The Alberta Court of Appeal recently denied an application by Celtic Exploration Ltd. ("Celtic") for leave to appeal a decision from a Companies’ Creditors Arrangements Act (Canada) ("CCAA") proceeding involving Celtic and SemCAMS ULC ("SemCAMS"). The CCAA court found that the parties’ gas purchase agreement had been suspended as of July 2008, and as a result, Celtic could not set off amounts it owed to SemCAMS after that date against indebtedness arising under the agreement.

SemCAMS is the operator and joint owner of natural gas processing plants and related gas gathering lines in Alberta.

The plant at issue in this case was the Kaybob South Amalgamated Plant ("KA Plant"). This plant operates pursuant to a Construction, Ownership and Operation Agreement ("CO&O Agreement") by which each joint owner is entitled to use a share of the throughput capacity in proportion to its ownership interest. When excess capacity is not used by the joint owners, it is used to process natural gas owned by third parties pursuant to Gas Processing Agreements. Both joint owners and third party users make monthly payments to SemCAMS as operator based on their projected use of the plant. At the end of the year, a “thirteenth month adjustment” reconciles projected throughput to actual throughput ("Thirteenth Month Adjustment").

Celtic is a natural gas producer who originally processed its gas at the KA Plant as a third party user under a Gas Processing Agreement. However, in 2006, Celtic and SemCAMS terminated their Gas Processing Agreement and entered into an Inlet Gas Purchase Agreement ("IGPA"). Under the IGPA, Celtic sold its natural gas to SemCAMS and, therefore, title to the gas transferred to SemCAMS at the KA Plant. This allowed SemCAMS to process the natural gas using its capacity and priority rights as a joint owner and permitted Celtic to avoid the risk of being shut out if the joint owners used their full capacity.

On July 22, 2008, SemCAMS was granted an initial order pursuant to section 11(1) of the CCAA ("Order"). The CCAA process permits a company to continue operating while it restructures its business and financial affairs in a court-supervised setting. Following July 22, 2008, Celtic continued to deliver raw natural gas to the KA Plant. However, SemCAMS believed that the IGPA had been suspended as of the date of the Order. Accordingly, SemCAMS thought they were accepting the deliveries of gas from Celtic in their capacity as operator pursuant to standard third party terms and not as a joint owner pursuant to the IGPA.

At the time of the Order, SemCAMS owed Celtic approximately $32 million, including $1.4 million owed pursuant to the Thirteenth Month Adjustment provision under the IGPA. Following the Order, SemCAMS as operator invoiced Celtic monthly for standard gathering and processing fees charged to third party users. In October 2009, Celtic purported to set off the Thirteenth Month Adjustment owed to it by SemCAMS against the gathering and processing fees Celtic owed to SemCAMS as operator.

SemCAMS then applied for a declaration that the IGPA had been suspended when the Order was granted in July 2008 and, as a result, Celtic could not set off amounts owed to SemCAMS after that date against indebtedness arising under the IGPA. The CCAA court found evidence that both parties had in fact agreed to the suspension of the IGPA and, therefore, the Court held that Celtic was not entitled to set off. The full text of the CCAA court’s decision can be found here.

Celtic sought leave from the Alberta Court of Appeal to appeal this decision. Among other things, Celtic proposed that the CCAA court erred in determining that the IGPA was suspended and that Celtic was not entitled to set off. In relation to suspension of the IGPA, the Court of Appeal found that Celtic had not demonstrated any error of law or fact in the decision of the CCAA court and, therefore, leave to appeal could not be granted on this issue.

Further, since the Court of Appeal denied leave to appeal on the issue of suspension of the IGPA, it followed that they must also deny leave on the issue of contractual set off. The CCAA court did not permit contractual set off because the IGPA was suspended as of July 22, 2008, and, therefore, the delivery by Celtic and acceptance by SemCAMS of raw natural gas arose under a new and distinct contractual obligation. This new obligation could not be set off against an obligation arising pursuant to a different contract, namely the IGPA.

However, Celtic argued that even if contractual set off was not permitted, equitable set off should have been found by the CCAA court. Equitable set off may be found when the debts sought to be set off arise from closely-related contracts. Here, Celtic sought to set off the Thirteenth Month Adjustment owed to it by SemCAMS as joint owner against amounts Celtic owed to SemCAMS as operator. Although both the IGPA and the third party gas processing agreement related to the processing and sale of natural gas, the benefits that both parties derived from these agreements were distinct. As a result, the CCAA court found that Celtic had not met the burden of establishing a close connection between the cross-claims. At the Court of Appeal, Celtic was unable to demonstrate that the CCAA court had erred in reaching this finding and, therefore, leave was also denied on this issue.

As a result, the Court of Appeal rejected all of Celtic’s proposed grounds of appeal and the application for leave was dismissed. The full text of the Court of Appeal’s decision can be found here.

In denying leave to appeal, the Court of Appeal followed their previous decision to deny leave in another SemCAMS proceeding involving set off and Trilogy Energy LP. We previously reported on this case here.