Where an operator commingles the monies of a joint-operator with its own funds and the account is depleted, a constructive trust may be imposed on the assets (and sale proceeds thereof) of the operator for the benefit of the joint-operator.
Under clause 507 of the 1990 CAPL Operating Procedure, an operator is expressly authorized to commingle its own funds with those of a joint-operator, but it is provided that the joint operator's funds are considered trust monies. In Brookfield Bridge Lending Fund Inc. v. Vanquish Oil & Gas Corporation and King Energy Inc., 2008 ABQB 444, the Alberta Court of Queen's Bench held that, where an operator empties its bank account to pay creditors, a constructive trust may be extended over the other assets of the operator, and the joint-operator will be granted priority over all of the operator's creditors.
Karl Oil and Gas Ltd. ("Karl") and Choice Resources Corporation ("Choice") were 55% and 45% working interest owners, respectively, of a well referred to as the "Simonette property". Karl was originally the operator until it sold its interest to Vanquish Oil & Gas Corporation ("Vanquish"), and Vanquish assumed the role of operator. The well came into production when Vanquish was operator.
The Simonette property was operated subject to the terms of the 1990 CAPL Operating Procedure. Clause 507 specifically allowed the operator to commingle the monies received from or on account of a joint-operator with its own funds, and these monies were deemed trust monies held by the operator as the joint-operator's trustee.
A related dispute not addressed in this specific action was whether Karl or Choice was the owner of the 45% working interest in the Simonette property, which was not previously owned by Vanquish. For the purposes of this case, it was clear that whomever was the owner of that 45% interest was entitled to have been paid by the operator a percentage of the net production revenues. Vanquish, as operator, kept a main operating account where all expenses were paid from and all production revenues were deposited. However, Vanquish did not pay the pro rata net production revenues, estimated to be in the amount of $320,539.00, to the owner of this remaining 45% interest.
Three years after Vanquish became operator, a receiver was appointed on application by Brookfield Bridge Lending Fund Inc. ("Brookfield"), a secured lender of Vanquish. The receiver applied for the sale of Vanquish's assets. From the proceeds of the assets sale, Karl and Choice advanced a claim to obtain the $320,539.00 which should have been remitted to the 45% interest owner for net production revenues.
The issue to be determined then was whether the joint-operator working interest owner in the property had a claim in trust, to the extent of the unpaid net production revenues, on the other assets or sale proceeds of the assets of the operator (ie. those not in the bank account).
Counsel for Brookfield argued that at the date of the receivership, approximately $58,000.00 remained on deposit in the main operating account, and accordingly, that was the maximum amount the joint-operator could claim in the proceedings.
The Court, however, determined that a constructive trust should be imposed on the assets of Vanquish, and not just on the money in the main operating account, on the bases that: 1) clause 507 of the 1990 CAPL Operating Procedure clearly established a valid trust; 2) there was a high probability that the net asset base of Vanquish was unjustly enriched by its breach of trust; 3) the 45% interest owner had a legitimate reason for seeking a remedy against Vanquish's property, rather than simply the money in the account, to ensure that parties like Vanquish would comply with clause 507 of the 1990 CAPL Operating Procedure; and 4) while the imposition of a constructive trust would adversely affect the rights of Vanquish's secured lender, Brookfield, it was not unjust because Brookfield was in a far better position to ensure that Vanquish conducted its business in a manner which complied with the 1990 CAPL Operating Procedure.
We are advised that this case has been appealed. This is an interesting decision, as the Court extended a constructive trust to a situation where the trust property, or proceeds of its disposition, may not be able to be directly traced. The effect is that joint-operators, whose revenues were held in trust by the operator, may have a successful claim against the assets of the operator, irrespective of tracing.
The outcome of this case is not favourable from the perspective of the secured creditors of operators, as they will have to ensure that a borrower-operator strictly complies with its CAPL obligations, and be mindful that the claim of the joint-operator is superior to their own claim. Prior to lending, creditors will now face the challenge of determining the extent of a operators' trust obligations, given the impact these obligations will have on potential claim priorities in the future.