Waiting for RedWater: A look behind the issues before the Supreme Court
By Regan Boychuk
Though rarely (if ever) utilized by Alberta officials, until recently the powers of regulators to hold polluters jointly and severally liable[1] was clearly established by the Northern Badger case (Laycraft, Foisy, and Irving 1991). The RedWater Energy case, currently before the Supreme Court of Canada, has recently cast doubt on these powers (Wittmann 2016; Slatter, Schutz, and Martin 2017). As we await the decision, it is crucial to understand the background to bankruptcy and environmental liabilities in Canada.
“Bankruptcy law is essentially a private system for the resolution of monetary disputes”, writes Dianne Saxe.
To a considerable extent, the risk has already materialized, and most of the money has been lost. Bankruptcy is therefore a defined procedure for allocating defined harms which have already occurred among a defined group. This structure does not accommodate, and was not designed to manage, risks of unlimited future harm to unlimited and unidentified parties. Some environmental conditions present exactly this sort of risk.[2]
According to Alexander Clarkson (2011: 33-34), “Canada’s current scheme of allocating the cost of environmental reclamation upon bankruptcy is environmentally harmful and fundamentally unjust.” “The problem with Canada’s environmental reclamation regime at bankruptcy is simple: At bankruptcy the cost of cleanup is often transferred from the bankrupt company to the public. Therefore, there is an incentive for companies to neglect their environmental obligations before bankruptcy.”
Up until about a decade ago, the legal consensus was that, even in bankruptcy, the public health and safety nature of environmental legislation rendered compliance mandatory. “The courts clearly voiced the opinion that the stay of proceedings does not and should not amount to permission to violate the law with impunity”, according to Nicholas Chaput. “Compliance with clean-up orders could not be assimilated to ordinary debts owed to the public authority charged with administering the statute.”[3] In the Alberta lower court decision on Northern Badger, Justice MacPherson decided environmental cleanup took a back seat to secured creditors. “This was incorrect”, Dianne Saxe wrote at the time. “The logical conclusion of the Justice’s argument would be that a trustee in bankruptcy could ignore all provincial statutes if they would thereby save money, including dumping hazardous waste in a school yard if that were cheaper than using licensed disposal sites as required by provincial legislation. Fortunately, Justice MacPherson’s decision was reversed on appeal.”[4]
However, the Northern Badger appeal court decision also introduced a complication, the ramifications of which are being felt today in the RedWater case. Because the oil company and its trustee misled the courts and disposed of all other assets except the seven inactive wells the regulator was asking be safely plugged before the appeal court ruled on the case, the Justices were not particularly sympathetic about the fact there were no funds remaining in Northern Badger’s estate to carry out their decision. The trustee was forced to abandon the wells in question at its own expense without any indication it could seek costs from the secured creditors that had benefited from the sale of the rest of Northern Badger’s assets.[5] This resulted in insolvency receivers and bankruptcy trustees being reluctant to take on oil or gas companies out of fear they could be held liable for imposed environmental cleanup costs. Federal legislators addressed these legitimate concerns with amendments to the Bankruptcy and Insolvency Act (BIA) in 1992 and 1997. The 1997 amendments, meant to resolve uncertainties, have however resulted in more confusion. (Chaput 2012: 13, 16)
According to Alexander Clarkson and others, the Parliamentary debates and government materials from 1997 state these amendments had two purposes: “(1) to limit the liability of the trustee/receiver so they would be comfortable administering bankruptcies with environmental liabilities and (2) to nonetheless provide the public with an avenue to recover the cost of environmental reclamation.” The 1997 amendments were part of Bill C-5, tabled by Minister of Industry John Manley. When asked in Parliament “whether any action has been taken to prevent the dumping of contaminated buildings and worksites on local governments”, Manley replied:
We have given claims which stem from environmental damage priority over those of other creditors, both secured and unsecured, so that dealing with contaminated properties and properties that are adjacent to the property where the damage occurred and linked to the activity that caused the environmental damage will be able to be used as a priority claim in order to effect the cleanup. This will not only relieve some of the responsibility from local governments, but it will also ensure that trustees are willing to move in and take on some of these very difficult files. (Manley 1995)
In regards to virtually identical amendments to the rules around corporate restructuring, Liberal MP Ron MacDonald stated:
We were concerned because we did not want companies to be able to walk away because of environmental liabilities and leave effectively the crown or the trustee or the municipality with the burden. I am very pleased to see that basically there is a type of super-priority given to environmental clean up of these orphaned sites. (MacDonald 1996)
Industry Canada’s Sustainable Development Strategy reported the 1997 amendments helped “avoid ‘orphan site’ problems, alert environment ministries quickly to environmental problems and provide available funds from the estate to help finance the cleanup.” “Overall,” Clarkson concludes, “it appears from the Parliamentary debates and government publications that the purpose of the 1997 amendments was to protect the trustee and to relieve the public of some of the cost of cleaning-up abandoned sites.”[6]
Indeed, that is exactly how Canadian courts interpreted the 1997 amendments in the decade that followed – despite efforts by industry to spin them to their advantage.[7] “It might be argued that [Bankruptcy and Insolvency Act] s.14.06(8) provides… that an environmental costs claim is a provable claim”, Justice Burrows decided in 2005:
That, in my view, would be a misinterpretation of s. 14.06(8). I interpret the section as intending only to overcome what would otherwise be the effect of s. 121(1). That section provides that liabilities to which the bankrupt is subject on the day on which he becomes bankrupt, or to which he may become subject before discharge by reason of an obligation existing at the time of bankruptcy, are provable claims. If that section applied, an environmental claim arising after the date of bankruptcy but before discharge might not be a provable claim. Section 14.06(8) deals only with that timing issue. It does not convert a statutorily imposed obligation owed to the public at large into a liability owed to the public body charged with enforcing it. The [Northern Badger] principle continues to be part of the law.[8]
This understanding of the 1997 BIA amendments was undone by court decisions in Ontario since 2007 and by the Supreme Court of Canada in its 2012 decision on AbitibiBowater. That case has provided the central justification for the recent Alberta court decisions on RedWater, despite the lower court in the AbitibiBowater case noting that one should be careful in the application of the case because it dealt with a unique set of facts (Chaput 2012: 25). According to Clarkson (2011: 56), “although advocating against a “third-party pays” principle, the effect of the [Supreme] Court’s [AbitibiBowater] decision is to place the brunt of the costs of remediation on a third party: the public. In most cases the public would be left with the vast majority of costs of remediation”.
In the RedWater case, Alberta courts were dismissive of such concerns.[9] In the appeal decision, the majority dismissed as “exaggerated” any fears the insolvency process as currently interpreted would be abused “for the purpose of avoiding environmental liabilities.”[10] This dismissal, without argument or evidence, was far too flippant given the scale of unfunded environmental liabilities that already exist in Alberta: ~$260 billion according to Wadsworth (2018). In fact, Nobel laureates George Akerlof and Paul Romer (1993) demonstrated a generation ago the economic logic of looting a company doomed to fail – a strategy they coined Bankruptcy for Profit. Harvard Economics Professor Greg Mankiw commented at the time: “Indeed, given the incentives that regulators set up, it would be irrational for operators… not to loot.”[11]
To summarize, the priority of regulators in bankruptcy was clearly established in Canada until courts began applying an alternative and widely permissive interpretation to the 1997 amendments to the federal Bankruptcy and Insolvency Act after 2007, culminating in the Supreme Court’s 2012 AbitibiBowater decision. The RedWater case has furthered the controversy in these regards with specific relevance to oil and gas operations in Alberta, but (at least in the opinion of this writer), there is a reasonable chance the Supreme Court will limit or reverse the current permissive interpretation of bankruptcy law and reestablish some or all of regulators’ priority in the matter of environmental liabilities in bankruptcy.
Even this favourable outcome, however, will still create a crisis. Lenders and investors carry on as if these cleanup liabilities do not exist.[12] If the Supreme Court reaffirms they do exist, and cannot be escaped in bankruptcy, the industry will for the first time be forced to take liabilities into serious consideration in their lending and investment decisions. The result will make raising debt or equity considerably more difficult.
And to conclude, environmental liabilities do not just go away if a firm becomes insolvent. There are significant and material differences between financial liabilities and environmental liabilities. “If shareholders manage to walk away from responsibilities associated with environmental liabilities they often fall to the creditors, and from there they fall to governments and society in general.” (Schneider, Michelon, and Maier 2017: 397)
SOURCES, LINKS, QUOTES, & NOTES
[1] ‘Joint and several liability’ is when multiple parties can be held liable for the same event or act and are responsible for all restitution required.
[2] Dianne Saxe, “Trustees’ and receivers’ environmental liability update”, Canadian Bankruptcy Reports, 3rd series, vol. 49 (1998), pp. 138-39.
[3] Nicholas Chaput, “Environmental clean-up in bankruptcy and insolvency: What priority for the environment?”, University of Toronto Faculty of Law Masters of Laws thesis (2012), pp. 13-14:
‘the consensus in this trilogy of cases [Bulora (Ontario High Court of Justice, 1980), Panamericana (Alberta Court of Appeal, 1991), and Lamford Forest (British Columbia Supreme Court, 1991)] was that, despite a debtor being in a liquidation or restructuring process, the public health and safety nature of environmental legislation rendered compliance a mandatory priority. The courts clearly voiced the opinion that the stay of proceedings does not and should not amount to permission to violate the law with impunity. …Compliance with clean-up orders could not be assimilated to ordinary debts owed to the public authority charged with administering the statute. It is important to note that, in all three cases, the court does not hesitate to address directly the “balancing of values” implied by conflicting environmental and bankruptcy laws and to discuss the importance and the social value of the environmental legislation.’
[4] Dianne Saxe, “Throwing the net wider: Can parent companies and lenders be held liable for contaminated land?”, Windsor Review of Legal and Social Issues, vol. 3 (May 1991), pp. 42-43.
A board member of the Alberta energy regulator from 1989-2001, Dr. Brian Bietz, confirmed regulators understood in 1991 the implications of the Northern Badger case: polluters could be held jointly and severally liable (Interview, June 2016).
[5] Dianne Saxe, “Throwing the net wider: Can parent companies and lenders be held liable for contaminated land?”, Windsor Review of Legal and Social Issues, vol. 3 (May 1991), p. 43:
‘the receiver had deliberately negotiated sales of the debtor’s assets designed to ensure that all of the valuable assets were realized for the benefit of the secured creditor, leaving for the trustee in bankruptcy only the burdensome “assets” such as the disused wells. This arrangement was made without notice to the Energy Resources Conservation Board, despite its express interest, and without drawing the fact to the attention of the court which approved the sale. For this reason, the receiver was ordered to perform the abandonment, (at an estimated cost of more than $250,000) notwithstanding the fact that there were no longer sufficient assets in the debtor’s estate. There was no indication in the decision as to whether the deficiency would have to be made up by the receiver personally, or whether he could look to the secured creditor for indemnity.’
[6] Alexander Clarkson, “In the red: Towards a complete regime for cleaning up environmental messes in the face of bankruptcy”, University of Toronto Faculty of Law Review, vol. 69, no. 2 (Spring 2011), pp. 46-47.
See also Chaput (2012: 27-28) and “Dissenting Reasons for Judgment Reserved of the Honourable Madam Justice Martin” in Slatter, Schutz, and Martin (2017: 60-63, paras. 205-215).
[7] According to a former liability management advisor to the Energy Utilities Board, Alberta regulators shared industry’s preferred interpretation of the 1997 BIA amendments as early as 1999 – eight years before Ontario courts began accepting any such interpretation and 16 years before Alberta courts ruled in the RedWater case. (Kavanagh, personal communication)
[8] Justice Brian R. Burrows, “Strathcona County v. PriceWaterhouseCoopers Inc.”, Court of Queen’s Bench of Alberta, Reasons for Judgment 559 (21 July 2005), p. 9, paras. 41-43.
[9] Justices Frans Slatter and Frederica Schutz, “Orphan Well Association v Grant Thornton Limited”, Court of Appeal of Alberta, Reasons for Judgment 124 (24 April 2017), p. 32 (paras. 97-99):
‘the appellants argue, there is no unfairness in subordinating the Alberta Treasury Branches’ position to Redwater’s environmental obligations. Alberta Treasury Branches knew of these risks, assessed them in its creditworthiness analysis, and should not now be able to complain that they have come to fruition. Fairness is perhaps in the eye of the beholder, but this argument cannot succeed. …Whether this is fair or not is not the issue, because the BIA and the general law of priority of claims expressly recognize the priority of secured claims.’
It is worth noting, that as a result of Northern Badger, lenders had in 1991 accepted their responsibility for enabling polluters:
‘In the event the polluter cannot pay, then the liability should be treated as a social cost. …[But] relief from direct liability risk would not relieve a lender from the credit risk caused by environmental liability. The lender must still contend with the possibility that a borrower may be a polluter and that cleanup obligations imposed on the borrower could cause the value of its security to be eroded or eliminated. The borrower’s cash flow may be insufficient to pay for cleanup and still service the debt. For this reason, lenders will undertake due diligence procedures whenever they have a concern that a borrower’s business may pose an environmental risk.’ (Canadian Bankers’ Association 1991: 9, 13)
[10] Justices Frans Slatter and Frederica Schutz, “Orphan Well Association v Grant Thornton Limited”, Court of Appeal of Alberta, Reasons for Judgment 124 (24 April 2017), p. 33 (para. 105).
[11] N. Gregory Mankiw, “Comments and discussion” in Akerlof and Romer (1993: 65).
[12] James Mahony, “Oilpatch lenders working with clients to get through downturn”, Daily Oil Bulletin (15 October 2009) (liabilities not mentioned, only collateral):
‘Banks base their loans to producers on reserves in the ground, adjusted for additions and revisions. While some producers are assessed annually, most juniors are evaluated twice yearly. …many producers have cut capital spending this year and aren’t replacing production with new reserves. That coupled with a lower gas price forecast could materially reduce borrowing capacity. …In reviewing reserves, evaluators assume a certain gas price. That figure can have a huge effect on the value of the reserves and on how much credit the junior can qualify for. One lender said this is where the industry was cut some slack, since the gas price applied on this year’s evaluations was higher than it could have been.’
“Brief of the Alberta Energy Regulator for declaration for trustee to comply”, Court of Queen’s Bench of Alberta in Bankruptcy, court file no. BK01-094570 (20 November 2015), p. 2 (paras. 6-8):
‘It is ATB’s standard practice in accordance with its Industry Knowledge Guide to specifically consider the debtor’s statutory abandonment and reclamation obligations when assessing its risk exposure and to expect its customers to comply with same. This exposure is managed by ATB through ensuring the debtor budgets for and sets money aside for abandonment. […]
In consideration of Redwater’s abandonment and reclamation obligations, ATB required Redwater to complete an environmental questionnaire that included questions regarding Redwater’s policies to ensure timely abandonment, reclamation and decommissioning of uneconomic sites. ATB also required submission of a third party report outlining abandonment costs in relation to calculations under the AER licensee liability rating (LLR) program, and engineering reports that included information regarding Redwater’s abandonment and reclamation liabilities. The December 31, 2014 engineering report indicated that certain Redwater properties would need to be abandoned in 2015 and others in 2020[…]
As of January 29, 2015, and prior to appointment of the Receiver by ATB, ATB records indicate it anticipated full recovery on its debt notwithstanding low commodity prices.’
Chief Justice Neil Wittmann, Court of Queen’s Bench of Alberta, Redwater Energy Corporation (Re), Reasons for Judgment 278 (17 May 2016), p. 22 (para. 81):
‘Answering the AER’s submission that the ATB knew the risks associated with advancing funds to Redwater including regarding the abandonment liabilities, the ATB submits that this is irrelevant. It adds that what is relevant is that the ATB secured the loan with a first priority charge against all the assets, subject to statutory exceptions. The ATB also took specific secured registration against each of the leases on the individual property. The ATB adds that the only thing it had in its possession regarding abandonment liabilities was a reserve report.’
Sayer Energy Advisors President Alan W. Tambosso, “The impact of changes to the AER’s LMR system on M&A activity”, Daily Oil Bulletin (29 April 2015):
‘Several years ago, most purchasers of assets appeared to pay little attention to the cost of dealing with future liabilities. Regardless of the number of non-producing wells, assets generally changed hands for prices based solely on the value of the producing wells. A few years ago we started to notice increased purchaser awareness of future liabilities. Many prospective purchasers were interested in purchasing only assets with few liabilities. A few savvy purchasers made offers to purchase that excluded liability wells from the property. As the LMR changes came into effect [after May 2013], the purchaser awareness has evolved to the point where acquiring shut-in or abandoned wells is a rare occurrence.’
Jeremy McCrea, “Intermediate oil and gas producers: Subtleties with industry ARO reporting ahead of Redwater hearing”, Raymond James Industry Comment (2 February 2018), pp. 1-2:
‘ARO values reported in a majority of company Financial Statements are calculated by a standard estimate provided by the AER/equivalent depending on the region/depth, etc. …As standard practice, [Asset] Retirement Obligations (AROs) are rarely included in debt, FFO [funds from operations] or valuation calculations. So long as an operator’s LLR rating was in compliance, these long-dated liabilities have remained immaterial to investors.’
List of References
“Brief of the Alberta Energy Regulator for declaration for trustee to comply” (2015). Court of Queen’s Bench of Alberta in Bankruptcy, court file no. BK01-094570 (20 November), 208pp.
Akerlof, G. and Romer, R. (1993). “Looting: The economic underworld of bankruptcy for profit”, Brookings Papers on Economic Activity, vol. 24, no. 2, pp. 1-74.
Burrows, B. (2005). “Strathcona County v. PriceWaterhouseCoopers Inc.”, Court of Queen’s Bench of Alberta, Reasons for Judgment 559 (21 July), 13pp.
Canadian Bankers Association (1991). “Sustainable capital: The effect of environmental liability in Canada on borrowers, lenders, and investors” (November), 18pp.
Chaput, N. (2012). “Environmental clean-up in bankruptcy and insolvency: What priority for the environment?”, University of Toronto Faculty of Law Masters of Laws thesis, 55pp.
Clarkson, A. (2011). “In the red: Towards a complete regime for cleaning up environmental messes in the face of bankruptcy”, University of Toronto Faculty of Law Review, vol. 69, no. 2 (Spring 2011), pp. 31-67.
Laycraft, H., Foisy, R., and Irving, H. (1991). “PanAmericana de Bienes y Servicios v. Northern Badger Oil & Gas Limited”, Court of Appeal of Alberta, Reasons for Judgment 181 (12 June), 20pp.
Manley, J. (1995). House of Commons Debates, 35th Parliament, 1st Session, no. 269 (1 December), p. 17087.
MacDonald, R. (1996). House of Commons Debates, 35th Parliament, 2nd Session, no. 088 (22 October), p. 5544.
Mahony, J. (2009). “Oilpatch lenders working with clients to get through downturn”, Daily Oil Bulletin (15 October).
McCrea, J. (2018). “Intermediate oil and gas producers: Subtleties with industry ARO reporting ahead of Redwater hearing”, Raymond James Industry Comment (2 February), 8pp.
Saxe, D. (1991). “Throwing the net wider: Can parent companies and lenders be held liable for contaminated land?”, Windsor Review of Legal and Social Issues, vol. 3 (May), pp. 22-44.
Saxe, D. (1998). “Trustees’ and receivers’ environmental liability update”, Canadian Bankruptcy Reports, 3rd series, vol. 49, pp. 138-64.
Schneider, T., Michelon, G., and Maier, M. (2017). “Environmental liabilities and diversity in practice under international financial reporting standards”, Accounting, Auditing & Accountability Journal, vol. 30, no. 2 (May), pp. 378-403.
Slatter, F., Schutz, F., and Martin, S. (2017). “Orphan Well Association v Grant Thornton Limited”, Court of Appeal of Alberta, Reasons for Judgment 124 (24 April), 74pp.
Tambosso, A. (2015). “The impact of changes to the AER’s LMR system on M&A activity”, Daily Oil Bulletin (29 April).
Wittmann, N. (2016). “Redwater Energy Corporation (Re)”, Court of Queen’s Bench of Alberta, Reasons for Judgment 278 (17 May), 58pp.
Personal Communications / Interviews
Bietz, Brian. Board member (1989-2001), Alberta Energy Resources Conservation Board/Energy Utilities Board. Interview (Calgary, Alberta), 1 June 2016.
Kavanagh, Mark. Liability management advisor (1999-2005), Alberta Energy Utilities Board. Interview (Calgary, Alberta) and email correspondence, August 2018.
Wadsworth, Robert. Vice President of Closure and Liability Management, Alberta Energy Regulator (Calgary, Alberta). Email correspondence, May 2018.
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