In Canpar Holdings Ltd v. Petrobank Energy and Resources Ltd. and Gentry Resources Ltd., the Alberta Court of Queen's Bench considered a claim by a corporate petroleum and natural gas lessor against a lessee for failure to comply with a prescribed royalty schedule. The lease expressly provided that royalties were to be calculated at a given percentage of either the sale price or market value, whichever was greater, and "all without deductions", except transportation expenses. The lessee took the position that the use of fuel gas was a permitted deduction pursuant to the definition of "operations" in the lease. The lessor argued that this deduction was beyond that authorized by the royalty clause and issued a notice of default. The lessee continued production after the notice of default was given.
The Alberta Court of Queen's Bench, in an oral decision issued by Justice Miller, considered (1) the correct interpretation of the lease with respect to the price of gas, and (2) whether fuel gas was a permitted deduction.
The Court relied on a strict interpretation of the terminated petroleum and gas lease to determine damages with respect to royalty pricing and payments. The Court found that in calculating royalties, only two options were available as provided in the royalty clause: the greater of sale price or market value. Contrary to prior decisions, which considered the conduct of the parties and common industry practice when interpreting such clauses, the Court applied a strict, rather than purposive interpretation to the phrase "all without deductions" in the royalty clause. Using this approach, the Court found that fuel gas was not included in the definition of "operations" and was, therefore, not an allowable deduction under the exemption provision.
570495 Alberta Ltd. v. Hamilton Brothers, a 2008 Alberta Court of Queen's Bench decision, provides similar guidance in that a royalty owner is only required to pay a share of processing expenses where it is expressly accounted for in the lease. On the other hand, although addressing a shut-in well provision, the 2008 Alberta Court of Appeal case of Kensington Energy Ltd. v. B&G Energy Ltd. gave direction on the interpretation of oil and gas lease agreements, suggesting that courts should examine the subtle meaning of language and give effect to the parties' intentions.
In determining the damages payable in the Canpar case, the Court concluded that a lessee's continuation of production after termination of a lease amounts to the tort of trespass or conversion, but does not warrant punitive or exemplary damages unless the lessee's conduct is high-handed, abusive or egregious. In this case, the Court held that the lessee's conduct after termination of the lease did not meet these criteria. The lessee was therefore only required to provide an accounting of profits, less any associated costs actually incurred. The primary focus was to restore the lessor to its original position had the tort not occurred.
This case is significant in that the Court gives full effect to the express language of the royalty clause prohibiting deductions. That said, the fact that royalties in this case were to be calculated based on the greater of sale price or market value may distinguish it from other cases where the royalty is calculated at the wellhead, where a more convincing argument may be made that deductions ought to be made for expenses that were incurred up to the time of sale.
This decision demonstrates that petroleum and natural gas leases, and specifically royalty clauses, must be drafted with care. Given the Court's reliance on the plain language of the agreement, future leases should expressly outline the percentage of production on which the royalty is payable, specific allowable deductions (i.e. operating expenses of the property, other overriding royalties, transportation and gathering, cleaning, processing, enhanced recovery, etc.) and any right of the lessee to use substances consistent with the royalty (for example, fuel gas for enhanced recovery to extend production), and whether the lessor is to bear a portion of that expense.