The Liability Management Rating (LMR) program administered by the Alberta Energy Regulator (AER) has created challenges for companies seeking to dispose of oil and gas assets and has resulted in litigation in a recent receivership matter (Alberta Treasury Branches v. Redwater Energy Corp., as of the date of this post a decision had not been issued). More recently, in National Bank of Canada v. Spyglass Resources Corp., the AER entered into an agreement with Spyglass’ court-appointed receiver and manager to deal with issues that were anticipated to be encountered in the marketing and sale of Spyglass’ assets. The agreement and court approval will allow for dispositions of Spyglass’ assets to be completed even if Spyglass’ pro forma LMR falls below 1.0 as a result of the transaction (and provided there is no other material non-compliance of AER regulations by Spyglass).
The LMR program is well-known to persons active in the industry and reflects a comparison of a company’s deemed assets to its deemed liabilities. The deemed asset calculation is based on cash flow derived from oil and gas production reported to PETRINEX from operated wells and therefore subject to fluctuation based on market factors, while the deemed liabilities calculation arises from three separate regulatory programs (the Licensee Liability Rating program, the Large Facility Liability Management program and Oilfield Waste Liability program) administered by the AER. A security deposit is required if the AER determines that the licensee’s liabilities exceed its deemed assets in an amount equal to the difference between the deemed assets and deemed liabilities and effectively operates to force the pro forma LMR back up to 1.0. The AER updates each licensee’s LMR calculation on a monthly basis and makes the information publically available.
The most important aspect of the Spyglass agreement is that it will permit the completion of asset sales even if Spyglass’ pro forma LMR dips below the 1.0 threshold. This issue has presented a significant impediment for energy companies that have LMR ratings near or below the 1.0 level mandated by the AER. Many parties looking to vend assets find themselves with a small collection of properties causing LMR difficulty and a potential purchaser who is interested in acquiring the vendor’s other, higher quality assets, but with no corresponding interest in also taking on the LMR challenged assets. This can make the transaction very difficult to complete even if there is broad consensus on other material terms. For Spyglass and its creditors this issue is now resolved. The Spyglass assets have been segregated into different packages and preference will be given to bids that are for the entire package of assets (as distinct from an offer for a subset of certain assets within a particular package), but the AER will permit license transfers to occur even if the transaction leaves Spyglass’ pro forma LMR at less than 1.0 so long as 50% of the security deposit that would usually be required is posted from the net sale proceeds. Other notable aspects of the agreement include the following:
- The AER will actively participate in the Spyglass’ sales and investment solicitation process and have the opportunity to review bids, including the ability to reject non-arm’s length bids;
- $5,000,000 of the sale proceeds will be segregated for the purposes of satisfying abandonment, shut-in and suspension obligations associated with Spyglass’ properties that cannot be sold. The AER has abandoned any further claim to the Spyglass’ assets for these obligations;
- Sale proceeds from transactions that do not cause Spyglass’ pro forma LMR to fall below 1.0. will be immediately available for distribution to Spyglass’ senior secured lending syndicate; and
- The statutory super-priority charge afforded to the receiver to secure payment of its fees, disbursements and borrowings is expressly confirmed by the terms of the agreement.
The agreement with the AER in respect of Spyglass will facilitate the ability of Spyglass to transact without the usual uncertainty that a LMR security deposit will be a barrier to securing the AER’s consent to the transfer of licenses. It remains to be seen whether this will become a precedent agreement for other formal insolvency proceedings involving LMR issues. While the goal of achieving certainty is laudable, many have observed that the AER’s insistence on receiving proceeds of sale in the absence of a legislative priority is overreaching and contrary to the well-established priority regime mandated by federal insolvency laws.