Skip Navigation

Reversal of Gas Cost Allowances Due to Insolvency on the Rise

January 21, 2018

Alberta Energy has increasingly been targeting insolvent lessees and the historical gas cost allowances claimed by those insolvent companies.

Alberta Energy deducts allowances for capital and operating costs and custom processing fees incurred and paid in Alberta for compressing, gathering and processing its royalty share of gas and gas products through the Crown share of allowable costs. Accordingly, there are three allowances available from the Crown: capital cost, operating cost and custom processing fee allowance.

Lessees report gas cost allowances annually to Alberta Energy, who reviews these records. Upon review, Alberta Energy may conduct an audit of those amounts and determine that a recalculation of the gas cost allowances is required. Alberta Energy may also reverse the gas cost allowance credits if audit or review requests are not completed or complied with. This reversal occurs whether or not there are actually any royalty amounts outstanding to Alberta Energy under the gas cost allowance. Put another way, the reversal occurs whether the gas cost allowance claimed by the lessee was correct or not.

If such a reversal occurs, the lessee will owe outstanding royalty amounts under the mineral agreement. The periods covered for examining gas cost allowances under such audits can extend back up to five years from the current production year, as per section 38(6) of the Mines and Minerals Act (Act). 

When an insolvent lessee receives an audit of its gas cost allowance credits, this request will be received by the receiver or trustee (collectively, the Trustee) appointed over the insolvent lessee’s estate. Generally, the Trustee will not incur expenses to comply with such audit requests as Alberta Energy would only have an unsecured claim against the insolvent estate and if the assets are insufficient to pay the secured creditors in full, there is no motivation or requirement to complete such audits.

However, a failure by the insolvent lessee to comply with such audit requests can result in Alberta Energy reversing all of the gas cost allowances claimed by the insolvent lessee for the particular period being audited, which can impact a number of parties. For example, this may affect parties who have previously purchased mineral agreements or facilities from the insolvent lessee, working interest partners (WIPs) or joint venture partners.

The Crown’s position regarding the lease of the insolvent entity is that, pursuant to section 91.1 of the Act and section 2 of the Natural Gas Royalty Regulation, 2009, it is entitled to pursue any remedy available to clear these now existing royalty arrears, including cancelling the mineral agreement in accordance with section 45 of the Act.

These remedies include pursuing payment from current leaseholders (even where reversals were for periods before current leaseholders acquired their interest in the mineral agreements or facilities) and WIPs. Accordingly, these actions by Alberta Energy could have a significant impact on other parties not involved in the insolvency proceeding if Alberta Energy is able to pursue third-party purchasers or WIPs for the purported royalty arrears of the insolvent corporation.

One example where this occurred was the receivership of Waldron Energy Corporation (Waldron). Alberta Energy sought to enforce Waldron's unpaid royalty obligations (resulting from the reversal of gas cost allowance credits), against a purchaser who acquired Waldron's mineral agreements pursuant to an asset purchase agreement between it and Waldron's court-appointed receiver.

In this case, the purchaser was the beneficiary of a sale approval and vesting order (SAVO) that expunged any obligations, claims, encumbrances and liabilities of Waldron as against the mineral agreements. Alberta Energy took the position that the definition of "permitted encumbrance" in the purchase and sale agreement and the SAVO was sufficient to allow its royalty claims to continue against the assets acquired by the purchaser. According to Alberta Energy, this obligation to pay outstanding royalty amounts continued with the mineral agreement acquired by the purchaser, notwithstanding it was solely an obligation incurred by Waldron.

In many cases, an approval and vesting order should provide adequate protection for third-party purchasers who participate in an insolvency proceeding. However, in cases where the asset sale occurred prior to insolvency, it is unclear whether Alberta Energy will be able to pursue payment from current leaseholders and WIPs outside of the insolvency process through the specific language contained in section 91.1 of the Act and the definition of permitted encumbrances under the purchase and sale agreements.

Blakes acts for FTI Consulting Canada Inc., the court-appointed receiver in the Waldron receivership.

For further information, please contact:

Ryan Zahara                  403-260-9628
Vanessa Williams           403-260-9788

or any other member of our Restructuring & Insolvency group.