To date, there has been little treatment of mineral royalties in Companies’ Creditors Arrangement Act (Canada) (“CCAA”) proceedings. Given the current weakness in the oil and gas and mining sectors, any case law that informs what assets will be available to benefit creditors and how royalty interests will be treated will be of value.

In a recent decision, the British Columbia Supreme Court shed some light on the treatment of mineral royalties. If the “rooting interest” is to have the Court grapple with the most interesting problem possible, the decision in Walter Energy Canada Holdings, Inc. (Re), 2016 BCSC 1746 (“Walter Energy Canada”), manages to fall somewhat short. Nonetheless, there is some guidance to be taken from Madam Justice Fitzpatrick’s reasons.

Background

Walter Energy Canada Holdings Inc. (“Walter Energy”), owned three mining properties in British Columbia and was under CCAA protection. It applied for court approval of a going-concern sale of its mining properties to a company called Conuma Coal Resources Limited (“Conuma”) pursuant to section 36(1) of the CCAA.

The transaction contemplated the sale to Conuma of real property, mineral tenures, buildings, equipment, current assets, water rights, intellectual property and other assets. Certain contracts were to be assigned to Conuma but there also were certain “excluded contracts” that would not be assumed by Conuma.

All stakeholders but one supported the sale. The objecting party was Kevin James (“James”), who held a royalty concerning one of the mines, Wolverine. James argued that his royalty rights ran with the land, such that Walter Energy could not transfer the Wolverine coal licenses to Conuma without regard for those rights and that an approval and vesting order could not extinguish his rights. Walter Energy’s position was that the royalty was merely a contractual right to be paid monies on the production and sale of coal by Walter Energy.

The “Interest in Land” Question

Much of the analysis in Walter Energy Canada focused on the characterization of the royalty – whether it did or did not create an interest in land – the alternative being that the royalty would represent a mere contractual interest. Such analysis is common in cases involving mineral royalties and Justice Fitzpatrick followed the existing case law and determined that the royalty held by James was merely a contractual right.

In so doing, Justice Fitzpatrick dismissed arguments by James that the royalty represented a perpetual obligation, that it was stated to be binding on successors and assigns, and that there were provisions requiring his consent to any assignment:

[69] … These clauses do not detract from the essential nature of the right granted to Mr. James found in clause 2.1, nor do they enhance his ability (or lack of ability) to control the petitioners’ disposition of the Properties after his transfer of them.

The Court further observed that James could have used other means to control further disposition of the properties, noting that another royalty holder, Pine Valley Mining Corporation (“PVM”) had agreements that included a restriction on the sale of interests subject to their royalty, required that any purchaser of the properties assume the royalty obligations to PVM, and also included a grant of security interest to PVM in respect of certain mineral titles. The question of whether PVM’s royalties represented interests in land was not before the Court, as PVM had “reserved its rights in relation to its royalty agreement pending anticipated negotiations between PVM and Conuma”, but the contrast drawn by the Court may be telling.

Dealing With a Contractual Royalty

The transaction contemplated that Conuma would not assume the royalty agreement, and thus would not have any obligation to pay the royalty to James. Having characterized the royalty as merely a contractual right, the Court classified the agreement as an executory contract for the purposes of CCAA proceedings.

An executory contract is one where neither party has fully performed their obligations and where contractual obligations are linked so that performance by one party is not required unless the other party is willing and able to perform (i.e. payment for coal production between the parties).

The significance of the Court having classified the royalty sharing agreement as an executory contract, is that the CCAA gives rise to the statutory power for a debtor company to disclaim a royalty sharing agreement pursuant to s. 32 of the CCAA. If disclaimed, a royalty owner then has a provable claim pursuant to section 32(7) of the CCAA that is addressed in the CCAA process along with any other stakeholder claims.

Thus, once his royalty agreement was found to not create interests in land, James was on a weak footing. He argued that it was unfair for the Court to approve a sale without protection of his rights. While Madam Justice Fitzpatrick did not entirely dismiss the impact on James as a valid consideration, she also found that it did not override the benefit to the overall group of stakeholders:

[78] I also see no unfairness in the Conuma transaction being approved without reference to Mr. James’ rights under the [Royalty Sharing Agreement]. As in any such transaction, a purchaser will assess the cost/benefit of assuming any contracts held by the debtor and make a determination on that basis. While Mr. James has been on the losing end of that assessment by Conuma in relation to the [Royalty Sharing Agreement], that does not mean that the process was unfair or unreasonable.

[79]It certainly does not lead to the conclusion that the Conuma transaction is not supported by the CCAA, s. 36 factors, as alleged by Mr. James. I agree that the RSA is a consideration for the court in the context considering that transaction. However, in the overall context of the APA, and the admittedly overwhelming benefit to the entire stakeholder group (which includes Mr. James), Mr. James’ disappointment in the outcome cannot rule the day.

Given the current weakness in the energy and mining sectors, royalty-holders may wish to examine their agreements closely to evaluate how they might fare if the operators obligated to pay the royalties become insolvent. Depending on whether the royalty grant language stands up to traditional “interest in land” scrutiny, they may not have what they think they have.