Set-off is one of the most effective and powerful remedies available to a creditor, and operators under oil and gas operating agreements find it especially useful, in that the operator can set off revenues or other funds or credits it receives as operator against amounts owed. Further, the operator's set-off rights are usually honoured in an insolvency.
In Spyglass Resources Corp v. Bonavista Energy Corporation, 2017 ABQB 504, the Alberta Court of Queen's Bench opened the door to expanding the scope of set-off, as it approved the operator's setting-off of joint royalty credits it received against the non-operator's1 share of abandonment and decommissioning costs. Even though the credits arose under one contract and the costs under another – the Court did so in the name of business efficacy. Further, the Court found that set-off was effective against the non-operator's receiver and also awarded costs against the receiver for the application challenging the set-off. These developments in the law of set-off are sure to influence the actions of creditors and debtors alike, both in the oil and gas industry and elsewhere.
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Bonavista Energy Corporation ("Bonavista") operated a series of wells, compressors, pipelines and a sour gas plant in the West Liege region of Alberta, for itself and Spyglass Resources Corp. ("Spyglass"). In accordance with its practice, Bonavista used one joint account to administer all the revenues and costs for the project, notwithstanding that the lands and facilities were each governed by different operating procedures and accounting procedures. The main project agreements were a Construction, Ownership and Operating Agreement for the plant (the "CO&O") and a Joint Operating Agreement (the "JOA") for the wells that incorporated a 1990 CAPL Operating Procedure (the "1990 CAPL"). As part of its original regulatory approval for the project from the Alberta Energy Regulator (the "AER"), Bonavista was required to prepare a Decommissioning and Land Reclamation Plan in case the plant stopped operating.
The wells produced gas that overlaid bitumen deposits and continued production of the gas wells could have reduced the pressure in the bitumen reservoir such that the reservoir's viability could have been compromised. In late 2011, the AER issued a permanent shut-in order of the wells, and as a result Bonavista and Spyglass were entitled to gas-over-bitumen royalty credits (the "GOB Credits"). Due to the wells being shut-in, the plant also ceased production and Bonavista began decommissioning the plant and abandoning the pipelines, in accordance with the Decommissioning Plan.
The CO&O required that where there were two facility owners, all Operating Committee votes were required to be unanimous, and also required the Operator to clean up and restore the site for the joint account, even without Operating Committee approval. Beginning in late 2013, Bonavista began issuing mail ballots and accompanying AFE's for plant decommissioning and pipeline abandonment, including one set of 35 AFE's, each with a face amount of less than $25,000.00.2 Each month, Bonavista issued Spyglass one joint interest bill (a "JIB") for the joint account detailing each cost borne by the project and GOB Credit (again, irrespective of the agreement pursuant to which the cost arose), and netted the GOB Credit against Spyglass's share of costs. Spyglass disputed the costs and did not pay the balance owing. During this time, Bonavista also ignored Spyglass's ongoing requests for a meeting to discuss the expenditures, and did not hold Operating Committee meetings to discuss the matter.
Spyglass entered receivership in November 2015. Spyglass's receiver, Ernst & Young (the "Receiver") demanded the return of Spyglass's interest in the GOB Credits that had been netted against Spyglass's share of costs – prior to the receivership, Spyglass had not made this demand. Bonavista refused to pay, arguing it was entitled to set the GOB Credits off against Spyglass's unpaid costs.
Bonavista also separately applied to the AER to determine the abandonment costs and to allocate to Spyglass its proportionate share. The AER issued an Abandonment Costs Order against Spyglass in June 2016, setting the decommissioning and abandonment costs at approximately $900,000 plus penalties.
The Receiver advanced three arguments for return of the GOB Credits.
- Because Bonavista did not obtain Spyglass's approval for incurring the costs (as required by the CO&O), and because Bonavista was not required by law to incur the costs and also refused to meet with Spyglass as required by the governing agreements, the costs were improperly charged and Bonavista was responsible for the whole amount.
- Because it obtained the Abandonment Costs Order, Bonavista's remedy was limited to pursuit of the Order's enforcement and not other remedies.
- Bonavista was not entitled to exercise set-off rights against Spyglass, because:
- the costs arose under one agreement and the credits another agreement;
- the costs were required to be ascertainable in order for set-off to be available; and
- the GOB Credits were not "intimately connected" to the costs.
Each of the above arguments was rejected by the Court, and Bonavista's set-off was approved.
First, the Court concluded that the requirement to comply with the Decommissioning Plan trumped the requirement for unanimous Operating Committee approval of the operations, and while Bonavista may have been in breach of contract for not seeking Operating Committee approval, that did not mean that Spyglass was off the hook for its portion of the costs, because the costs were legally required to be borne by Bonavista.
Second, the Court found that obtaining the Abandonment Costs Order did not preclude Bonavista from enforcing its other remedies, including exercising set-off rights. The Court found that the Abandonment Costs Order merely validated and allocated the abandonment costs and did not require Bonavista to give up its other remedies.
Third, the Court assessed Bonavista's set-off right. There are three types of set-off under Alberta law:
- Contractual set-off, where the contract itself provides set-off rights;
- Legal set-off, where there are offsetting debts and they are ascertainable; and
- Equitable set-off, where a court awards set-off, effectively because it would be manifestly unjust to allow one party to succeed on its claim while the other party is left to pay. In equitable set-off, the party claiming the remedy must arrive "with clean hands", having behaved appropriately.
The Court held that the facts supported each of the types of set-off – a clean sweep for Bonavista.
Contractual Set-off: The set-off provisions in the CO&O and JOA created different set-off rights: the CO&O only allowed set-off of costs against amounts due "pursuant to this Agreement", while the 1990 CAPL allows set-off of amounts arising "under this Operating procedure or under any other Agreement" between the parties. The GOB Credits arose under the JOA, while the decommissioning and abandonment costs were borne under the CO&O, and hence the Receiver argued that contractual set-off was not permitted because the CO&O only allowed Bonavista to set off revenues that arose pursuant to the CO&O.
The Court found that, while the project was governed by a number of agreements each having its unique characteristics, the agreements in the aggregate should be interpreted as permitting netting of costs against credits to promote business efficacy, and therefore it awarded contractual set-off. The Court held that "it would be inimical to the interests of the parties whose activities are governed by a number of agreements, but for whom a single joint account is maintained, to deny the operator the ability to net amounts coming into the joint account under some of those agreements against amounts payable from the joint account under other agreements. In my view, such netting should be permissible when various revenues and expenses, accounted for through the use of the joint account, reflected integrated operations".3
Legal Set-off: Legal set-off requires that obligations existing between the two parties must be debts, the amounts of which can be ascertained with certainty; and they must be cross-claims between the same parties and in the same right. The Receiver argued that the costs did not crystallize until the AER issued the Abandonment Costs Order, which was after the date of receivership, and hence Bonavista was not entitled to exercise legal set-off. The Court disagreed with the Receiver's position, finding that the amounts owing by Spyglass were ascertainable through the delivery of the monthly JIBs by Bonavista and that such amounts crystallized when the time period for them to be paid expired –the Court therefore also awarded legal set-off.
Equitable set-off: In order to be awarded equitable set-off, Bonavista was required to show that the claims were "so clearly connected" that it would be manifestly unjust to enforce payment without considering the cross-claim. Bonavista argued that the costs were a direct result of the shut-in order, and the shut-in order led directly to the GOB Credits. Thus, the same order gave rise to the requirements to incur the costs, and the GOB Credits; and further that it would aksi require the costs to be paid without the corresponding credit. The Court agreed and awarded equitable set-off.
This case is significant for a number of reasons.
First, the Court's characterization of the CO&O and the JOA in the "aggregate" to allow for contractual set-off is an expansive one. It looked at the entire business relationship of the parties rather than parsing the specific terms of the underlying contracts, and as the parties had operated with one joint account, found that their business relationship allowed for the set-off terms of the contracts to be read together. Operators that have resisted setting off costs because the governing agreements do not allow it should be rejoicing because the Court indicated it is prepared to look at the whole business relationship, including whether one joint account was maintained for the project, to determine whether contractual set-off is available. A less generous court might have found that because the CO&O only permitted set-off of costs against those revenues arising "under this Agreement", and not "under this Agreement and any other agreement between the parties", it would not grant contractual set-off, as the GOB Credits arose under the JOA and not the CO&O. Drafting parties should ensure that their agreements contain this broader set-off language, but this case may provide some protection if the agreements do not.
Second, the Court's award of equitable set-off is a bit of a surprise. A party coming to a court looking for an equitable remedy is required to come with "clean hands". The Court could easily have viewed Bonavista's issuance of 35 AFE's of less than $25,000.00, and its refusal to hold Operating Committee meetings, as conduct which would preclude the award of an equitable remedy.
Third, the Court allowed the exercise of set-off rights against the Receiver. While set-off against a Receiver is permissible where the constituent elements can be established, courts examine set-off more closely in insolvency situations. This is because the effect of a set-off is to give one creditor a priority claim in the insolvency, as the whole set-off claim is paid in advance of other creditors.
Finally, the Court also found that the Receiver acted as a "real litigator" in this application as Spyglass had not commenced a claim prior to the receivership and did not challenge Bonavista's netting of the costs in the JIBs. As a result, the Court awarded costs against the Receiver, a relatively rare occurrence. This costs award may act as a deterrent against receivers aggressively pursuing future claims on behalf of a debtor if the debtor itself elected not to bring the claim prior to the receivership.