Supreme Court of Canada: Environmental Obligations First, Creditors Second

(Disponible en français : Les obligations environnementales avant les créanciers, dit la Cour suprême du Canada)

In a decision handed down on 31 January 2019 in Orphan Well Association v. Grant Thornton Ltd., the Supreme Court of Canada (the Court) ruled that, after going bankrupt, oil and gas companies have to “fulfill provincial environmental obligations before paying anyone [they owe] money to.”

Orphan Well Association v. Grant Thornton Ltd.: Background and decision

Redwater, an Alberta oil and gas company, went bankrupt in 2015. At that time, it owned oil and gas facilities that included 19 producing wells and 72 dry or inactive wells.

Under Alberta law, oil and gas companies are responsible for dismantling wells they no longer operate and restoring the land. In the case of Redwater, the costs to meet these end-of-life obligations exceeded the company’s value. As a result, Redwater’s trustee in bankruptcy, Grant Thornton Ltd., decided not to take possession of the inactive wells to avoid having to fulfill these obligations, believing it was allowed to do so under the Bankruptcy and Insolvency Act (BIA). The Alberta Energy Regulator immediately issued an order requiring the trustee to dismantle the inactive wells and restore the land. The trustee argued that the order constituted a claim in the bankruptcy and that, under the payment order set up in the BIA, the resulting cost should be paid after the repayment of priority debts.

However, the Court decided otherwise. In its decision, the Court said that, while the BIA allowed the trustee to disclaim certain assets to avoid personal liability, the trustee must still perform the company’s environmental obligations from the company’s assets.

With respect to the abandonment and reclamation order, the Court determined that the resulting obligations are not subject to the BIA’s liquidation process. The Court held that the order cannot be considered a claim in the bankruptcy given that the Alberta Energy Regulator does not stand to benefit financially. In doing so, Redwater’s end-of-life obligations were excluded from the liquidation process and must be performed by the trustee before the company’s debts are paid.

In its decision, the Court noted that an environmental obligation – such as an abandonment and reclamation order – is treated as a claim subject to the BIA liquidation process only when the three requirements set out in 2012 in Newfoundland and Labrador v. AbitibiBowater Inc. are met: first, there must be a debt, a liability or an obligation to a creditor; second, the debt, liability or obligation must have arisen before the debtor becomes bankrupt; and third, it must be possible to attach a monetary value to the debt, liability or obligation. In the past, because some environmental obligations involve a financial commitment to regulatory bodies, courts have often ruled that reclamation orders are subject to the BIA’s priority scheme.

Alberta’s inactive and orphaned wells

The Court’s decision in this case raises the issue of who should bear the financial burden of abandoning oil and gas wells in insolvency proceedings. This is an important issue because the decline in crude oil prices in 2014–2015 led to an increase in the number of insolvent companies unable to meet their end-of-life obligations to their inactive wells. As Figure 1 shows, the inventory of orphan wells in Alberta has increased significantly, due in part to bankruptcies of oil and gas companies. For example, following the 2017 bankruptcy of Lexin Resources, 1,117 wells were transferred to the Orphan Well Association.

Figure 1 – Inventory of Orphan Wells to be Dismantled or Restored and Number of Bankruptcies in the Oil and Gas Extraction Sector in Alberta, 2012–2013 to 2017–2018

This figure shows the number of orphan wells to be abandoned or reclaimed for fiscal years 2012–2013 to 2017–2018. The number of orphan wells to be abandoned increased steadily over this period, from 74 in 2012–2013 to 1,778 in 2017–2018. The number of orphan wells to be reclaimed followed a similar trend, increasing from 387 in 2012–2013 to 1,085 in 2017–2018. The figure also shows the number of bankruptcies in the oil and gas extraction sector in Alberta during this period. Bankruptcies do not seem to have followed this trend, with a low of one in 2014–2015 and a high of seven in 2015–2016.

Notes: An orphan well is one for which no legally or financially responsible party can perform end-of-life obligations. In Alberta, the well is then transferred to the Orphan Well Association.
The Orphan Well Association’s fiscal year ends on 31 March.
The chart shows the number of bankruptcies in Alberta for companies in the 211113 economic sector (conventional oil and gas extraction) of the North American Industry Classification System.
Sources: Figure prepared by the authors using data from the Orphan Well Association, the Supreme Court of Canada Decision on Redwater Energy Appeal media release of 31 January 2019 and the Office of the Superintendent of Bankruptcy Canada, Insolvency statistics in Canada by North American Industry Classification System (NAICS).

According to the Alberta Energy Regulator, as of 20 February 2019, the province had nearly 90,000 inactive wells that had not been abandoned. In 1994, there were roughly 30,000. A study published by the School of Public Policy at the University of Calgary notes that abandonment and reclamation costs per well can range from $50,000 to several million dollars. Although these wells could, in theory, be reactivated if it became profitable to do so, the study suggests that most of these wells would remain inactive indefinitely as there is no set time limit for their abandonment and reclamation. For neighbouring communities, these inactive wells pose safety and environmental risks, as well as an opportunity cost because the land is not being used.

Map 1 – Orphan Wells in Alberta

This map of Alberta illustrates where the Orphan Well Association (OWA) is managing wells to be abandoned and wells to be reclaimed, as of January 29th, 2019. The OWA listed more than three thousand (3,000) orphan wells for abandonment and nearly fifteen hundred (1,500) wells presently under reclamation. Both types of wells are dispersed across Alberta but do not to fall within the protected areas in the northern part of Alberta or in Jasper and Banff National Parks in the southwest. There are some noticeable groups. A large cluster of wells to be abandoned is located south-southeast of Calgary, near High River. Immediately east, and adjacent to that group, is a small cluster of wells being reclaimed. While another large group of wells to be abandoned is located near the town of Fairview, in northwestern Alberta, a cluster of wells being reclaimed appears even farther north.

Sources: Map prepared by the Library of Parliament, Ottawa, 2019, using data from Natural Resources Canada (NRCan), Administrative boundaries in Canada – CanVec Series, Administrative features, 1:5M, Ottawa, NRCan, 2018; Natural Resources Canada (NRCan), Canadian Digital Elevation Model, Ottawa, NRCan, 2015; Environment and Climate Change Canada (ECCC), Protected Areas Indicators – Protected areas, Canada, Ottawa, ECCC, 2016; Alberta Energy Regulator, ST37: List of Wells in Alberta, 1 March 2019; Orphan Well Association, Orphan Wells to be Abandoned and OWA Reclamation Sites, 28 January 2019. The following software using information available under the Open Government Licence – Canada was also used: Esri, ArcGIS Pro, version 2.3.0.

Potential impacts of the decision

The Court’s decision may restrict access to credit for oil and gas companies. Lenders, when extending credit, consider the amount they could recover in the event a company begins insolvency proceedings. As the Court’s decision may result in greater losses for lenders in insolvency proceedings, they may be inclined to restrict access to credit to companies with end-of-life obligations, particularly those whose obligations account for a high proportion of their assets. Lenders may also require companies to meet their end-of-life obligations more quickly than they do now to prevent these obligations from accumulating and increasing the risk of non-payment in the event of bankruptcy.

The Court’s decision could also restrict the use of the bankruptcy process under the BIA. In their brief to the Court, some stakeholders, including Grant Thornton Limited and the Canadian Association of Insolvency and Restructuring Professionals, stated that giving priority to end-of-life obligations in a bankruptcy could lead trustees in bankruptcy to refuse bankruptcy mandates for companies having such obligations. Ultimately, this would lead to an increase in the number of orphan wells because all of the bankrupt company’s assets might have to be used to cover end-of-life obligations, leaving nothing to pay the trustee’s fees. The Court rejected this argument, stating in its decision that it was already well established in Alberta that certain environmental obligations continue to be binding on a bankrupt company’s estate and that this did not lead trustees to refuse mandates.

In summary, it remains to be seen whether the impacts of this decision will be limited to the Alberta oil and gas sector. In Saskatchewan, for example, the number of inactive wells has also increased in recent years. And in other sectors, such as mining, companies may have environmental obligations that, in the event of bankruptcy, may have to be met before their creditors’ claims are settled.

In addition, as the provision in the BIA allowing trustees to dispose of certain assets of the bankrupt company leads to significant confusion, the Supreme Court of Canada suggested that Parliament may well wish to reconsider its wording.

Additional Resources:

Dachis, Benjamin, Blake Shaffer and Vincent Thivierge. “All’s Well that Ends Well: Addressing End-of-Life Liabilities for Oil and Gas Wells,” C.D. Howe Institute Commentary, No. 492, September 2017.

Muehlenbachs, Lucija. “80,000 Inactive Oil Wells: A Blessing or a Curse?”, SPP Briefing Paper, Vol. 10, Issue 3, The School of Public Policy, University of Calgary, February 2017.

Authors: Alexandre Lavoie and Michaël Lambert-Racine, Library of Parliament