Take or Pay, Disclaim or Stay: Alberta Clarifies Eligible Financial Contract Boundaries

Eligible financial contracts (EFCs) cannot be disclaimed in proceedings under the Companies’ Creditors Arrangement Act (CCAA). For commodity suppliers, lenders and restructuring professionals, this raises a recurring question: when is a physical supply contract an EFC? No appellate court has yet interpreted the Eligible Financial Contract Regulations, enacted in 2007. In Canacol Energy Ltd (Re), Justice Feasby of the Court of King’s Bench of Alberta provided detailed guidance and expressly disagreed with earlier authority.

Background

Canacol Energy Ltd. and its subsidiaries (collectively, the Canacol Group) are in the business of exploration and development of natural gas in Colombia. They obtained relief under the CCAA after declining gas production left them unable to meet delivery obligations, resulting in charges for unutilized transportation capacity and penalties for non-delivery. The CCAA proceedings have been recognized in both the United States and Colombia.

The Canacol Group sought to disclaim several categories of contracts to facilitate its restructuring. The counterparties resisted, arguing the contracts were EFCs that could not be disclaimed. The agreements at issue included:

• Long-term “offtake agreements” for the sale of natural gas, structured as “take or pay” contracts with minimum delivery obligations, penalties for non-delivery and fixed monthly pricing adjusted annually on contractually agreed terms rather than market benchmarks
• “Ship or pay” transportation contracts requiring fixed monthly tariff payments regardless of pipeline utilization
• A long-term liquefied natural gas (LNG) logistics services contract to transport LNG supporting certain offtake agreements

Modified Disclaimer Procedure

The Canacol Group sought the Court’s permission to disclaim these contracts. Rather than following the disclaimer procedure set out in Section 32 of the CCAA, the Canacol Group brought an application seeking disclaimer orders from the Court, which they could then seek to have recognized and enforced in Colombia. 

The Law on Eligible Financial Contracts

In opposing the Canacol Group’s proposed disclaimers, the respondent contractual counterparties (Respondents) argued that their agreements were EFCs which could not be disclaimed under Section 32. EFCs are defined in the Eligible Financial Contract Regulations and are generally risk management agreements — such as derivatives agreements, repurchase agreements and margin loans — that are given special protections in insolvency proceedings in Canada.

The Court found that determining whether a contract is an EFC requires examining (1) the contract itself, and (2) the market in which the contract exists. This contextual determination turns on whether a contract has a financial purpose distinct from any physical supply obligation. Subjective intentions carry no weight unless they were communicated to the counterparty prior to contracting or use of the type of contract was so well known in the industry that all market participants may be presumed to understand the purpose of the contract. The determination should be based on the objective nature of the contract at the time of contracting, not a retrospective analysis of how it operated.

The Colombian Market and the EFC Analysis

The Court held that whether the agreements were “derivatives agreements” must be assessed in the context of the relevant market. The Court will, in turn, look at the relevant market to determine whether an agreement has a financial purpose. The Court found there were limited opportunities for the Respondents to obtain alternative supply if the Canacol Group ceased supplying natural gas. 

The Court determined that none of the agreements at issue were EFCs, having regard to the following contextual analysis:

1. There was little evidence of an active derivatives market in Colombia
2. Regulated-market agreements did not function as hedges because price increases were passed through to end users
3. The secondary market was too small for the contracts to be seen as hedging against it
4. The true purpose of most long-term supply agreements was supply certainty
5. Fixed pricing was a practical necessity due to the absence of a liquid market for price discovery

The Disclaimer Analysis

The Canacol Group and the Monitor believed the contracts needed to be disclaimed to facilitate restructuring as a going concern. Participants in the Canacol Group’s ongoing sale process reinforced this view, and without renegotiation or disclaimer, there was a real and substantial risk that the sale process would not result in any going-concern transaction.

The Court found the disclaimer appropriate, having regard to this evidence, and that the Respondents had failed to make out financial hardship as a result of the disclaimer. 

Key Takeaways

This decision clarifies the proper approach to determining whether a particular contract falls within the prescribed categories of EFCs. The Court held that the analysis is objective and must focus on the nature of the contract and the market in which it exists. The assessment must be based on information that is known or reasonably knowable at the time of contracting and not with the benefit of hindsight. Certain Respondents have sought leave to appeal the decision to the Alberta Court of Appeal.

For more information, please contact the authors or any other member of our Restructuring & Insolvency group.