Who Pays?

The decision in Redwater shifts responsibility for environmental clean-up away from insolvent energy companies and towards the public and industry. But it remains to be seen who will ultimately pay.
WHEN OIL WELLS ARE ABANDONED and environmental remediation work needs to be conducted, where does this responsibility lie in the case of an insolvent operator? This question, watched with intense interest by domestic and international investors, lenders, regulators and politicians, as well as the energy industry at large, achieved more clarity earlier this year.

According to Janice Buckingham, a partner with Osler, Hoskin & Harcourt LLP in Calgary, the decision of the Alberta Court of Queen’s Bench in regard to bankrupt Redwater Energy (Re), 2016 ABQB 278 “established that a trustee in bankruptcy can disclaim an insolvent debtor’s uneconomic oil and gas properties while retaining and selling its valuable assets to maximize recovery for secured creditors.”

The decision in Redwater, a publicly listed junior oil and gas producer in Alberta, says Buckingham, clarified what happens when the mandate of provincial oil and gas regulators such as the Alberta Energy Regulator (AER) comes into conflict with principles within the federal Bankruptcy and Insolvency Act.

As such, says Buckingham, “certain provisions of Alberta’s regulatory regime that require a trustee to satisfy abandonment and remediation of an insolvent debtor’s oil and gas wells in priority to the claims of its secured creditors is in conflict with the federal bankruptcy and insolvency laws and is therefore inoperative to the extent of the conflict.”

The Redwater decision is a continuation of a series of cases that allocate liability when environmental and insolvency law intersect, says Alexandria Pike, a Toronto-based environmental and energy partner with Davies Ward Phillips & Vineberg LLP. She says this intersection “has been described by the courts as ‘messy’ but the decisions consistently support the paramountcy of Canada’s insolvency laws, regardless of the extent of environmental risk.”

In Pike’s view, although the Redwater decision may appear as a new issue, it expands on the principles of the Newfoundland and Labrador v. AbitibiBowater, 2012 SCC 67 and Nortel Networks Corp. (Re), 2013 ONCA 599, “cases that prevent a regulator from jumping the queue and demanding [100 cents on the dollar] for environmental issues. While companies must satisfy their well closure obligations during the course of operations, the regulator cannot impose such liabilities on an insolvent company, whether or not there is a significant environmental impact.”

The implications for Alberta’s energy industry are diverse and wide-ranging. In July 2017, the AER applied to the SCC for leave to appeal. Buckingham says, if leave is not granted, or the appeal court decision is upheld by the SCC, “the interests of the lending community to maximize recovery for secured creditors will have priority over the regulator’s rights to enforce end-of-life obligations through bankruptcy.”

The result of such a finding will mean that the industry will be responsible to fund a greater share of such liabilities, says Buckingham. Obligations associated with the renounced properties will fall principally to the oil and gas industry through annual levies collected by the Orphan Well Association (OWA) to conduct reclamation and remediation activities. “While the OWA can assert that costs of performing such activities are provable claims in bankruptcy against the debtor,” she says, “the proceeds of sale of the debtor’s valuable assets are often insufficient to repay both the secured and all unsecured debts of the debtor.”

CHERRY-PICK ASSETS

The Alberta Energy Regulator (AER), in Bulletin 2016-16, responded to Redwater by requiring a higher liability management rating (LMR). This rating prevents prospective acquirers that are deemed financially unstable from obtaining a transfer of well licences. The regulator also required that that all applications for licence eligibility be considered and processed as non-routine, says Christopher Nixon, a partner with Stikeman Elliott LLP in Calgary. In light of the Redwater decisions and the response of the AER, Nixon says potential acquirers have a heightened sensitivity to the LMR and to obtaining a licence if they are a new entrant into Alberta’s oil and gas patch.

Nixon says a number of potential asset acquisitions have been delayed or scuttled by reason of the financial security that would potentially be required to be deposited with the AER. International investors have, in particular, been discouraged by the uncertainties.

Business strategy has also shifted as a result of Redwater. Nixon says that “where the owner of the assets is not in strong financial position, secured lenders and potential asset acquirers may be better served to await the bankruptcy of the owner of the assets to be able to ‘cherry-pick’ the better assets without the financial detriment of the less desirable assets that are overburdened by asset retirement obligations.” This “cherry-picking” ultimately means more wells will end up in the orphan well fund.

A further consequence of the AER requirements for higher LMRs, adds Nixon, is to advantage the larger companies that have high LMRs based on large asset bases, as those companies can undertake the asset acquisitions without the threat of having to post an incremental deposit with the AER. “From the perspective of the AER and, perhaps, the protection of the public purse in bailing out orphan wells, the advantaging of larger companies has some attractiveness,” he says. “However, it limits the investment of new capital in smaller corporations, which has been important historically to the success of the energy industry.”

DIRECTORS AND OFFICERS ACCOUNTABLE

According to Pike, environmental legislation such as Alberta’s Oil and Gas Conservation Act allows for liability to be imposed on directors and officers. Consequently, directors and officers may find themselves facing significant liability for well closure and clean-up costs after an insolvency.

For example, says Pike, former directors and officers have been pursued for years in the case of AbitibiBowater, long after the insolvency proceedings had ended. “Where the Ontario regulator was facing the challenge of getting an insolvent company to address environmental issues, it ordered directors and officers to conduct remediation. A lengthy appeal process has followed. Directors and officers will want to ensure they are not the last ones standing when it comes to environmental liabilities in an insolvency.”

On a practical and ongoing basis, given that the AER is becoming increasingly proactive in instances of non-compliance, says Buckingham, licensees should maintain a positive working relationship with the regulator. As well, she suggests boards should ensure that management’s standing operational report to the board includes a status report on the company’s receipt of and compliance or non-compliance with any regulatory orders or directives; the number of shut-in/abandoned wells and their status, the company’s LLR/LMR (licensee liability rating and liability management rating); the LLR/LMR of other operators who are its working interest participants; and how management’s efforts to address its asset retirement obligations is consistent or inconsistent with industry standards.

“POLLUTER PAYS” PRINCIPLE

For companies already doing business in Alberta or looking to invest in the energy sector in the province, the crux of the matter is what happens if the Redwater decision is upheld, says George Antonopoulos, an energy partner with Dentons Canada LLP in Calgary.

In this scenario, he suggests, there will likely have to be a re-thinking of the licensee management scheme that the AER uses. “The only way the existing scheme works, when comparing deemed assets to deemed liabilities, is on the assumption that those deemed liabilities will not become detached from those deemed assets at the most critical juncture, upon an insolvency.”

According to Antonopoulos, the only other way the situation can be addressed from a government standpoint, in his view, is for the federal government to enact amendments to the Bankruptcy and Insolvency Act — amendments that ensure that the “polluter pay” principle is enshrined in a way that assures it is given a super-priority status over the claims of secured creditors.

Osler’s Buckingham adds, “Parliamentary resolution of the purported conflict is appropriate if the court declines to grant leave or determines not to reframe the issues to permit parallel application of federal and provincial laws that preserves the application of the ‘polluter pays’ principle.”

In addition, says Melanie Gaston, also an Osler partner in Calgary, if Parliament does not correct legislatively, it seems contrary to the general policy underlying the environmental framework in Canada and would undermine efforts to have licensees deal responsibly with environmental obligations by prioritizing creditors’ rights.

“It would be more consistent to have creditor pressure on debtor licensees to deal with environmental obligations than what this decision suggests,” Gaston explains. “A policy conflict arises where it is contrary to the interest of creditors for debtors to meet their environmental obligations.”

Still, says Antonopoulos, the fact of the matter is that the Alberta Energy Regulator, with this decision in hand, having lost in the appeal courts, is not going to sit on the sidelines. In his view, it can be anticipated that the AER “won’t just allow this operational conflict to continue to exist such that the province and the public of Alberta would continue to be at risk for these abandonment obligations — through tactics taken by trustees in bankruptcy to renounce valueless properties or properties that have a negative asset value because of the environmental liabilities, so that they can sell off the assets that are still valuable.”