OCA: Much-needed clarity on the treatment of royalties in insolvency proceedings

The Ontario Court of Appeal (OCA) has released its much-anticipated decision in Third Eye Capital Corporation v. Ressources Dianor Inc./Dianor Resources Inc. (2019 ONCA 508). Until now, there was significant uncertainty as to the scope of the court’s authority to extinguish royalty interests (even if properly interests in land) through a vesting order made in insolvency proceedings.

The decision provides clarity on whether and under what circumstances a court sitting in insolvency proceedings has jurisdiction to extinguish a third party’s royalty interest using a vesting order that approves the sale of the subject properties.

What you need to know

The OCA affirmed that an insolvency court’s jurisdiction is broad; however, it imposed significant restrictions on the authority to extinguish third-party interests in land—including royalties—by way of vesting orders approving sales of an insolvent person’s property.

Background

On August 20, 2015, a receiver was appointed over the property of Dianor Resources Inc. at the behest of Third Eye Capital Corporation, a secured creditor of Dianor. In due course, Third Eye Capital sought to acquire the property of Dianor as purchaser from the receiver. However, its bid was conditioned on extinguishing certain gross overriding royalties (GORs) registered on title in favour of the royalty holder. At first instance, the sale was approved and the GORs were held not to be interests in land and were extinguished pursuant to a vesting order granted by the court.

In the initial appeal of this decision, the Ontario Court of Appeal had held that the GORs did constitute interests in land and that the trial judge was in error on the point (2018 ONCA 253). The Ontario Court of Appeal requested further submissions as to whether the GORs, as interests in land, could be extinguished by a vesting order that approved the sale of the land to a purchaser.

Losing the battle but winning the war

The Ontario Court of Appeal held that a more transparent and conscientious application of formative equitable principles and considerations relating to vesting orders is needed to assist in establishing a proper balancing of interests and a framework understood by all participants. It proceeded to provide this much-needed framework. Importantly, the Court of Appeal affirmed that jurisdiction to grant a vesting order is rooted in the general language of the receivership provisions found in the Bankruptcy and Insolvency Act. Such jurisdiction is incidental and ancillary to a receiver’s power to sell property under its control.

The Court of Appeal then considered the appropriate scope of vesting orders and established a framework that adopts a “rigorous cascade analysis”:

• First, one must assess the strength and nature of the interest that is proposed to be extinguished. The Ontario Court of Appeal noted that fee simple interests and many other lesser interests in land defy extinguishment due to the nature of the interest. A key inquiry is whether the interest in land is more akin to a fixed monetary interest that is attached to real property (e.g., a mortgage) or whether the interest in more akin to a fee simple that is in substance an ownership interest in some ascertainable feature of the property itself. Is it the reasonable expectation of the owner of the interest that its interest is of a continuing nature and, absent consent, cannot be involuntarily extinguished in the ordinary course through a payment in lieu?
• Second, the courts should consider whether the parties have consented to the vesting of the interest (including via prior agreement, such as contractual subordination of interests). The Court of Appeal affirmed that parties ought to be permitted to contractually negotiate and prioritize their interests in the event of insolvency, and that their express intentions ought to be given sufficient weight.
• Where the foregoing is not conclusive, the court may then engage in a consideration of the equities to determine if vesting is appropriate. This includes: (i) consideration of prejudice, if any, to the interest holder; (ii) whether the third party is adequately compensated for the interest from the proceeds of sale; (iii) whether, based on evidence of value, there is equity in the property; and (iv) whether the parties are acting in good faith.

Although the GORs were found to be interests in land that could not be extinguished by vesting order, the royalty holder ultimately lost its appeal for other reasons (namely, it had commenced its appeal too late and was out of time, and the test was not met to extend the time for commencing the appeal). While this outcome is unfortunate for the appellant, there is considerable comfort for other holders of interests in land that their interests may not readily be extinguished by vesting orders in future insolvency cases.

Guidance for royalty holders

This decision provides much-needed clarity for holders of royalty interests in mining and oil and gas projects on how their interests may be treated in insolvency proceedings. When entering into new royalty agreements, royalty holders should take the following steps to protect their interests:

• a royalty should be clearly structured and drafted to be an interest in land rather than solely a contractual entitlement;
• parties should clearly articulate their expectations and intentions, including as to priorities in the event of an insolvency;
• it should be clear that the royalty is not viewed as simply securing or being akin to a monetary obligation; and
• parties should carefully consider implied consents to vesting, including as a result of contractual subordination and postponements provisions.