Operating agreements for oil and gas assets typically contemplate the immediate replacement of the operator by another working interest owner in the event of the operator’s insolvency. However, these provisions often become practically unenforceable because, once proceedings are commenced under either the Companies Creditors’ Arrangement Act, RSC 1970, c C-25 [CCAA] or the Bankruptcy and Insolvency Act, RSC 1985, c B-3 [BIA], stays are imposed that prevent creditors from exercising any remedies against the insolvent operator, including these “immediate replacement” provisions.

The recent decision in Bank of Montreal v Bumper Development Corporation Ltd, 2016 ABQB 363 [Bumper] indicates that immediate replacement clauses may be given effect in proceedings under the BIA, although, as discussed below, whether immediate replacement clauses will be given effect in CCAA proceedings remains uncertain.

Background

Eagle and Bumper were parties to a Joint Operating Agreement (JOA) relating to approximately 28 wells and to a Construction, Ownership and Operation Agreement in respect of a battery facility. The JOA incorporated the 2007 Canadian Association of Petroleum Landmen operating procedure. The agreements gave Eagle the right to replace Bumper as operator upon the latter’s insolvency.

In February 2016, a Receiver/Manager was appointed for Bumper under the BIA in order to protect and realize upon Bumper’s assets and distribute the proceeds. As is typically the case, the receivership order stayed the exercise of all rights and remedies against Bumper.

Bumper’s Receiver/Manager conducted a sale of the Assets. Both Eagle and Forent submitted bids. In the interim, Eagle notified the Receiver/Manager that it intended to assume operatorship and those parties met regarding the terms of the sale. Prior to a bid being accepted, the Receiver agreed with Eagle that the Receiver would not entertain any offer purporting to convey operatorship of Bumper’s assets to anyone other than Eagle. The Receiver later indicated to the Court that operatorship would not be part of any sale.

Forent was the successful bidder. The Court approved the Receiver/Manager’s application for sale and vesting of the assets subject to later determination of Eagle’s application to assume operatorship, which Forent opposed.

The Court appointed Eagle operator of the assets.

Decision

In holding for Eagle, the Court reached the following conclusions.

  • Eagle had not slept on its rights. Had Eagle sought to become operator at the time the receivership order was granted, or soon thereafter, there would have been no reason not to grant its motion. In any case, Eagle “acted reasonably” by meeting with the Receiver/Manager to negotiate a deal (para 22);
  • Forent “did not have any reasonable expectation that it was purchasing operatorship” (para 22); and
  • Eagle’s right to operate arose under a contract predating the receivership and there was “no reason to interfere with the contractual rights of Eagle which are not subject to the security of Bumper’s creditors” (para 19); to do so “would be tantamount to appropriating Eagle’s right for the benefit of Bumper’s creditors” (para 23).

The Court distinguished the decision in Norcen Energy Resources Ltd v Oakwood Petroleums Ltd (1988), 92 AR 81 (QB) [Norcen], which held that a filing under the CCAA was sufficient to stay proceedings brought by a non-creditor working interest owner to enforce its right to replace the insolvent operator. The overriding concern in the Norcen proceeding was to afford the company a chance to restructure, not to realize on its assets as in Bumper, the Court in Bumper reasoned.

Instead, the Court in Bumper appeared to consider the matter more analogous to Tri-Star Resources Ltd v JC International Petroleum Ltd (1986), 48 Alta LR (2d) 355 (QB) [Tri-Star], in which a working interest owner successfully applied to have the insolvent operator summarily removed notwithstanding a statutorily imposed stay in the context of a proposal under the Bankruptcy Act, RSC 1970, c B-3.

The predominant purpose of the CCAA remains the restructuring of the insolvent company. For that reason, in situations analogous to that in Norcen, courts may be more willing to preserve the valuable operatorship position of a debtor company, at least temporarily, to better assist it in its exit from CCAA proceedings.

It is also important to note that in Bumper Eagle was able to secure an agreement from the Receiver not to seek to assign operatorship to the successful bidder.

Implications

Given the prevalence of “immediate replacement” provisions in operating agreements and the current heightened risk of further insolvencies in the natural resources sector, non-operators should take note of how and when they can enforce such provisions in light of Canadian insolvency legislation.

Any application to assume operatorship is likely to be highly fact-specific; non-operators wishing to assume operatorship under the guise of an immediate replacement clause would be best advised to make their position known as soon as possible, in writing.