"[B]ankruptcy is not a license to ignore rules"—so said the majority in Canada's highest court in the Redwater decision, holding that there was no conflict between Albertan energy and environmental legislation and federal bankruptcy law. This decision has serious implications for sector participants and lenders in the oil and gas landscape in Alberta.
What You Need To Know
- Impact on lending:
For secured lenders, the decision underscores how important it is
to consider the financial implications of environmental end-of-life
obligations when assessing whether, and on what terms, to extend
financing to oil and gas companies. Considerations will include
what types of financial reserves will have to be held against
traditional lending values to account for these obligations as it
would be unrealistic to expect lenders to bear the risk of a
company's management (or lack thereof) of such obligations,
where such obligations, by the SCC's admission, are too remote
and uncertain to quantify.
- The size of these reserves could end up having a significant impact on the ability of junior and some intermediate oil and gas companies to raise sufficient capital to not only grow, but also survive.
- Further, events of default, environmental liability stress tests and reporting and auditing requirements imposed as terms by lenders in the oil and gas industry may become significantly more onerous.
- Impact on receiverships and bankruptcies: The decision will likely also add a considerable amount of time (and therefore administrative and professional costs at the expense of a secured creditor's claims) to an already lengthy realization proceeding process as receivers, trustees and lenders will all be careful to ensure these obligations are able to be satisfied prior to a distribution of the bankrupt estate's assets.
- Impact on insolvency professionals: The decision may also serve to discourage insolvency professionals from accepting mandates where the value of a company's potential outstanding environmental liabilities exceeds the value of its realizable assets. If an estate's entire realizable value must go towards its environmental liabilities, leaving nothing behind to cover administration costs, there is little to be gained from stepping in to serve as receiver or trustee.
- Polluter pays?: The
public policy objective here appears to have been to try to
preserve or advance the "polluter pays" principle in
circumstances where allowing the appeal was the only way to ensure
that the financial abandonment and reclamation burden was not
shifted to taxpayers (or to the industry as a whole). However, in
doing so, the SCC effectively shifted the burden to lenders and
other secured creditors, and it is difficult to see that as a
reasonable extension of the "polluter pays"
- Furthermore, Redwater has significantly lessened the incentive for the provincial government and the AER to make rules and regulations that could better keep the financial abandonment and reclamation burden where it belongs—with licensees. At the very least, Redwater has blunted the urgency of the need for such changes.
- What's next: The canary in this particular coal mine has long been dead, with little action on the part of either the provincial government or the AER to address a well-known problem. We suspect the financial services industry (and perhaps even the oil and gas industry, if Redwater seriously affects the availability of reasonable cost debt), will soon lobby the provincial government for regulatory changes to ameliorate the adverse effects Redwater may have on risks to lenders and on access to capital for an already beleaguered sector.
Redwater was a publicly traded Alberta-based oil and gas company who had principal assets of approximately 87 licensed oil and gas wells along with various affiliated pipelines and facilities. In mid-2014 Redwater began experiencing financial difficulties, and Grant Thornton Limited (GTL) was appointed as its receiver in May 2015. At the time GTL was appointed, Redwater owed its primary creditor Alberta Treasury Branches (now ATB Financial) approximately $5.1 million. Of its assets, 17 of its wells remained productive and profitable, however the majority of the wells it owned were spent and burdened with abandonment and reclamation liabilities that exceeded their value. The estimated value of Redwater's environmental liabilities exceeded the estimated value of its profitable assets. In accordance with the Alberta regulatory regime, at the time GTL became receiver for the estate of Redwater, it was also deemed to become the licensee of Redwater's regulated oil and gas assets.
Upon being notified of Redwater's receivership, the AER determined that Redwater's Liability Management Rating (LMR), the ratio between the value of an entity's assets and the estimated cost of abandoning and reclaiming those assets, was lower than 1.0, which at the time was below the ratio a licensee is required to keep.1 To bring a low LMR back up to a ratio prescribed by the regulator, a licensee is required to pay a security deposit. If a licensee fails to do so, the AER may cancel or suspend the company's licenses. As an alternative to posting security, a licensee may also perform its end-of-life obligations or transfer licences (with AER approval) in order to bring its LMR back up to the prescribed level. The AER advised GTL that, notwithstanding the receivership, Redwater, and GTL in its capacity as receiver and deemed licensee, remained obliged to comply with all regulatory requirements, including the abandonment and reclamation obligations for all of Redwater's assets prior to distributing any funds or finalizing any proposal to creditors. It further advised that it would not approve the transfer or sale of any of Redwater's licenses unless it was satisfied all regulatory obligations would be fulfilled.
In response, GTL sought to disclaim all of Redwater's non-producing assets burdened by environmental liabilities pursuant to section 14.06 of the BIA. GTL informed the AER it was not taking possession or control of any of Redwater's assets other than the 17 productive wells and associated facilities and pipelines, and indicated its position that it had no obligation to fulfill any regulatory requirements in relation to the disclaimed assets.
Subsequently, the AER issued orders under the Oil and Gas Conservation Act and the Pipeline Act requiring Redwater (and GTL as receiver) to immediately suspend and abandon the disclaimed assets. The AER (along with the Orphan Well Association, or OWA) then filed an application seeking a declaration that GTL's renunciation of the disclaimed assets was void, an order requiring GTL to comply with certain well abandonment orders that were issued by the AER, and an order requiring GTL to "fulfill the statutory obligations as licensee in relation to the abandonment, reclamation and remediation" of all of Redwater's licensed assets. The AER did not seek to hold GTL liable for these obligations beyond the assets remaining in the Redwater estate. GTL brought a cross-application seeking approval to pursue a sales process excluding the disclaimed assets, and an order directing that the AER could not prevent the transfer of the licenses associated with the retained assets on the basis of the abandonment orders, the LMR requirements, or GTL's refusal to take possession of the disclaimed assets.
In May 2016, the Alberta Court of Queen's Bench (ABQB)2 found in favor of GTL, and held that under section 14.06 of the BIA, trustees and receivers of insolvent companies were entitled to disclaim uneconomic oil and gas assets, and that as a result of the doctrine of paramountcy, the Oil and Gas Conservation Act and the Pipeline Act were inoperative to the extent they conflicted with the BIA. The ABQB authorized GTL to proceed with the sale of the retained assets and the distribution of the proceeds to Redwater's creditors. The AER and OWA appealed the decision of the ABQB to the Alberta Court of Appeal, which dismissed the appeal and upheld the lower court's decision.3
The SCC decision
In overturning the lower court decisions, the majority of the SCC determined there was no genuine conflict between the reclamation and abandonment provisions of Alberta regulatory regime and section 14.06 of the BIA, and that neither the abandonment obligations nor licence transfer restrictions under Alberta's regulatory regime frustrate the purpose of the BIA such that the doctrine of paramountcy need not be engaged. The SCC held that the purpose of section 14.06 of the BIA is to provide a trustee with protection from personal liability in relation to any environmental orders against a bankrupt's estate, but that it does not affect the ongoing environmental obligations and liability of the estate itself. As such, so long as a trustee is protected from personal liability,4 no conflict arises from the trustee being able to disclaim liability under the BIA, but also being deemed to be licensee under the Alberta regulatory regime, and thus responsible for complying with all environmental obligations associated with the bankrupt's assets. The SCC therefore found that GTL continues to have the responsibilities and duties of a licensee to the extent that assets remain in the Redwater estate, and that it must use the proceeds realized from estate to comply with valid orders made by the AER before paying out Redwater's creditors. "Disclaimer" under the BIA cannot be used by a receiver to walk away from the environmental regulatory obligations attached to licensed assets of a bankrupt estate.
The majority of the SCC further held that in requiring the Redwater estate to comply with its environmental obligations under the Alberta regulatory regime, the AER was not asserting any claims "provable in bankruptcy," and that the AER, in exercising its regulatory authority in the public interest and for the public good by issuing the abandonment orders and enforcing the LMR requirements, is not a creditor of the estate, such that it is entitled to continue to enforce the Alberta regulatory regime during the bankruptcy process, in priority to creditors thereunder.
The majority reached this determination by applying the test set out in Newfoundland and Labrador v Abitibi Bowater Inc., 2012 SCC 67 (Abitibi). In Abitibi the SCC set out the test for determining whether a particular regulatory obligation amounts to a claim provable in bankruptcy:
First, there must be a debt, a liability or an obligation to a creditor. Second, the debt, liability or obligation must be incurred before the debtor becomes bankrupt. Third, it must be possible to attach a monetary value to the debt, liability or obligation.
Based on its finding that the abandonment and reclamation obligations were public duties owed to the people and not financial obligations owed to the province, the SCC determined the AER was therefore not a creditor such that the environmental obligations were not a "claim provable in bankruptcy," under the first prong of the Abitibi test. The SCC further held that the environmental obligations also failed the third prong of the Abitibi test on the basis that the claim was too remote and too uncertain to be a claim in the bankruptcy process.
The majority of the SCC concluded by reminding insolvency professionals that "bankruptcy is not a license to ignore rules"—a caution that affirms that non-monetary regulatory environmental obligations cannot be gerrymandered out of bankrupt estates and onto the public, for the benefit of creditors.
The authors would like to thank Tanis Makowsky who assisted in the publication of the bulletin.
1 Subsequent, and in response, to the insolvency of Redwater, the AER changed the requisite LMR ratio to 2.0, requiring a company to hold assets valued at double the estimated abandonment and reclamation cost immediately subsequent to any license transfer in order for the AER to approve a license transfer.
2 Re: Redwater Energy Corporation, 2016 ABQB 278.
3 Orphan Well Association v Grant Thornton Limited, 2017 ABCA 124.
4 Except to the extent that the environmental damage occurred after the trustee's appointment as a result of its own gross negligence or wilful misconduct.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.