Overview
In the recent decision of Invico Diversified Income Limited Partnership v NewGrange Energy Inc, 2024 ABKB 214 ("NewGrange"), the Alberta Court of King's Bench clarified when gross overriding royalties ("GOR") can be vested out of a debtor company's estate pursuant to a reverse vesting order ("RVO"). The Court allowed GORs to be vested off under the Applicant's, Invico Diversified Income Limited Partnership ("Invico"), proposed RVO, finding the GORs to be mere contractual rights and not proper interests in land.
Background Facts
Free Rein Resources Ltd. ("Free Rein") is the debtor company in proceedings under the Companies' Creditors Arrangement Act, RSC 1985, c C-36 ("CCAA"). Invico, as Free Rein's first secured creditor, stalking horse bidder, and the proposed purchaser in these CCAA proceedings, applied for approval of a corporate share transaction for substantially all of Free Rein's business and property using an RVO structure. The main issue before Hollins J was not the use of the RVO, but rather whether two GORs held by each of NewGrange Energy Inc. ("NewGrange") and a group of 19 shareholders of Free Rein could be vested off title to certain lands into a residual trust as unsecured claims, as required under Invico's proposed transaction.
The first GOR arose from the non-arm's length sale of certain oil and gas assets by NewGrange to Free Rein, which sale terms included a 5% GOR granted back to NewGrange (the "NewGrange GOR"). Free Rein granted the second GOR to a group of shareholders after the latter funded Free Rein's recompletion of a particular well (the "Shareholder GOR").
The Decision
Justice Hollins began her analysis by determining whether the GORs in issue constituted interests in land, or mere contractual rights to receive royalty payments, with the courts being limited in their ability to vest off the former. The well-established analysis known as the Dynex test, used to determine whether a GOR constitutes an interest in land, is as follows:
- the language used in describing the interest is sufficiently precise to show that the parties intended the royalty to be a grant of an interest in land, rather than a contractual right to a portion of the oil and gas substances removed from the land; and
- the interest, out of which the royalty is carved, is itself an interest in land.
In regard to the NewGrange GOR, the Court found that while the relevant granting clause in the royalty agreement explicitly stated that the GOR would be an interest in land, the assignment clause in the same rebutted such intention. The assignment clause allowed Free Rein to assign the lands, but Free Rein would remain liable to NewGrange for the royalty payments in such circumstances. The wording of the assignment clause was a clear indication that the NewGrange GOR appeared to follow Free Rein and not the land, with such language being fundamentally inconsistent with the granting of an interest in land.
On the second step of the Dynex test, Hollins J's analysis turned on the principle of nemo dat quad non habet, or "no one can give what he does not have". Free Rein granted the NewGrange GOR on October 30, 2018, but did not take title to the oil and gas assets until November 30, 2023, pursuant to the terms of the applicable purchase and sale agreement. The Court found that the timing of the acquisition of interests was then crucial to their determination of the issue, specifically that the NewGrange GOR could not be a true interest in land as Free Rein granted the royalty to NewGrange before it had acquired the underlying interest itself. The NewGrange GOR could then only be a mere contractual right.
The Court found that the Shareholder GOR neither purported to be an interest in land nor was treated as such, making the Shareholder GOR a contractual right for the following reasons:
- the royalty agreement for the Shareholder GOR granted the shareholders' a right in substances produced from a certain well and not in the land or substances produced from the land;
- the assignment clause was identical to the clause contained in the royalty agreement for the NewGrange GOR and, therefore, attracted the same treatment from the Court;
- the royalty agreement provided that in the event of a corporate sale of Free Rein the GOR would terminate indicating an interest in the operator and not the land; and
- there was no evidence to support that the Shareholder GOR was registered or constituted a registerable interest.
Having concluded that the GORs did not constitute interests in land, the Court ultimately approved the proposed transaction and RVO with both GORs being vested off as unsecured claims into the residual trust. The Court did so without determining the issue of whether it would have had the power to do so in any event if the GORs were interests in land.
Implications and Key Takeaways
The Court's decision in NewGrange affirms that GORs are not sacrosanct, and parties must consider and analyze the true nature of the royalty granted to determine whether it may be vested off as part of an insolvency proceeding. This analysis will have an impact upon the valuation of a debtor's estate, structuring of transactions respecting oil and gas interests, and terms of vesting orders, including RVOs. Justice Hollins' reasons also serve as an important reminder to contracting parties seeking to convey an interest in land to take care with the language used across all aspects of a transaction to properly describe the interest and to prevent the creation of a mere contractual right, where such creation is not the desired outcome.
Fasken's Robyn Gurofsky and Anthony Mersich acted as counsel for Invico in this matter.
The views and opinions expressed in this article belong to the authors and should not be relied upon as a substitute for independent legal advice. Should you wish to discuss the particular circumstances of a case further, any one of the members of Fasken's Insolvency and Restructuring team would be happy to do so with you.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
