Still waters run deep—the ramifications of Redwater

Oil and gas companies are still scrambling to understand exactly how the Supreme Court of Canada’s precedent-setting decision in Redwater will impact their operations moving forward.

While the sector will inevitably feel the full brunt of the decision, they’re not the only industry set to suffer. Industries like mining, power, lumber, pulp and paper, and any one where the provinces legislate on abandonment, reclamation and remediation are all set to be impacted.

There’s no doubt Alberta’s junior and mid-size oil and gas producers are the biggest losers out of the decision. The decision comes after what has been a rough run for many of these companies, and there is no certainty of a sunnier day around the corner.

So, what does this decision mean for industry and what can we expect in the coming year?

On the lending side, the banks will become a second position creditor, at best, behind the regulator’s environmental claims. The cost of capital will increase as the realization risk has intensified. Lenders will have to spend more time monitoring their borrowers’ asset retirement obligations and practices. This will likely be a major point in the course of renegotiation of these loans, and stricter terms will be imposed for their renewal. At least for the immediate future, there will be a chill in lending into the energy sector until Redwater is more fully digested.

There’s no doubt Alberta’s junior and mid-size oil and gas producers are the biggest losers out of the decision.

Trustees of insolvent oil and gas producers will have to adapt, and deal with the Alberta Energy Regulator earlier on and prior to taking on any bankruptcy or receivership engagements. This has long been a practice of many trustees, but now it is a virtual requirement for any formal oil and gas insolvency. Trustees cannot abandon or disclaim uneconomic wells, and they must deal with the environmental liabilities associated with these properties. This will make the administration of the insolvent estates more complex and costly. The result will be that more properties will be turned over to the Orphan Well Fund, if an en bloc asset sale is not possible. This may well be the case if asset packages are overly burdened with liability-laden properties, which is often the state of affairs in any given insolvency scenario.

This was the argument that carried the day at the Supreme Court. In a 5-2 vote, overturning the decision of the Alberta Court of Appeal, the majority of the SCC said: “Bankruptcy is not a licence to ignore rules, and insolvency professionals are bound by and must comply with valid provincial laws during bankruptcy.” In other words, if properly drafted, the provinces’ respective legislative schemes will have an impact on the respective priorities in a bankruptcy or receivership scenario.

There will have to be discussion between the Alberta Government, its regulators, the oil and gas industry and financial institutions.

In addition, the SCC’s decision did not speak to the priority that receivers and trustees in most cases have for their professional fees. Although an arrangement with the provincial regulator can be reached by way of an administrative agreement of some sort, the starting point is that costs related to environmental claims come first. This justifiably will cause some concern for prospective trustees of these insolvent companies.

Canada has long led the way on an international basis with its robust environmental legislation, and the government made laws have been endorsed and strictly enforced by our courts. Reclamation and abandonment liabilities must now be dealt by trustees before a distribution can be made to these insolvent companies’ creditors. These liabilities are unquantifiable until they are fully realized. Going forward, there will have to be discussion between the Alberta Government, its regulators, the oil and gas industry and the financial institutions who fund these companies.

The predicament is one with many facets and contributories, and a balance must be struck to allow for continued production under a new regulatory and court-imposed framework.