Insolvency and Environmental Law Collide: Supreme Court of Canada Rules in Favour of Alberta Energy Regulator in Redwater Decision

February 5, 2019 | Tamara Farber, Sherry A. Kettle

The Supreme Court of Canada (“SCC”) has released its decision in Orphan Well Association v. Grant Thornton Limited (2019 SCC 5) regarding the bankruptcy of Redwater Energy Corporation, and the strategy of Redwater’s trustees in bankruptcy to try to sell off productive assets of the company to pay creditors, while disclaiming environmentally challenged assets and leaving them to the industry funded Orphan Well Association and potentially the Government of Alberta to address.

Not so fast, says the Supreme Court of Canada! There are end-of-life remedial obligations associated with the bankrupt’s non-productive wells that have to be addressed.  This isn’t a battle of federal versus provincial legislation and paramountcy; it’s a prioritization of the use of the bankrupt’s assets for compliance with its regulatory obligations to clean up under the terms of its licenses.

“Insolvency professionals are bound by and must comply with valid provincial laws during a bankruptcy” says the SCC in its decision.

The story began when Grant Thornton (“GT”) was appointed as receiver and trustee over the assets and liabilities of Redwater Energy Corporation (“Redwater”) under Canada’s Bankruptcy and Insolvency Act (“BIA”) in 2015.  Redwater was a publicly traded oil and gas company, which held licenses under the jurisdiction of the Alberta Energy Regulator (“AER”) for various properties.  Under the applicable provincial legislation, a receiver/trustee is a “licensee” who can operate the licensed assets of the debtor.  GT’s strategy was to disclaim non-producing wells – those that had no economic value and significant environmental liabilities – using the BIA to effectively pick and choose the prime assets to maximize recovery for Redwater’s creditors.  GT took the position that the end-of-life abandonment and reclamation obligations of Redwater were unsecured claims which could not take priority over the claims of secured creditors.

The AER, on the other hand, took the position that the remaining value of the bankrupt estate should be applied to satisfy the abandonment and reclamation obligations associated with the estate’s licensed assets before any distribution to creditors.  AER and the Orphan Well Association brought proceedings to compel GT, as trustee under the remedial orders in effect for each well, to comply with proper abandonment and remedial obligations.  AER reasoned, as a regulator, that it was not a creditor, that Redwater’s environmental obligations associated with the non-performing wells were not “claims provable in bankruptcy”, and that its environmental obligations were therefore unaffected by the bankruptcy proceedings.  When GT took over as receiver and trustee in bankruptcy, argued AER, it was obliged to discharge the licensee’s obligations prior to distributing funds to Redwater’s creditors.  When GT purported to disclaim the non-performing assets, AER issued remedial orders for those disclaimed assets.  GT objected.

At its first judicial hurdle before the Alberta Court of Queen’s Bench (Re Redwater Energy Corporation, 2016 ABQB 278 (CanLII)), GT succeeded.  The Court agreed with GT that it could disclaim un-economic assets of the bankrupt and sell off productive assets to satisfy the claims of Redwater’s creditors under the priority scheme in the BIA.  The Court found that claims of secured creditors had priority over the environmental obligations created under provincial statutes. The Court held that the doctrine of paramountcy was engaged.  The provincial regulator’s approach conflicted with section 14.06(4) of the BIA by (a) imposing obligations of a licensee on the trustee in respect to the disclaimed assets and (b) interfering with the priority scheme in the federal BIA by giving the regulator a super priority, to which it was not entitled, ahead of secured creditors.   As such, the provincial environmental legislation was constitutionally inoperative to the extent of the conflict.  The trustee was entitled to disclaim the unproductive assets pursuant to section 14.06(4) of the BIA and was not subject to any obligations in relation to the disclaimed assets.

The regulators appealed  but, again, GT succeeded (Orphan Well Association v. Grant Thornton Limited, 2017 ABCA 124 (CanLII)). Relying on the history of changes to the BIA which specifically limited trustee liability, and relying upon the Supreme Court of Canada’s 2012 decision in Newfoundland and Labrador v. AbitibiBowater Inc. (2012 SCC 67) (“Abitibi”), environmental claims are provable in bankruptcy if sufficiently expressed in monetary terms, (or if they will “ripen into a financial liability” considering the factors set out in Abitibi) and are still subject to the priorities established under the BIA for priority payment to secured creditors.  Environmental obligations of the nature in Redwater did not create a super priority.  The regulators’ claim was able to be expressed in monetary terms because AER conceded that the cost of compliance with its orders would decrease the amount recoverable by the creditors.  The Alberta Court of Appeal held that AER’s objective was to disrupt the priority scheme for payments under the BIA.  Although there was a lengthy dissenting opinion, AER and Orphan Well did not prevail.

If at first, (or second) you don’t succeed…..

AER and the Orphan Well Association appealed to the SCC, which overturned the Court of Appeal’s decision.  The SCC ruled that the trustee had license obligations while it managed the estate of the bankrupt.  When it assumed control of the licensed assets, the regulatory obligations that attached to those licenses could not be ignored.  There was no conflict between section 14.06 of the BIA and the relevant provincial legislation because section 14.06 of the BIA only resulted in the trustee not being personally liable for failing to comply with certain environmental orders while the liability of the bankrupt estate continued.  Further, AER was not asserting a claim “provable in bankruptcy” and thus there was no conflict between the priority scheme in the BIA and the provincial environmental legislation.  The SCC clarified and applied the test outlined in Abitibi for determining whether a regulatory obligation in the circumstances of each case amounts to a claim provable in bankruptcy:  (1) there must be a debt, liability or obligation to a creditor; (2) the debt, liability or obligation must be incurred before bankruptcy; and (3) it must be possible to attach a monetary value to the debt, liability or obligation.  It was not disputed that the second part of the test was met.  With respect to the first part of the test, the majority of the SCC clarified that Abitibi does not stand for the proposition that a regulator who exercises its enforcement powers is always a creditor.  In exerting its power to enforce a public duty, it was not a creditor. The regulator would not gain anything financially from the remedial orders. Rather, it was the public who would benefit from the orders in requiring the end-of-life environmental obligations be satisfied.  Unlike in Abitibi, there was no apparent attempt by the regulator to recover a debt.  Wagner C.J., on behalf of the majority  went on to state that even if the regulator was a creditor, the third part of the Abitibi test was not met because it was not sufficiently certain that the regulator would perform the abandonments and make a claim for reimbursement.

“Insolvency professionals are bound by and must comply with valid provincial laws during a bankruptcy”, said the SCC.  It drew a distinction between the liability of the trustee personally, and the liability of the bankrupt’s estate.  The latter is unaffected by the BIA where the trustee disclaims assets.  The SCC reiterated the test in Abitibi as applicable, and held that not all environmental obligations enforced by a regulator will be a “claim provable in bankruptcy”  (despite this common interpretation post Abitibi).  Because the regulator here acted in the public interest in issuing the remedial orders, and did not stand to benefit financially, it was not a creditor.

What to make of all of this?  A few “tips” for trustees and creditors:

Trustees / insolvency professionals:  Tread lightly.  Insolvency professionals need to be mindful of personal liability, but not lose sight of a bankrupt estate’s regulatory obligations.

Secured Creditors:   The Supreme Court has given every regulator a roadmap to potentially overriding the BIA.  A regulator can stand up and say it is not going to benefit financially, and is acting in the interests of the public.  If the bright line under the Abitibi test is whether the environmental duty will “ripen into a financial liability”, that is, it must be sufficiently certain that the contingency will come to pass that the regulator will actually incur the costs and undertake the remedial obligation, a regulator can actively take steps to obscure its regulatory enforcement path, or even block it.  By doing so, it would take itself outside of the creditor definition, and ahead of secured creditors.

Secured creditors usually require debtors to provide financial and environmental liability disclosure at the beginning of a relationship, but are less diligent about updates.  Environmental liabilities of a debtor should be investigated fully, financial reporting and disclosure of changes in environmental liabilities should be more frequent, and more detailed.  Environmental covenants in loan documentation should be secured with a broader base of collateral from the debtor and related entities, together with guarantees.  When solvency issues arise, secured creditors should consider whether some engagement with the regulator is warranted, although this carries some potential risk.

Secured creditors should engage in discussions with the debtor, environmental and insolvency professionals as quickly as possible to protect their investment in collateral.  Secured creditors will need to consider whether it makes financial sense to commence an insolvency process as there is a risk that there will be no distribution to creditors after satisfying environmental obligations.

While some may attempt to limit the application of the Redwater decision in other cases, the scope and use of remedial powers of regulators like AER seems to be growing. If a solvency issue arises and there are ongoing regulatory obligations, creative strategies will have to be brought to the table.  As noted by the SCC, the only issue on which the parties could agree was that the interpretation of section 14.06 of the BIA was not at all clear.  What is clear is that the SCC has invited Parliament to re-examine this issue.

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