The fallout after Redwater

Jean-Yves Simard, a partner with Lavery Lawyers in Montreal specializing in bankruptcy, may be far removed from Alberta’s oil patch. Still, he’s keenly interested in the Supreme Court of Canada’s January 2019 ruling in a case involving a small insolvent Alberta oil and gas producer called Redwater Energy Corp.

“We don’t get that many decisions from the Supreme Court in matters of insolvency, so people in the field pay attention,” Simard told CBA National.

In the landmark 5 to 2 judgment, the court overturned lower court decisions and ruled that insolvent firms like Redwater can no longer “disclaim” or walk away from assets they don’t want – in this case, non-producing oil wells—and leave the resulting environmental cleanup to Alberta’s Orphan Well Association, a non-profit operating under the authority of the Alberta Energy Regulator.

The ruling has enormous implications for the oil and gas industry, not just in Alberta but in Saskatchewan and British Columbia, at a time when the industry is already facing low prices and difficulty accessing capital. But the implications are likely to be much broader, affecting other industries across the country.

The impact of the Redwater decision will be discussed by Simard, along with Tom Cumming, a partner with Gowling WLG in Calgary and Orest Konowalchuk, a CPA and managing director in Calgary for Alvarez & Marsal Canada, a corporate restructuring firm, at a panel next week (Nov. 8) during the CBA’s insolvency conference in Banff.

When it went insolvent in 2015, Redwater may have been a small company, with only 19 producing wells and 90 dormant wells. But its situation reflects a much broader industry problem, says Cumming, who acted for Grant Thornton, Redwater’s receiver.

Under the system in place for many years, big producers would assemble blocks of producing and non-producing wells and sell them off to smaller players who would see some residual value in the wells even if production was in decline.

As part of these deals, the new owners would also take on the responsibility to clean up the wells at the end of their productive life. This includes “abandonment,” which involves sealing the well with cement and removing pumps and other heavy equipment. That leads to the further step of “reclamation,” which means cleaning up the site and restoring it to its natural state. But these small companies would often lack the financial capacity to pay for the cleanup. Those wells would end up with the industry-funded Orphan Well Association.

The statistics are striking. According to Cumming, in 1989 there were 25,000 non-producing wells in Alberta that had been neither abandoned nor reclaimed. By 2017, that number had soared to 88,000 wells that hadn’t been abandoned and another 155,000 that hadn’t been reclaimed. “The system did not encourage producers to carry out abandonment and reclamation in their ordinary course, so the inevitable result was that they didn’t.” 

“The problem in Redwater is that Section 14.06 of Bankruptcy Act allowed the receiver to walk away from environmentally-contaminated assets if cleaning up the land would empty the estate of any funds,” Cumming said. “What the Supreme Court said was that the receiver is not personally liable for doing it, but he does have to use [all the funds] that are left in the estate to do the abandonment and reclamation.”

The ruling also amended the court’s 2012 ruling in the AbitibiBowater case in which it had defined when a regulatory claim in an insolvency case should be treated as a monetary claim and handled like any other unsecured creditor. Under the new approach, the court now says that if a regulator is fulfilling a public obligation and isn’t seeking any financial benefit, the claim is considered to be a regulatory claim and must therefore take precedence over secured and unsecured claims.

The decision exacerbates the severe problems in the whole oil and gas sector, where prices are low, and capital is scarce, says Cumming. When it comes to mergers and acquisitions, buyers used to look first at the asset values of the facilities that they were buying and at the liabilities second. “It’s now flipped around, and the focus is now on their abandonment and reclamation obligations.”

“The people who would buy assets are also facing liquidity issues, and everybody is having access to capital challenges right now, he adds.”

What it meant in the case of Redwater is that the receiver handed over the proceeds (about $600,000) of the sale of assets to the regulator, with nothing left for other creditors, both secured and unsecured. That cash went to the Orphan Well Association, which will earmark the money for the Redwater well cleanup, but it will only cover a fraction of that $4.5-million cost. 

Simard’s firm is still evaluating the likely breadth of the decision. Beyond the oil and gas sector, he expects it to be relevant in insolvency cases involving a range of environmental responsibilities from abandoned mines to brownfield industrial sites. Or it could affect other regulatory matters as well. Simard cites, as a possibility, the case of real estate promoter that goes bankrupt after a provincial building regulator has ordered the firm to tear down a project and rebuild it, he said.

“I think people are still reeling from the decision because the decision is very complicated,” Simard said. He expects there will inevitably be consequences as lenders evaluate their risks going forward.

And in the end, both Simard and Cumming don’t eliminate the possibility that a similar issue could once again make its way to the Supreme Court.