that time, Exhibit "A" to the Draft Unit Agreement of August 15 was the latest draft.

On December 6, 1974, Voyager sent a letter to the Deputy Minister of the Department of Mines and Minerals that included copies of the draft Unit Agreement. For the first time, the attached Exhibit "A" of the Unit Agreement showed the Glauconite formation of the Section 8 Lands as being included in the Unit. There was no evidence that HBOG ever received a copy of this letter or that it was aware of the change by Voyager to include the Glauconite formation in the Unit.

The Unit became effective as of February 1, 1975. However, the Section 8 Lands were not qualified for the Unit at that time. The Section 8 Lands did not qualify until Dyco earned its interest under the Farmout Agreement and obtained title to the Section 8 Lands. On April 22, 1975, Dyco and HBOG executed a sublease made effective as of January 31, 1975. The sublease granted the strata for the Section 8 Lands down to the base of the Viking formation to Dyco. On May 1, 1975, the Section 8 Lands qualified for and were included into the Unit with an effective date of February 1, 1975.

When the Unit Agreement was finally executed by all parties, the then current Exhibit "A" to the Unit Agreement was the revised version that had been sent to the Deputy Minister of the Department of Mines and Minerals on December 6, 1974, including the Glauconite zone of the Section 8 Lands in the Unit. This Exhibit "A" listed Dyco and not HBOG as the only working interest owner of the Section 8 Lands.

In March 1992, Poco Petroleums Ltd. (Poco), which had replaced Voyager as the operator of the Unit, issued Revision No. 13 to Exhibit "A" of the Unit Agreement. The revision, among other things, revised Exhibit "A" to show the Glauconite zone as an excepted zone with respect to the Section 8 Lands. The revision was circulated at the time to all members of the Unit. No party to the Unit objected to or commented on this revision.

Signalta is the successor in title to Dyco and beneficially owns the working interest earned under the sublease between HBOG and Dyco with respect to the Section 8 Lands.

Decision at Trial

At trial, Signalta argued that all of the conditions for inclusion in the Unit of the Section 8 Lands, including the Glauconite formation, were satisfied. Signalta relied upon clause 1302 of the Unit Agreement, which states that if a Party owns a working Interest and a Royalty interest, its execution of this Agreement shall constitute execution in both capacities. As a result, Signalta argued that HBOG's execution of the Unit Agreement, together with the execution by Siebens and Dyco, committed both the Viking and Glauconite formations to the Unit, as both formations were included in Exhibit "A" to the Unit Agreement when the Agreement was executed. As a result, Signalta argued, HBOG had contributed the Glauconite to the Unit. Signalta also argued that if HBOG had not contributed the Glauconite zone, Dyco had contributed that zone by virtue of the Farmout Agreement, notwithstanding that the sublease giving effect to the farmout encompassed rights only to the base of the Viking formation. (This argument was abandoned on appeal.)

The Court of Queen's Bench rejected Signalta's arguments, stating that the Glauconite formation under the Section 8 Lands was not committed to the Unit by HBOG or Dyco as at the effective date of the Unit. Rather, the Unit's Title Committee had misunderstood the title and interest that Dyco conveyed to the Unit. The misunderstanding was based on the assumption that HBOG was conveying to Dyco all of HBOG's working interest ownership, which included the Glauconite formation. However, this was not the case, as HBOG had only subleased its working interest ownership to the base of the Viking formation. The Court found that the Title Committee, the Operating Committee and Dyco had each failed to determine, accurately or at all, whether Dyco held title to the interest they believed Dyco had contributed to the Unit. Had a proper title examination been completed in 1975, it would have been clear that Dyco could not contribute any rights to the Glauconite formation to the Unit, as Dyco held no such rights.

Decision on Appeal

On appeal, Signalta submitted that the trial judge had erred in interpreting the Unit Agreement, resulting in his erroneous conclusion that HBOG did not contribute the Glauconite zone to the Unit. Signalta further submitted that the trial judge erred in his reliance upon extrinsic evidence in interpreting the Unit Agreement and in finding that Poco was entitled, in 1992, to issue the revised Exhibit "A" exempting the Glauconite formation from the Unit.

The Court of Appeal rejected these arguments and found that the trial judge had carefully reviewed the documentary evidence within the context of expert testimony relative to industry practices and procedures common to unitization and was correct in concluding that the Glauconite formation was never part of the Unit. The Court of Appeal agreed that the Glauconite formation had not been contributed by Dyco because Dyco had never acquired title to, or an ownership interest in, the formation. HBOG at all material times possessed the working interest in the Glauconite formation. However, HBOG did not, and never intended to, contribute its working interest in that formation to the Unit. While HBOG had executed the Unit Agreement, it had not done so in the capacity of a working interest owner of the zones lying beneath the Viking formation, nor did the members of the Unit deal with HBOG as a working interest owner following the introduction of Dyco in that capacity in place of HBOG in December 1974.

The Court of Appeal found that the conclusion reached by the trial judge – that Exhibit "A" to the Unit Agreement mistakenly failed to except the Glauconite formation at the time that the Section 8 Lands qualified for admission to the Unit, effective February 1, 1975 – was correct. The Court of Appeal also agreed that the extrinsic evidence admitted at trial was admissible for the purposes of showing the mistake which allowed Poco in 1992 to correct Exhibit "A" to the Unit Agreement, and otherwise to show that HBOG executed the Unit Agreement and Unit Operating Agreement in 1975 only in its capacity as the holder of a royalty interest in the Section 8 Lands. Accordingly, the Court of Appeal found that Poco's revision of Exhibit "A" – to show the Glauconite formation as an excepted zone with respect to the Section 8 Lands – was made to correct the earlier mistake and was within the powers of Poco, as the Operator, pursuant to the provisions of the Unit Agreement that allowed the operator to correct mistakes.

Finding that there had been no errors made by the trial judge, the Court of Appeal rejected the appeal and upheld the trial decision in its entirety.

Title Review

Title review is an important aspect of the due diligence process. In particular, the title review process will alert a prospective purchaser to ownership issues surrounding reserves, encumbrances thereon, any title deficiencies, material terms of the title and operating documents, and details respecting existing wells, spacing units, facilities and surface rights.

A full title review will provide anyone dealing with mineral interests with a reasonable degree of comfort regarding the chain of title and ownership of the target reserves. During this review, all documents – including correspondence, lease and contract summary sheets and agreements contained in the mineral contract files and mineral lease files, as well as all relevant titles, search letters and registered encumbrances – are reviewed and a title opinion may be provided. The scope of the title review can be adjusted to fit the nature of the transaction and, in some cases, the scope of review may be narrowed simply to conducting relevant searches, reviewing land summary sheets, and examining the key documents relating to such interests.

Significance of the Decisions

The decisions in this case underscore the importance of such title review as necessary to protect the interests of those dealing with mine and mineral interests. Such a review is necessary because:

(i) there is no registry of working interest owners and other interests on which those dealing with such interests can rely to ascertain ownership of and interest in reserves; and

(ii) those holding interests in mine and mineral reserves are usually not prepared to provide an adequate warranty and indemnity in respect of those interests.

While the mineral title and Torrens land system offer some protection in obtaining and determining ownership of mineral interests, each has limitations in ensuring that the current and proper beneficial owners of the interests have been recognized and registered in the relevant lands or leases. Often, ownership interests in petroleum and natural gas rights are acquired through various sale agreements and may include joint venture title, with such interests ultimately being derived from a single source document, typically being a lease. Such owners may or may not have an actual registered interest in the lease or lands. Accordingly, it is necessary to examine all title documents relevant to a parcel of land in order to ensure that each party has acquired the interest that it purports to have. Proper title review will also reveal whether the encumbrances on such interests are as stated, whether the leases and other title and operating documents on which any such interests are based are in good standing, and whether there are any other defaults or issues existing under the leases or other title documents. Had the Unit in this case performed a proper title review, the issues in this litigation may have been avoided.

The case is also significant in confirming the rights and responsibilities of the various interest holders that may exist with respect to any oil or gas producing property and, in particular, how these rights and responsibilities operate and interact in the context of a Unit. The decisions confirmed that only working interest owners execute the unit operating agreement and have the right to work the mines and minerals in question, that both working interest owners and royalty holders will execute the unit agreement and that the failure of a party to sign the unit operating agreement and authorities for expenditure is evidence as to the status of such party as a royalty holder rather than a working interest owner.

Finally, the decision is significant for litigation counsel in confirming the ability to rely upon extrinsic evidence at trial to interpret petroleum and natural gas agreements in certain circumstances. In particular, the trial judge confirmed that extrinsic evidence may be relied upon to prove mistake by one or more parties notwithstanding the express written terms of the agreement, to resolve ambiguity in the agreement pursuant to the parol evidence rule or to demonstrate the capacity or status of a party in which it executed the document in question. In this case, although the Exhibit "A" to the Unit Agreement that was effective as of the effective date of the Unit listed the Glauconite zone as included within the Unit, with Dyco as the 100% working interest owner, it was clear upon a review of the extrinsic evidence that Dyco had no title to the Glauconite and therefore no ability to contribute that zone to the Unit. Similarly, the extrinsic evidence revealed that HBOG as the working interest owner of the Glauconite had no intention to contribute that zone to the Unit, that it signed the Unit Agreement only in its capacity as a royalty interest holder in the Unit, and that it did not at any time contribute the Glauconite to the Unit prior to the effective date of the Unit. As a result, title to the Glauconite zone remained with HBOG and its successors in interest, including Dominion.

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