Introduction

In its recent decision in IPF Technologies (Canada) Inc. v EnCana Midstream and Marketing ("IFP Technologies"), the Alberta Court of Appeal provided clarity on the meaning of the term "working interest" as it is used in Alberta's oil and gas industry. The Court also provided guidance on the role of evidence regarding the circumstances surrounding a contract's execution in interpreting a contract, and on the standard of review applicable on certain issues.

Background

Once upon a time, IFP Technologies (Canada) Inc. ("IFP") and a predecessor to PanCanadian Resources ("PCR") entered into a technology licencing agreement (the "TLA"), which granted IFP a 3% gross overriding royalty over certain lands (the "Eyehill Lands") owned by PCR in exchange for PCR's use of certain technology owned by IFP. When it came to pass that, PCR wanted to end the TLA, PCR and IFP began negotiating an end to the TLA with IFP. At the time, both PCR and IFP were of the view that primary production of the Eyehill Lands was at an end, but further production could be obtained through a SAGD operation. After initially proposing that IFP should take a working interest in all thermal production from the Eyehill Lands, PCR later agreed to grant a IFP 20% working interest in PCR's 100% working interest the Eyehill Lands.

Ultimately, PCR negotiated a farmout of its remaining interests in the Eyehill Lands with the Wiser Oil Company of Canada. Under the contract between IFP and PCR, PCR had both a right of first refusal ("ROFR") over the Eyehill Lands and right to consent (or not) to any disposition by PCR of its interest, so long as such consent was not unreasonably withheld. IFP did not exercise its ROFR and did not consent to PCR's transfer of its interest to Wiser, as Wiser intended to produce the Eyehill Lands is a way that would render SAGD production impossible. Even though IFP did not consent, PCR transferred its interest in the Eyehill Lands to Wiser, but indemnified Wiser against any future claims made by IFP.

After the transfer of lands to Wiser, Wiser proceeded with its plans to produce the Eyehill Lands by conventional methods. As it produced the Eyehill Lands, Wiser did not provide any information to IFP regarding its production and did not pay anything to IFP. Accordingly, IFP sued PCR for breach of contract and claimed damages for same, an accounting of net revenue from the Eyehill Lands, or $45 million in damages. Unfortunately, the first trial judge passed away following a lengthy trial, but both parties agreed under Rule 13.1 to have another judge continue with the trial on the basis of the written record.

The second trial judge dismissed IFP's claim on the basis that PCR had only conveyed a 20% working interest in production obtained through thermal and enhanced recovery methods. As Wiser had produced the Eyehill Lands through other methods, IFP had no interest in any minerals recovered. IFP appealed.

The Decision

Standard of Review

In considering the IFP's appeal, the Court of Appeal confirmed that, as a general rule, questions of contractual interpretation are questions of mixed fact and law, which attract a "reasonableness" standard. Under the reasonableness standard, an appellate court will generally defer to the findings of the lower court. However, the Court of Appeal also held that, where the contractual interpretation question contains an extricable question of law, that question will be subject to the "correctness" standard of review, under which the Court of Appeal will substitute its own findings for the Trial Court's. In this case, the Court of Appeal identified the lower Court's failure to consider evidence of the factual matrix surrounding the execution of the contract and the failure to consider the definition of a "legal term of art" as extricable questions of law to which the correctness standard apply.

Working Interest as a Legal Term of Art

As noted in the introduction above, the Court of Appeal made a specific finding that "working interest", as it is used in the Alberta oil and gas industry, is a "legal term of art". As the Court of Appeal held, there is no need to define such terms of art in a contract, as industry participants rely on the common industry meaning (though the meaning can be changed by explicit agreement of the parties to an agreement). Further, it is a reversible error for a Court interpreting a contract to ignore the industry standard meaning of a legal term of art. With respect to a "Working Interest", the Court of Appeal held that it "constitutes the percentage of ownership that an owner has to explore, drill, and produce minerals from the lands in question."

In this case, the trial judge erred when he failed to apply the industry standard definition of "working interest" as it was used in the agreement between IFP and PCR. Where the trial judge concluded that PCR only conveyed a 20% interest in minerals produced through thermal or other methods, the Court of Appeal found that, on the clear language of the contract (and considering the industry standard meaning of "working interest"), PCR clearly conveyed a 20% working interest in all minerals in the Eyehill Lands.

Use of Evidence of Surrounding Circumstances

The Court of Appeal also found that it is an error of law for a trial judge not to consider evidence of the circumstances surrounding a contract's formation. As the Court of Appeal held, evidence of the surrounding circumstances is admissible even if there is no ambiguity in the contract. In addition, the presence of an "entire agreement" clause does not preclude evidence of the surrounding circumstances.

In IFP Technologies, the Trial Judge erred when he found that the lack of ambiguity in the agreement between IFP and PCR meant that he could not consider evidence of the circumstances surrounding their agreement, which was evidence of the parties' objective intentions. At the same time, the Court of Appeal held, the Trial Judge erred when he considered evidence of the parties subjective intentions, which should have been inadmissible under the parol evidence rule (which prohibits such evidence absent any ambiguity in the contract).

Industry Implications

For participants in Alberta's oil and gas industry, the Court of Appeal's clear definition of a "working interest" will provide certainty when entering into agreements. However, it remains to be seen what other terms will be held to be "legal terms of art" with an industry standard meaning. Prudent parties will still take steps to define with precision the any terms in their agreements where ambiguity in the definition has the potential to affect the rights being granted or interests being conveyed.

In addition, parties involved in contractual disputes will take note of the Court of Appeal's finding that essentially, evidence of the surrounding circumstances is always relevant to contractual interpretation. Wise parties asking the Courts to interpret their agreements will come to Court prepared with evidence of the surrounding circumstances which supports their position.