This post has been prepared jointly by Lisa Benjamin (Killam Post-doctoral Fellow, Schulich School of Law), and Meinhard Doelle, Colin Jackson and Sara Seck (all Faculty Members, Schulich School of Law, Dalhousie University)

The recently released Supreme Court of Canada decision in Orphan Well Association v Grant Thornton has been warmly welcomed by those who are concerned that the burden of environmental remediation too often falls upon taxpayers when companies run into financial difficulties and seek bankruptcy protection. In this post, we will examine the decision itself, and reflect upon its implications for oil and gas development in a climate vulnerable world and for environmental liability more broadly.

Factual Background

At the heart of the case is the relationship between the provincial regulatory system for oil wells and other oil infrastructure and assets in Alberta and federal Bankruptcy and Insolvency Act (BIA). Part of the provincial regulatory system seeks to prevent companies from walking away from depleted oil wells without proper abandonment, which includes the proper capping of the well and remediation of the surface.

The Licensee Liability Rating Program is a key part of the provincial effort to ensure proper abandonment of oil wells. Under this program, the Regulator creates a Liability Management Rating (“LMR”) for each company operating in Alberta. The LMR is the ratio between a company’s licensed assets and the liability attributed by the Regulator to the eventual cost of abandoning and reclaiming those assets. When the LMR drops below the acceptable ratio between assets and liability, the company will be required to take action to satisfy the regulator that it has the ability to ensure the proper abandonment of its well, usually by paying a security deposit.

Redwater was an oil company that operated 84 wells, 36 pipelines, and 7 facilities in Alberta. Redwater began to experience financial difficulties in 2014. By the time Grant Thornton Limited (“GTL”) was appointed as trustee in bankruptcy in 2015, Redwater owed its major creditor, the Alberta Treasury Branches (“ATB”, now called ATB Financial), approximately $5.1 million. By this time, 72 of the 84 wells were inactive or spent, but, since Redwater’s LMR did not drop below the prescribed ratio until after it went into receivership, it never paid any security deposits to the Regulator.

GTL decided to only take possession of the active, profitable wells, and to disclaim the inactive wells. Its plan was to sell the assets it deemed profitable and distribute the proceeds to secured and preferred creditors in accordance with the provisions of the BIA, leaving nothing for the proper abandonment of the inactive wells. The regulator, in turn, ordered GTL, as Redwater’s trustee in bankruptcy, to properly abandon the inactive wells, which would require GTL to apply the proceeds to properly abandon any inactive wells, leaving nothing for secured and preferred creditors, such as ATB. This action was justified under provincial law on the basis that Redwater’s LMR was below the ratio deemed acceptable, allowing the regulator to step in and demand action, including the abandonment of the inactive wells.

The key issue in the case, ultimately, was whether GTL was required to use the remaining assets of Redwater to properly abandon the inactive wells, or whether it was entitled to disclaim Redwater’s inactive wells, distribute the proceeds from the sale of the profitable wells and other assets to secured and preferred creditors without spending money on the abandonment of inactive, unprofitable wells.

A previous decision of the SCC involving the province of Newfoundland and Labrador and AbitibiBowater loomed large over this case. In that case, the SCC had established the following three-part test for when a provincial regulator’s actions amount to a provable claim under the BIA and therefore would rank below secured and preferred creditors of the bankrupt company.

• First, there must be a debt, a liability or an obligation to a creditor.
• Second, the debt, liability or obligation must be incurred before the debtor becomes bankrupt.
• Third, it must be possible to attach a monetary value to the debt, liability or obligation.

Where this three part test was met, the SCC in Abitibi found that the principle of federal paramountcy would apply to hold provincial law inoperative to the extent that it was in conflict with federal bankruptcy law.

The Lower Courts’ Decisions

Applying this test, the lower courts in the Orphan Wells case held that the provincial energy regulator was a creditor whose liability was incurred before Redwater became bankrupt, and that it was possible to attach a monetary value to the debt. Essentially, the trial judge and the Alberta Court of Appeal both took the position that the provincial regulator’s true purpose in ordering the trustee to properly abandon the inactive wells was to avoid having to spend public funds on the abandonment of these wells.

At the Alberta Court of Appeal, Justice Martin dissented, taking the position that the regulator was not a creditor of the company, and that there was no obvious or clear monetary value attached to the claim, in part because it was not clear that the regulator would ever spend any money on the proper abandonment of the wells. Rather, this was left to an independent, though underfunded entity, the Orphan Well Association, which was funded by the industry and would decide on how to spend its limited resources to abandon orphan wells. The dissent further concluded that while the BIA does protect the trustee from personal liability, it disagreed with the majority that the protection extended to the bankrupt company. On that basis the dissent found that there was no conflict between the BIA and the order of the provincial regulator ordering the trustee to properly abandon the inactive wells.

The Majority Opinion

Ultimately, the majority of the SCC largely agreed with Justice Martin’s dissent at the Alberta Court of Appeal. At the first stage of the Abitibi test, the Court pointed to the scholarship of the University of Calgary’s Fenner Stewart and the University of Alberta’s Anna Lund to help draw a distinction between a creditor collecting a debt and a regulator enforcing the law. Here, the regulator was seeking to have the corporation perform duties it owed to the public, and so the court concluded that it was not a creditor. On the third step of the Abitibi test, the Court found that the obligation the regulator seeks to enforce is not a monetary one. Generally, future and contingent claims can be provable claims in bankruptcy, so long as the possibility of the claim actually coming due is not too remote or speculative. In the context of environmental liabilities, this was reframed in Abitibi to ask whether there is sufficient certainty that the regulator will perform the environmental remediation and seek reimbursement. In this case, the Court found that there was not the sufficient certainty that the obligation to properly abandon the wells would “ripen into a financial liability.” Redwater’s abandonment obligations, therefore, remain non-monetary obligations rather than provable claims that would be dealt with within the bankruptcy framework.

Furthermore, the majority of the SCC agreed with Justice Martin’s analysis of the applicable provisions of the BIA and concluded that they did not allow the trustee to disregard the company’s liability with respect to the inactive wells. The trustee was protected from personal liability, not shielded from having to deal with the companies’ liabilities.

The Dissenting Opinion

In dissent, two members of the court expressed complete disagreement with the analysis and result of the majority. The dissent highlighted that GTL had assessed Redwater’s valuable assets at just over $4 million, while GTL’s assessment of the abandonment and reclamation liabilities of the non-producing properties put their net value at -$4.7 million. (para 173) This valuation made it impossible for GTL to comply with the conditions that the regulator had imposed before agreeing to allow GTL to sell any of the valuable assets. As the net value of the properties was negative, it would be impossible for GTL to find a single buyer. Moreover, GTL could not complete the abandonment and reclamation work itself as the environmental liabilities exceeded the estate’s value. (paras 166-167) The practical result of the regulator’s attempt to get GTL to “comply with its obligations as a licensee, including the obligation to abandon the non-producing properties” must be understood, according to the dissent, as “an effort to hold GTL personally liable. Where else would the money required to abandon the disclaimed properties come from?” (para 228) Yet this is precisely what the BIA provision at issue was designed to avoid.

Of equal concern to the dissent was that if all of the value of the valuable assets would be required for abandonment and reclamation, this would create a disincentive for insolvency professionals ever agreeing to serve as receivers and trustees as there would be no money available even to cover their administrative costs. (para 221) It would also, the dissent suggested, lead to an increase in the number of orphan wells as debtors and creditors would not bother to petition for bankruptcy and “none of a bankrupt’s estate’s assets will be sold – not even an oil company’s valuable wells.” (para 221). This result would be contrary to the 1997 BIA amendments which were designed to encourage greater acceptance of mandates by insolvency professionals by ensuring that bankruptcy trustees would not be subject to personal liability for environmental remediation costs. (The majority contested these claims in paragraph 113).

Analytically, the dissent came to an entirely different conclusion in its interpretation of the relevant statutory provisions of the BIA, and as a result concluded that there was both an operational conflict and frustration of purpose between the federal statute and the provincial regulatory regime. The dissent took issue with the majority’s conclusion that the regulator was not a creditor under the Abitibi test, and concluded that it was sufficiently certain that the regulator (whether AER or the OWA) would “ultimately perform the abandonment and reclamation work and assert a monetary claim for reimbursement.” (para 225). As a result, the dissent found the third Abitibi test was met in its entirety.

Notably, the dissent concluded by framing the problem as one that necessitates a balance between “environmental protection and economic development” (para 289). It then provided a list of alternate regulatory measures that could be implemented to avoid the problems at issue here, including “up-front bonding” as found in some US jurisdictions, or increased industry levies to properly resource the orphan well fund. (paras 289-290). The dissent’s penultimate paragraph claims that the majority’s decision displaces the ‘polluter pays’ principle enacted in the BIA, “in favour of a ‘lender-pays’ regime’.”

Ultimately, however, the question may be whether it is possible to ensure both that the polluter pays and that creditor financial institutions fully anticipate future environmental remediation costs and so integrate these costs into financing. While the effect in the case of Redwater’s bankruptcy may be that the lender pays, we can reasonably expect that lenders will take the Orphan Well decision into account as they make decisions around loan amounts, collateral requirements and interest rates. In other words, if lenders are forced to pay in bankruptcy, we can expect that polluters will be forced to pay before bankruptcy. As discussed below, the potential environmental costs would ideally include not only the costs of remediating environmental damage, but also the costs of climate change.

Implications for the ability of regulators to go after companies in receivership or bankruptcy

While the outcome of the case in the majority opinion is described by most commentators as aligning with the polluter pays principle, the reasoning is more nebulous. Part of the SCC’s reasoning relied heavily on the assumption that the regulator and the OWA would not necessarily foot the bill for end of life obligations for these inactive wells. The background to this reasoning may have been the considerable backlog of orphans’ wells remediation due to OWA’s lack of funding. If the regulator had declared the wells orphan wells and triggered OWA’s clean up responsibility, the regulator or OWA would likely have been categorized as a creditor, and its claims would then be subsumed into the bankruptcy process. The case therefore encourages regulators to not convert, or at least delay converting, a regulatory claim into a financial claim.

The Court is clear that trustee’s status as “licensee” in the regulatory scheme and the obligation to abandon the wells can survive the commencement of bankruptcy; however, it is less clear how the abandonment obligations can be enforced. If the regulator attempts to enforce them by collecting money, the regulator likely becomes a creditor, the obligation becomes a debt, and the regulator is left with an unsecured claim in bankruptcy—precisely the result that the regulatory in Orphan Well sought to avoid. No penalties can stick against the corporation itself, which, in most cases, will soon be wound up or dissolved. The judges in the case all agree that the subsections 14.06(2) and 14.06(4) of the BIA protect the trustee from personal liability for environmental damage or failure to perform environmental remediation.

The answer, at least in the context of the Alberta energy sector, may lie in the regulator’s continued control over the transfer of licenses. While Redwater would have other assets that a trustee could liquidate—mineral rights, surface rights, drilling equipment, contractual rights—it seems that much of Redwater’s value was tied to the licences to extract oil or gas. The SCC’s affirmation of the regulator’s continued power to deny the sale of the licences forces the trustee in bankruptcy to find a solution that satisfies the regulator or be prevented from realizing much of the estate’s value. Alternatively, broader financial arrangements for licensees could be contemplated to ensure financial recourse for the regulator, such as increasing the LMR or securing up-front bonds.

Implications for fossil fuel industries in Alberta and beyond

The number of ‘orphan wells’ in Alberta is increasing dramatically, up from 80 in 2013 to almost 700 in 2015. In addition, as the balance of energy sources shifts away from coal, oil and gas, and traditional energy companies become less profitable, some will enter bankruptcy. In 2016, a number of coal companies entered into bankruptcy, including Arch Coal Inc., Patriot Coal Inc., Walter Energy Inc., and Peabody Energy. The impact of bankruptcy law on environmental law will likely gain a higher profile as the question of who foots the bill for bankrupt companies’ environmental liabilities becomes more pressing. In Canada, insolvency law prioritizes the repayment of secured creditors and gives preferential treatment to certain claims of other creditors, including employees, municipalities, and landlords. However, its treatment of environmental liability has been rightfully criticized. The BIA’s preference scheme thus risks leaving more of the bill for the clean-up of environmental damage in the hands of regulators, and therefore taxpayers.

But local environmental costs and liabilities are not the only part of the equation in the bankruptcy and energy field. Alberta’s oil and gas industry is 8th largest in the world, and contributes a significant amount of greenhouse gas emissions globally. As the impacts and costs of climate change mounts, in particular loss and damage due to climate change, claims against fossil fuel intensive corporations are exploding. In 2017, three municipalities in California sued a number of fossil fuel corporations, including Peabody Energy, for abatement costs due to the impacts of climate change. Their claim against Peabody was dismissed as the company was shielded from climate impacts incurred before its 2016 bankruptcy filing under its bankruptcy plan. In 2019, one of the largest electricity utilities company in California, PG&E, filed for bankruptcy due to the costs incurred from the catastrophic wildfires last year which were exacerbated by years of drought. As global temperatures continue to increase, so will the impacts of climate change, and with them liabilities for energy and utility corporations. Bankruptcy law, as currently interpreted in the Orphan Well case, does not provide a secure legal footing for the prioritization of repayment and remediation of environmental liabilities for the public benefit.