Court of Appeal of Alberta to Reconsider Whether Gross Overriding Royalties Run With The Land

Court of Appeal of Alberta to Reconsider Whether Gross Overriding Royalties Run With The Land

A recent chambers decision holding that gross overriding royalties (“GOR”) can be vested off in a reverse vesting order (“RVO”) is on its way up to the Court of Appeal of Alberta (the “ABCA”). The ABCA has granted leave to appeal Invico Diversified Income Limited Partnership v NewGrange Energy Inc, 2024 ABKB 214 (“Invico”).

The Chambers Decision

In Invico, Justice Hollins found that the GOR held by NewGrange Energy Inc (“New Grange”) was merely a contractual right and did not “run with the land”. This allowed the Court to vest the GOR off in an RVO in favour of a stalking horse bidder, Invico Diversified Income Limited Partnership, without further restraint.[1] In coming to this decision, the chambers judge applied the Dynex test, pursuant to which a royalty interest can be an interest in land if:

1. 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
2. the interest, out of which the royalty is carved, is itself an interest in land.[2]

For the first prong of the Dynex test, the chambers judge determined that express language in the royalty agreement granting an interest in the land merely created a rebuttable presumption that the GOR ran with the land.[3] The presumption was rebutted by an assignment clause in the royalty agreement allowing Free Rein Resources Ltd (“Free Rein”), the now debtor company subject to proceedings under the Companies’ Creditors Arrangement Act, RSC 1985, c C-36 (“CCAA”), to assign the lands, but holding Free Rein liable for the royalty payments.[4]

On the second prong, the chambers judge held Free Rein did not have an interest in the land to give because the royalty agreement establishing the GOR pre-dated the purchase agreement which permitted the taking of title of the oil and gas assets.[5] Thus, Free Rein could not give what it did not have.

As a result, the chambers judge determined the GOR was merely a contractual right and, given that the test to order an RVO was otherwise cleared, could vest off the GORs into a residual trust.[6]

Leave to Appeal

NewGrange sought leave to appeal the decision that the GOR did not constitute an interest in the land and should be vested off the title to lands.[7] NewGrange did not object to the approval of the RVO, nor the chambers judge’s finding on a second GOR held by shareholders.[8]

In a Single Appeal Judge decision, Justice Woolley agreed with NewGrange that there were “serious and arguable grounds that are of real and significant interest to the parties” which warrant review by the ABCA.[9] Specifically, Justice Woolley granted leave to appeal on the following questions:

1. “whether an assignment clause which requires the assignor to remain liable for payment of a royalty in certain circumstances rebuts an expressly stated intention that the GOR is an interest in land”; and
2. “whether a single transaction in which a royalty agreement is executed prior to the execution and closing of the associated asset purchase agreement fails to satisfy the second part of the Dynex test.”[10]

The standard that applications for leave to appeal must meet in CCAA proceedings is a high bar with “considerable deference” to the chambers judge.[11] But in this case, Justice Woolley found the appeal was “sufficiently meritorious ‘to justify delaying the ultimate disposition of the issue under review’”.[12] Further, the two questions raised for appeal were of sufficient importance to the practice to merit review by the ABCA because the use of GORs in the oil and gas industry is a common practice.[13]

The determination of whether a GOR runs with the land and would or would not be appropriate to vest off is a highly fact-based determination. However, in this case, the royalty agreement used was, at least in part, based on the CAPL template royalty agreement,[14] and the manner in which a court would interpret such provisions will be eagerly awaited clarification for the oil and gas industry. As well, it will be interesting to see how the ABCA rules on the second prong of the Dynex test as it relates to the issue of the royalty agreement pre-dating the purchase and sale agreement. The Court may provide some guidance in drafting such agreements that may allow future acquired asset to be properly included in a royal agreement and foreclose any arguments that the after acquired asset was not an interest in the land.

The decision from this appeal will be eagerly awaited by the industry and restructuring professionals alike. McMillan’s Restructuring & Insolvency Group will be well-positioned to help your business navigate the commercial impacts of the ABCA’s decision.

[1] Invico Diversified Income Limited Partnership v NewGrange Energy Inc, 2024 ABKB 214 at paras 106, 116 [Invico ABKB].
[2] Invico ABKB at para 34, citing Bank of Montreal v Dynex Petroleum Ltd, 2002 SCC 7 at paras 21–22.
[3] Invico ABKB at paras 46–49. In other words, the fact that the royalty agreement provided that: “The [royalty] is intended to be an interest in land in the [relevant lands] and to be a covenant running therewith” was, by itself, not determinative of whether the GOR was in fact an interest in land.
[4] Invico ABKB at paras 89, 106.
[5] Invico ABKB at paras 43, 102–105.
[6] Invico ABKB at para 106.
[7] NewGrange Energy Inc v Invico Diversified Income Limited Partnership, 2024 ABCA 244 at para 1 [Invico ABCA].
[8] Invico ABCA at para 2.
[9] Invico ABCA at paras 11, 14.
[10] Invico ABCA at para 15.
[11] Invico ABCA at para 13.
[12] Invico ABCA at para 14, citing Mudrick Capital Management LP v Lightstream Resources Ltd, 2016 ABCA 401 at para 51.
[13] Invico ABCA at para 16.
[14] Invico ABKB at para 88.

by Michael Briggs, KC; Sean Ralph; Adam Maerov; Spencer Klug; Lena Clayton (Summer Law Student)

A Cautionary Note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2024