Bankrupt Companies’ Environmental Obligations

By ,


Una Jefferson: Would you start by telling us how Alberta’s System for ensuring oil and gas companies close and reclaim wells properly is supposed to work and how it’s worked in practice?

Fenner Stewart: The regulator in question is the Alberta Energy Regulator and it uses a program, the Licensees Liability Rating Program to ensure that well sites are abandoned and reclaimed. To abandon a well means to place permanent plugs in the well hole, and remove all equipment. To reclaim the well is to put the land in the original condition prior to drilling or as close to it as possible. The regulator does not require performance bonds. A performance bond is deposited money that guarantees the fulfillment of abandonment and reclamation application. Instead, it uses a Liability Management Ratio, which is the total deemed assets of the company over its total liabilities. When that ratio falls below a set standard, then the regulator may require a performance bond at that time. Companies are required to provide these liability management ratios on a monthly basis and the regulator monitors the balance between assets and liabilities. The underlying reasoning for this is that as long as the company has more assets than liabilities, it will always be able to meet its abandonment and reclamation requirements.

Una Jefferson: As I understand that this case was about conflict between federal bankruptcy law and provincial environmental regulations. What was the nature of this conflict?

Fenner Stewart: I’ll start by introducing the basic constitutional principle that underpins the conflict. When there’s an area of regulation in which the province and federal government are at the exact same time regulating, and there’s a conflict between the two, the federal law says to do one thing, the provincial law says to do something else, and that conflict prevents the citizen from doing both things at the same time. In those sorts of cases, the federal law trumps the provincial law. The whole issue here is whether the federal law and provincial law conflict. Because if they do, then the provincial law will be read down to the degree that it conflicts with a federal law.

Una Jefferson: I saw that you were cited in the Supreme Court’s decision on this question of federal penalty.

Fenner Stewart: Yes I was, it was a great honor and I’m very pleased. So put that principle into the context of this case, when a drilling company goes bankrupt, the regulator, in this case, the Alberta Energy regulator, does not allow the trustee in bankruptcy, which would be Grant Thornton in this case, to take and sell the bankrupt’s valuable assets for the secured creditors. So again, a trustee comes into the situation, liquidates all the assets, gets as much money as it possibly can and then allocates that to the secured creditors in the ranking order that exists in bankruptcy. That’s how it would work. But in this case the regulator stepped in and said, you can’t do it that way in this case, you also have to take the bankrupts negative value non producing wells and reclaim them or sell them or post a security to cover the environmental liabilities associated with those negative value assets before they’re going to allow the sale to go through it. When the regulator refused to facilitate the sale, the trustee for Redwater said that the the regulator’s authority to force them to do one of these three things ran afoul with the federal bankruptcy law. It argued that when the regulator was trying to impose one of these three conditions, it was actually trying to collect a debt as a creditor and was attempting to use provincial law to jump the queue, budding in line of other creditors who by federal law had priority to the proceeds from the sale before the regulator did.

Una Jefferson: I’m wondering if you can tell me a bit more about the federal bankruptcy law because I took a quick look and there are provisions in there for what happens when there are environmental obligations that need to be met by the bankrupt party. But the Supreme Court’s decision says something along the lines of the special nature of property ownership in the oil and gas industry because of which these provisions can’t be interpreted as usual. Why is this?

Fenner Stewart: There had been amendments to the federal bankruptcy law that accommodate, environmental clean-up. To speak in general terms it is basically based on the principle that if a company owns, say a mining site or owns the land, after that land is reclaimed, it can be sold for other purposes, so it has value. In upstream oil and gas activities, that’s drilling activities, a company doesn’t own a site, it only owns the working interest in the property, which is the right to go on the land and drill for oil and gas. It’s not the real property, the actual physical site which in this case is usually owned partly by the province and partly by probably a farmer. So there’s no actual property as commonly thought that could be reclaimed and then sold to cover the costs of reclamation. So in other words, if an oil and gas company only owns the right to go on the line and produce oil and gas, if there’s no oil and gas to produce any longer where that well was drilled, the interest has no redeemable value. Therefore, environmental protection under the Bankruptcy Act doesn’t quite work because the property interest doesn’t have any value. That is after you reclaim the land, the province couldn’t just seize and sell the property to cover the cost. And that’s basically how it usually worked. Now, what was being argued here is that those environmental provisions would be the only environmental provisions that the bankruptcy act contemplated. So if it didn’t work in this case, then too bad.

Una Jefferson: Is an environmental regulator a normal creditor or do they have special status, meaning they get paid first? My understanding of the Supreme Court decision is that it says the Alberta Energy regulator is not a normal creditor. Is that a fair characterization?

Fenner Stewart: Yeah, that is a fair characterization.

Una Jefferson: There was another Supreme Court case back in 2012 called Newfoundland and Labrador versus Abitibi Bowater, which seems to be similar. In this case, the government of Newfoundland and Labrador was trying to enforce environmental orders against pulp and paper company, Abitibi Bowater, after that company had been into financial trouble. But in this case, the Supreme Court ruled against the government saying that they were a regular creditor and had to line up. So why did these decisions differ?

Fenner Stewart: This is a great question because it really goes to the heart of the case and it goes to the heart of the distinction in what the case really hinges on. So Abitibi Bowater, a Quebec based company, announced that it was going into restructuring and closing operations in Newfoundland. So restructuring is kind of like bankruptcy. In bankruptcy, usually the company doesn’t exist any longer and all the assets are sold and then distributed to creditors. With the restructuring, the company is able to write down a lot of its debts, but the company after the restructuring will still exist. The restructuring provisions were created in the 1930s during the great depression and creates an opportunity for businesses to continue on for the benefit of the people that do business with that company and also the employees. So restructuring is slightly different than bankruptcy, but they actually use the same act on it, and the procedures are relatively the same. So it didn’t really make a difference in this case. So it was a restructuring case, not a bankruptcy case. That’s the first distinction. The government of Newfoundland heard of the news and reacted by seizing all of the in-province properties of Abitibi. The province then imposed environmental orders upon Abitibi that the company could not meet because it no longer had access to the land to meet those environmental order. So when the company failed to meet the requirements of these environmental orders, the province posed high fines for non-compliance with the environmental orders. Now this was a situation where when the company was leaving the province, which was going to be quite an economic loss for the province, the province did everything that it could to generate as many claims against the company as it possibly could. It seized all the property. It actually did that through a piece of legislation that it created. And then it created these environmental orders that the court deemed it could never meet because it didn’t have access to the land and then imposed fines upon it to degenerate other liabilities against the company. Then the province asserted, that it had a super priority for collecting such fines prior to the claims than any other creditors. In other words, and this is what the court found, Newfoundland was acting like a creditor who was attempting to frustrate the bankruptcy process and take the proceeds from Abitibi that the federal bankruptcy law dictated belong to other creditors. So this is a classic case of when a company would run a fowl with the bankruptcy law. And key to that is being deemed to be a creditor. If a province is a creditor, then it has to abide by the ranking of creditors and the process for bankruptcy. If it is not a creditor, then it’s doing something other than trying to collect a debt. It’s not subject to the bankruptcy yet. So that the other case, the other side of the distinction is what happened in the case of question. By comparison, the regulator in Alberta was acting as a disinterested regulator, not a creditor, because it was merely ensuring that the bankrupt party complied with its legal obligation. In other words they were merely looking to enforce the public interest and not attempting to extract a financial benefit through the manipulation of law. Anytime a regulator imposes regulation upon a company, to comply with that regulation costs money. So it does get lost in the weeds into when a regulator is acting as creditor and when a regulator is just enforcing the law when both actually cost money and both will reduce the amount of money that will be given to the creditors in the final incident. So it’s a fine distinction in some cases.

Una Jefferson: In the case of Abitibi, do you think it was important that the government of Newfoundland seemed to be acting in retribution?

Fenner Stewart: It’s not a requirement of the test. So legally speaking, no. But, factual circumstances somehow inform judges’ opinions when you take the totality of the case and look at it. And certainly in that case Newfoundland was at a more extreme end of the spectrum.

Una Jefferson: If a disinterested environmental regulator is no longer considered to be a creditor, what do you think this will mean for Alberta’s Orphan-well problem? Do you think this will reduce the number of wells with nobody to pay for their closure and cleanup in Alberta?

Fenner Stewart: Actually I don’t. The judgment can’t really fix the Orphan-well problem. I think that’s more of a problem with the provinces’ overall environmental protection. And I think it’ll take regulatory reform to fix that.

Una Jefferson: Will this affect the willingness of financiers to lend to potentially risky oil and gas ventures?

Fenner Stewart: No. In terms of affecting finance, the court has merely confirmed what the law has always been, at least since the early 1900. So it’s business as usual. This has always been this. So the lending risk created by abandonment regulations are exactly the same as what the business has been for the last 30 years. It doesn’t change the risk profile at all. At least the risk profile as it relates to these regulations.

Una Jefferson: So where do you think its impact will be?

Fenner Stewart: Well, I think if it would’ve went the other way it would’ve changed a lot, then it would have had a significant impact on both. When a court reaffirms the status quo, it doesn’t really change anything. I think that the fact that we got into this orphan-well problem in the first place is certainly not generated by the Redwater case. It was due the fact that there were so many companies that were going into bankruptcy with such a large amount of unreclaimed non-producing wells. It had nothing to do with the case and it had everything to do with the regulatory architecture that was in place at the time. That’s what needs to be reformed to avoid this sort of thing in the future.

Una Jefferson: I’m curious, what’s your prescription there?

Fenner Stewart: Although there is a very detailed mechanism for how to do a well reclamation and abandonment, there’s no timeframe. So there’s no obligation for an oil and gas company to abandon wells unless there are orders made by the regulator to do so. So many wells just are left without being abandoned and reclaimed because there’s no timeframe to do it. So let’s say that if a well has not been producing for 10 years, it needs to be reclaimed after that. I haven’t really contemplated what would be the optimal time frame, but it has to be a timeframe that would prevent companies from just procrastinating and getting this work done. That’s the key.