The Alberta Court of Appeal recently ruled on a case1 dealing with the priority of claims to the bank accounts of a petroleum operator which had gone into receivership, where the operatorship was governed by the 1990 CAPL Operating Procedure. The operator had failed to pay to the non-operators revenues of approximately $300,000, having only $58,000 left in the commingled account. The Operating Procedure imposes a trust on the production revenues but also expressly allows intermingling of these funds with the operator's general funds. The money received on account of non-operators is specifically to be applied only to the intended use.2

When the receiver sold the operator's assets, there were competing claims from the non-operators and a secured creditor. The non-operators argued that there was a constructive trust created by the Operating Procedure that attached to the sale proceeds, whereas the secured creditor argued that this was limited to the amount of cash on deposit at the time of receivership. The trial judge agreed with the non-operators based on a blatant breach of trust by the operator when it used the revenues for unauthorized purposes.

The Court of Appeal confirmed that it is clear that the funds left in the bank account are protected by the trust, and that the operator was in clear breach of its fiduciary duty to not expend the trust funds in unauthorized ways. The difficulty that the Court of Appeal majority could not reconcile was whether the non-operators could trace unremitted trust funds through to the sale proceeds via a constructive trust. Given the fact that the funds were commingled with general moneys, the Court of Appeal was not convinced that the non-operators had a right which was greater than that of a perfected security interest holder. To succeed, the non-operators would have to have been able to trace the trust funds to specific assets and that was not possible in this case. The secured creditor also deserved protection and the Court of Appeal majority decided that the trust only attached to the money left in the account. The majority was critical of the common practice in the oil industry of allowing commingling of funds and decided that, because the non-operators had permitted the commingling, they should assume the burden created.

The dissenting opinion in the judgment presents a strong argument that the true purpose of a constructive trust has been ignored by the majority and that recognition of the trust in this case would serve to protect the integrity of this trust relationship which is so crucial to the industry. The argument stated that the secured creditor was a sophisticated party which was very experienced in the industry’s risks, and it had unjustly benefited from the operator's wrongdoing. The dissenting opinion fully supported the trial judge's findings.

The updated 2007 version of the CAPL Operating Procedure uses the same language as the subject 1990 version permitting commingling, although there are now additional provisions allowing the non-operators somewhat better remedies to terminate the operator’s commingling right if the operator is in distress. The annotations explain some of the prior caselaw and reflect the industry view that commingling should continue to be allowed since the cost savings to industry of allowing this practice are not overshadowed by the risk posed by the few bad industry operators.

Although changing the common practice of allowing the commingling of trust funds will likely not happen any time soon, this judgment provides a clear explanation of the risks involved with intermingling general funds and trust funds. It also is a very clear indication that the issue of how far a non-operator can go to recover moneys owed and never paid remains a matter of intense debate and principled argument. Non-operators may be able to protect themselves by insisting on segregation of funds but the practicability of doing so is quite suspect in an industry which has developed its practices around a commingled account structure. Given the split decision and the importance of the issues being examined, we may not have seen the last of this issue, and we will watch for, and report on, any further developments. Vigilance and quick action in the face of non-payment remain the non-operators' best defence!