Getting Closure: Alberta Court Rejects Attempt to Hold Purchaser Liable for a Seller’s Post-Closing Royalty Arrears

On April 21, 2023, the Court of King’s Bench of Alberta (Court) released its decision in Terra Energy Corp (Re). In this decision, the Court rejected the Government of Alberta’s attempt to recover oil and gas royalty arrears, owed by Terra Energy Corp. (Terra), from Enercapita Energy Ltd. (Enercapita). Terra is a bankrupt oil and gas company, and Enercapita is a company that had purchased Crown oil and gas leases from Terra prior to its bankruptcy. The decision establishes that a purchaser’s liability for royalty arrears under Crown mineral leases does not necessarily include liability for such arrears discovered by audit conducted after the purchase closes.

Background

In Alberta, royalties on Crown-owned oil and gas leases are calculated based on the net proceeds of sale, pursuant to formulas set out in regulations made under the Mines and Minerals Act (MMA). For natural gas (other than solution gas), lessees are allowed to deduct certain costs that they incur and must provide annual reports to Alberta Energy setting out the details of those costs. Alberta Energy then has the authority to audit that information.

In September 2015, Enercapita purchased certain Crown-owned oil and gas leases from Terra. Terra later became bankrupt in November 2016.

After Terra became bankrupt, Alberta Energy audited Terra’s royalty filings for 2011 to 2014. Specifically, Alberta Energy requested that Terra provide supporting documentation for cost allowances it claimed in calculating its natural gas royalty obligations for those years. The majority of these cost allowances related to gas from wells that Enercapita did not acquire.

Neither Terra nor its trustee in bankruptcy provided the requested information. Accordingly, Alberta Energy amended Terra’s allowable expenditures for 2011 to 2014 to zero, resulting in Terra owing royalty arrears of approximately C$3.2-million.

Alberta Energy then demanded payment of approximately C$2.8-million of these arrears from Enercapita. Alberta Energy relied on section 91.1 of the MMA, which provides that a transferee of a Crown mineral lease may be liable for certain liabilities of the transferor. At the time, Alberta Energy owed Enercapita approximately C$1.2-million in royalty overpayments, and the ministry sought to retain this amount by setting it off against Terra’s arrears under subsection 46(4) of the MMA.

Over the following three years, Enercapita engaged extensively with Alberta Energy to obtain and provide supporting documentation for Terra’s natural gas cost allowances, even though Enercapita had no connection to Terra other than as a purchaser of some of Terra’s leases.

Alberta Energy did not accept this documentation. After Alberta Energy issued a final refusal to refund Enercapita’s overpayment in December 2020, Enercapita applied to the Court for relief.

Decision

The Court decided in favour of Enercapita on all issues. The Court found that Alberta Energy could not rely on either section 91.1 or subsection 46(4) of the MMA.

The Court interpreted section 91.1 narrowly and found that it applies only to liabilities existing at the time a Crown mineral lease is transferred. The Court found that at the time of the transfer of the leases from Terra to Enercapita, the possibility that Terra might have royalty arrears discovered in the audit process was a contingent liability, and that such a contingent liability did not come within the scope of section 91.1.

The Court found that even if section 91.1 allowed Alberta Energy to recover Terra’s royalty arrears from Enercapita, Alberta Energy had not established a right to set off those arrears against Enercapita’s overpayment under subsection 46(4). The Court held that section 91.1 did not support Alberta Energy’s approach of allocating Terra’s arrears to Enercapita even though the majority of the arrears related to gas were from wells that Enercapita did not acquire. Further, because Enercapita had provided supporting documentation for the natural gas cost allowances claimed by Terra, the Court was not convinced that Terra owed any arrears at all. Therefore, the Court found that Alberta Energy had not established that Enercapita owed a debt. Accordingly, the Court ordered Alberta Energy to refund Enercapita’s royalty overpayment.

Alberta Energy has not appealed the Court’s decision and the deadline for doing so has passed, meaning that the decision is now final.

Takeaway

This decision provides comfort to purchasers of Crown oil and gas leases that their potential liability for a vendor’s royalty arrears is narrow. Based on the Court’s interpretation of section 91.1 of the MMA, a purchaser will only be liable for arrears that Alberta Energy has identified prior to closing. If Alberta Energy conducts an audit of the vendor’s royalty account after closing and alleges additional amounts owing, it will likely only be able to recover these amounts from the vendor, and not the purchaser.

For more information, please contact:

Michael O’Brien           +1-403-260-9753
Kevin Kerr                     +1-403-260-9746
Michael Matwichuk     +1-403-260-9787

or any member of our Energy, Litigation & Dispute Resolution or Restructuring & Insolvency groups.