In a pair of decisions, the Ontario Court of Appeal considered (i) whether a gross overriding royalty (GOR) is an interest in land and (ii) whether an interest in land can be extinguished by a vesting order (and, if so, when). Deliberately recognizing the commercial realities of financing an oil and gas or mining operation, and the expectations of the parties, the court’s analysis suggests that typically (i) a GOR will be an interest in land and (ii) subject to an agreement to subordinate that interest to secured creditors of the mining claim holder or the consent of the GOR holder to the vesting order, it will not be appropriate to vest out a GOR.
Third Eye Capital made loans to Dianor Resources, which became insolvent. Third Eye requested that the court appoint a receiver over Dianor’s assets pursuant to s. 243 of the BIA. The receiver ran a sales process, which generated two bids for Dianor’s assets, which largely consisted of a group of mining claims. Both bids required that the royalty interests (in favour of Essar Steel Algoma) and the gross overriding royalties (in favour of a group of companies related to the seller of the mining claims to Dianor) in the mining claims be extinguished. Third Eye was the successful bidder with a bid that included a credit bid of some of its debt as well as cash payable to the holders of the royalty and GORs intended to represent fair market value for the holders’ interests. The holder of the GORs did not oppose the sale but asked that the mining claims be transferred subject to the GORs. The judge approved the sale and granted a vesting order that transferred the mining claims and vested out the royalty and GORs. The GOR holder did not immediately appeal.
After the applicable appeal period, the holder of the GORs applied to the court to set aside the sale and to obtain an order that the GORs constitute an interest in land, presumably with the expectation that, as such, they could not be vested out.
The terms of the GORs provided that that the holders retained a 20% GOR for diamonds and a 1.5% GOR for all other metals and minerals, and expressly provided that the GORs were intended to constitute an interest in land running with the property. Notices of the GORs were registered on title to the relevant lands pursuant to the Land Titles Act (Ontario) and the mining claims pursuant to the Mining Act (Ontario).
The court of first instance held that the GORs were not an interest in land and that therefore the court had jurisdiction to vest them out. The court suggested that it might have jurisdiction to vest out the interests regardless of whether they constitute interests in land. The GOR holder appealed.
First Court of Appeal Decision: GORs can be an interest in land notwithstanding the GOR holder has no right to enter on the property or extract minerals
On appeal to the Court of Appeal, that court overturned the lower court’s decision, finding that the GORs were interests in land.
The Court of Appeal canvassed the common law prior to the Supreme Court of Canada’s decision in Dynex, which was to the effect that an interest in land could not arise from an incorporeal hereditament such as a working interest, and then described the Supreme Court’s deliberate change of the common law in response to commercial realities of financing oil and gas operations: “Providing lenders with real property interests protects them in the event of an insolvency and leads to better financing terms for borrowers.” (This may have been a harbinger of the court’s determination on the issue of whether the court could vest out interests in land.)
The Court of Appeal described how, in Dynex, the Supreme Court held that “a royalty which is an interest in land may be created from an incorporeal hereditament such as a working interest or a profit à prendre, if that is the intention of the parties.” That is, a royalty may be an interest in land “if (1) the language used in describing the interest indicates that the parties intended the interest to be an interest in land and not just a contractual right to a portion of the oil and gas substances recovered from the land, and (2) the interest out of which the royalty is carved is itself an interest in land.”
The Dianor court of first instance had held that the express statement in the GOR documents that the GORs were intended to constitute an interest in land and the registration of the GORs on title to the land and mining claims were insufficient to create an interest in land. The GOR holder had no right to enter on the property to explore and extract minerals, but only to receive a percentage of the value of the minerals: as such, the GOR was not an interest in land.
The Court of Appeal applied the test in Dynex to different effect, overturning the lower court’s decision. The Court of Appeal first noted that Dianor’s interests were working interests or profits à prendre, and therefore the second element of the Dynex test was satisfied. The Court of Appeal cited with approval the Court of Appeal decision in Dynex to the effect that “the court must ‘examine the parties’ intentions from the agreement as a whole, along with the surrounding circumstances” and found that the plain language of the agreements creating the GORs and the fact that the GOR holder registered the GORs against the lands and mining claims evidenced the parties’ intentions to create an interest in land.
The Court of Appeal in Dianor took the opportunity to clarify the Dynex test, noting that a royalty right does not have to have the incidents of a working interest (such as the right to enter on to property and to extract minerals) in order to constitute an interest in land and that the fact that the GORs are calculated on production need not defeat the clear intention of the parties to constitute the GORs as interests in land.
The Court of Appeal distinguished the decision of the Court of Appeal of Quebec in Anglo Pacific, a decision which was based entirely on the civil law rather than the common law of Dynex, stating that Dynex represents the law in Ontario.
Given the court’s finding that the GOR’s interests were interests in land, the court requested submissions from the parties with respect to whether the court had jurisdiction to vest out such interests in a receivership scenario.
Second Decision: Certain interests in land may be vested out by a vesting order
The same 3-judge panel heard the submissions on whether an interest in land can be vested out by order of the court. After an extensive canvassing of the legislative history and statutory purpose of vesting orders in Canada, the court concluded that a court has jurisdiction pursuant to s. 243 of the Bankuptcy and Insolvency Act (Canada) (BIA) to approve a sale proposed by a receiver and to grant a vesting order which both conveys title and extinguishes encumbrances on title to facilitate the sale.
The court then considered whether the motion judge, having jurisdiction to grant the vesting order, exercised such jurisdiction inappropriately in vesting out the GORs from title. The court stated that:
“in considering whether an interest in land should be extinguished, a court should consider (1) the nature of the interest in land; and (2) whether the interest holder has consented to the vesting out of the interest either in the insolvency process itself or in agreements reached prior to the insolvency.
If these factors prove to be ambiguous or inconclusive, the court may then engage in a consideration of the equities to determine if a vesting order is appropriate in the particular circumstances of the case. This would include: consideration of the prejudice, if any, to the third party interest holder; whether the third party may be adequately compensated for its interest from the proceeds of the disposition or sale; whether, based on evidence of value, there is any equity in the property; and whether the parties are acting in good faith. This is not an exhaustive list and there may be other factors that are relevant to the analysis.”
At the first stage of the test, “the court should assess the nature and strength of the interest that is proposed to be extinguished. The answer to this question may be determinative thus obviating the need to consider other factors.” The court went on to comment that a fee simple interest, as a rule, should not be vested out and also noted that an easement in active use “may also defy extinguishment”.
In considering the nature and strength of the interest:
“a key inquiry is whether the interest in land is more akin to a fixed monetary interest that is attached to real or personal property subject to the sale (such as a mortgage or a lien for municipal taxes), or whether the interest is more akin to a fee simple that is in substance an ownership interest in some ascertainable feature of the property itself. This latter type of interest is tied to the inherent characteristics of the property itself; it is not a fixed sum of money that is extinguished when the monetary obligation is fulfilled. Put differently, the reasonable expectation of the owner of such an interest is that its interest is of a continuing nature and, absent consent, cannot be involuntarily extinguished in the ordinary course through a payment in lieu.”
On the facts of the case, the Court of Appeal held that the GORs, while not fee simple interests, “did not exist simply to secure a fixed finite monetary obligation; rather they were in substance an interest in a continuing and an inherent feature of the property itself”. The court held that “[t]he interest represented by the GOR is an ownership in the product of the mining claim, either payable by a share of the physical product or a share of revenues. In other words, the GOR carves out an overriding entitlement to an amount of the property interest held by the owner of the mining claims.” Presumably, this analysis would be applicable to GORs generally unless, perhaps, the GOR secured repayment of a monetary obligation.
At the second stage of the test, consent of the third party to the vesting order would obviously be a clear indicator, but an agreement of the interest holder to subordinate its interest to a secured creditor may also be indicative of an agreement to permit the interest to be vested out. On the facts of the case at issue, the court held that no such agreement to be vested out existed. As a result, the motion judge had erred in permitting the GORs to be vested out. (The court found that no consideration of the equities was required as the factors were neither ambiguous nor inconclusive.)
However, given the conduct of the GOR holder, including its failure to file its appeal in a timely manner, the Court of Appeal refused to grant the requested order to set aside the sale. The limitation period for the appeal was 10 days from the motion judge’s decision to approve the sale, pursuant to the BIA rules. On that point, the court noted that “[a]bsent some emergency that has been highlighted in its Receiver’s report to the court that supports its request for a vesting order, a Receiver should await the expiry of the 10 day appeal period before closing the sale transaction to which the vesting order relates.” There is a suggestion that, even then, if the Receiver is aware that an appeal is under consideration, it may be appropriate not to preclude such appeal by closing the transaction. However, on the facts at issue, the Receiver was entitled to close the transaction and transfer the mining claims.
Royalty holders will be comforted by this pair of decisions of the Court of Appeal, which recognize and give effect to the intentions of the parties in granting and accepting royalty interests and the need for such intentions to carry the day when the property at issue is the subject of a vesting order.