Background
The continuing saga of the bankruptcy of Sequoia Resources is finally back at the trial stage. On March the twenty-fifth the Alberta Court of Appeal (ACA) directed the Trustee in bankruptcy’s challenge of Perpetual Energy’s sale of its “Goodyear” assets must precede to trial. The unanimous decision by ACA justices Patricia Rowbotham, Ritu Khullar and Jolaine Antonio took particular exception to the manner in which Perpetual Energy Inc. and associated entities -Perpetual Operating Trust (POT), Perpetual Operating Corp.(PEOC), and Susan Riddell Rose had relitigated their defense with two applications to the Masters of Chamber judge opposing the claim by PricewaterhouseCoopers’ LIT (PWC) acting as the Trustee over the estate of bankrupt Sequoia Resources.
The long saga commences in 2016 when Perpetual Energy Inc., a publicly- traded reporting issuer and its associates put oil and gas assets (and embedded environmental liabilities) up for sale. In July, Kalias Capital and Perpetual signed a letter of intent with 1986114 Alberta being created to effect the transaction. The numbered company became Sequoia Resources and was owned by Messrs. Wang and Yang. On 23 March 2018, after operating for only 17 months, Sequoia Resources applied for voluntary bankruptcy under the Bankruptcy and Insolvency Act (BIA). On 2 August 2018, the court-appointed Trustee PricewaterhouseCoopers LIT (PWC) filed a statement of claim with Alberta’s Court of Queen’s Bench stating that the asset transaction violated the BIA. (The voluminous documentation can be found at PWC. A helpful timeline of the various litigation and important Supreme Court decisions is found at the back of the 25 March ACA decision).
The starting point of this feast for law firms was the 2 August 2018 affidavit of Paul Darby of PWC. The 206-page affidavit alleges is that when the purchase and sale of Perpetual’s “Goodyear” assets (an ironic name) was consummated the value of the environmental liabilities for the non-producing wells was roughly forty times higher than the value of the producing assets.
Challenges under section 96 of the BIA relate to whether an asset “transfer at undervalue” took place or the parties were not dealing at “arms-length. Perpetual and Susan Riddell Rose, who was the President of Perpetual Energy and sole director of the operating company (PEOC) and the sole trustee of POT, quickly filed a defense and applied to the court to resolve questions and to stay the plaintiff’s application filed by the Perpetual Defendants. In October 2018, Perpetual and Riddell Rose amended their application and sought a “summary dismissal” and “striking pleadings”
“Summary dismissal” is a process to adjudicate and resolve legal disputes and are a less expensive and more expeditious way to determine actions (para. 37- first appellate decision by Justice Nixon ACA 2021). “Striking pleadings” is aimed at court backlogs by eliminating litigation where there is “no reasonable prospect of success.” According to Justice Nixon, “striking claims promotes litigation efficiency, reduces time and cost and contributes to justice by permitting all stakeholders to focus on the serious claims” (para. 30).
This general approach meant that matters stalled for months as the legal-judicial process dragged on. Hearings on the application took place before a Chambers Judge in November 2018. In August the Chambers Judge delivered an oral decision in favour of Rose and Perpetual. This decision was appealed a week later by PWC to the Alberta Court of Appeal. The written decision by the First Chambers Judge was available in January 2020. The following month a second application by Rose and Perpetual was filed well before the PWC appeal at the ACA was heard. In August 2020, Perpetual and Riddell Rose sought to strike intervenor affidavits from CNRL, Torxen, Cenovus, and the Orphan Well Association.
From May to October 2020 various affidavits were presented by CNRL, Imperials Oil , Torxen, and briefs given from the Orphan Well Association and the County of Lamont. The first appeal by PWC was heard by Justice Nixon of the ACA in December 2020. This was followed in January 2021 by the Second Chambers decision and a week following that PWC’s appeal of the second application. Four days after PWC filed its second appeal, the ACA gave its decision sending the matter to trial. Finally, the second appellate hearing took place on 10 February 2022 with written judgment at the end of the following month.
PWC as Trustee in Bankruptcy
PWC LIT is part of a huge multinational professional services firm. Its claim has merit and it has the resources to seek a declaration that the asset transfer and share transfers invalid and to go after the Riddell Rose personally and Perpetual Energy and directors. Given its notoriety and implications for corporate law, environmental law and the accounting profession the case may well make it up to the Supreme Court of Canada after another appeal to the ACA on the Queen’s Bench court decision on the PWC claim.
Significance
The significance of the case to provincial taxpayers, the energy industry, the Alberta Energy Regulator, the Orphan Well Association, and for the legal and accounting profession, is enormous. Should the courts ultimately decide that the transaction is void, this may stop similar practices to evade environmental liabilities by structuring an asset sale with no consideration of the financial resources of the acquisitor. This has been a big problem at the Alberta Energy Regulator for decades. If trustees and government regulators can go after previous owners of orphan or abandoned oil and gas wells, maybe the Alberta taxpayers will be shielded from some of the province’s regulatory mistakes. We won’t know for several years whether energy companies can still get away with that process and whether the industry-funded (also with significant loans from the taxpayers) Orphan Well Association will or will not be paying up for past sins of earlier owners. At least with PWC’s outstanding claim, lawyers, directors, and lenders will have to be very thoughtful and careful about selling a lot of environmental liabilities to unsuspecting or uninformed purchasers.
The implications for accounting and legal profession may be significant. Purchasers and vendors rely heavily on expert opinion and advice when entering into multi-million-dollar transactions. If the courts shine a light on integrity of these professional service firms in in giving structuring advice and opinions, litigation might be launched by parties to the transaction who relied on legal and accounting advice.
Another implication relates to the analysis by the courts on the question of what is the meaning of “liability.” As analyzed below, accounting and legal definitions differ with different justices of the same appeal court. This definition goes to the heart of both the “going concern” judgment of auditors and when a liability “30 to 60-years down the road” for financial statement purposes is seen differently by governments, their regulators, investors, creditors, and the courts. In other words, what could have been a financially healthy oil company might iin the future be deemed as insolvent as a result of a Supreme Court of Canada or ACA decision. The stakes are very high also for financial institutions– banks and insurers= with loans to oil, gas and oilsands producers and OSFI and the Bank of Canada are watching.
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Under the going concern assumption, an entity is viewed as continuing in business for the foreseeable future. General purpose financial statements are prepared on a going concern basis, unless management either intends to liquidate the entity or to cease operations, or has no realistic alternative but to do so. Special purpose financial statements may or may not be prepared in accordance with a financial reporting framework for which the going concern basis is relevant (for example, the going concern basis is not relevant for some financial statements prepared on a tax basis in particular jurisdictions). When the use of the going concern assumption is appropriate, assets and liabilities are recorded on the basis that the entity will be able to realize its assets and discharge its liabilities in the normal course of business.(Emphasis added) |
First Appellate Decision- January 2021
How issues are framed by courts is crucially important since they define the core legal issue from their point of view. In the view of Justice D.B. Nixon, the issues were firstly whether the share and asset transfers were “at arms-length” and not contrary to section 96 of the BIA. Second, can the Trustee PWC bring an oppression claim against Perpetual under Alberta’s Business Corporation’s Act. Third, can PWC claim for relief on the “grounds of public policy, statutory illegality, and equitable rescission.” The remaining issues were largely technical relating to a release in favour of Riddell Rose and her alleged breach of fiduciary duty to Perpetual Energy’s Operating Company.
Justice Nixon’s decision on the BIA claim was not to summarily dismiss nor strike the BIA claim of PWC against Perpetual and Riddell Rose. Justice Nixon emphasized the importance of the “factual issue” concerning the allegations of whether the purchaser exercised de facto control over Perpetual Energy Operating Company in the purchase of the Goodyear assets (paras. 97-98). “I find that the determination of the “arm’s length issue” will turn on the credibility of witnesses who were directly involved in the negotiation of the Asset Transaction,” he wrote (para. 98- emphasis added). Further, “In short, the critical factual evidence pivots on this credibility point, and the inferences that I can draw from the current record are too weak to allow me to draw the necessary conclusions on the balance of probabilities” (para. 99).
History of Regulation of environmental liabilities
The judgment explores the oppression claim and whether the assets were transferred at fair value taking into account the environmental liabilities. In analyzing questions of law and public policy, the appellate judge referred to some very interesting regulatory history. In December 1989, the Energy Resources Conservation Board (ERCB), predecessor to the Alberta Energy Regulator (AER) published Recommendations to Limit the Public Risk from Corporate Insolvencies Involving Inactive Wells. The report recommended the primary beneficiaries, or well licensees, should bear responsibility, rather than the working interest owners of the well and a proposed order as to who would bear the obligation for abandoned wells. This recommendation was rejected by the Getty government. Subsequently representatives from three industry associations formed a task force which rejected the ERCB’s proposed order of responsibility which had proposed that well licensees could be liable for the well indefinitely (para 122). No policy change was instituted and as a result the Justice properly choose not to substitute the Trustee’s policy preference to fix a regulatory regime which is exclusively a legislative prerogative.
The next question dealt with the argument that the Trustee was a legitimate “complainant” for an oppression remedy because the Trustee was a creditor. Justice Nixon went through the Redwater case and interpreted the judgment did not support regulatory obligations to clean up wells as being a “debt” or “liability” or an “obligation” (para. 138). Part of the difficulty of establishing a debt and whether the regulator “would ultimately perform the environmental work and assert a monetary claim for reimbursement” (para 140). “A contingent claim must be capable of valuation in order to be a provable claim,” wrote Nixon. The statement is relevant since the Justice rejected PWC’s assertion that the environmental liabilities were valued at over $200-million rendering Perpetual insolvent before the asset and share transfers (para. 368).
Other reasons given for why the value of the environmental liabilities were treated as nil include:
- The liability is “inchoate” as found in the ACA’s Northern Badger judgment (para. 143);
- “Insufficient certainty” that rehabilitation work would be undertaken by the Regulator who would seek reimbursement (para. 151);
- Future obligations did not equate to a current monetary claim (para. 168);
- There was no indication that abandonment notices had been given to Perpetual by the Regulator unlike the situation in Redwater (para. 173);
- Even if the Trustee was considered a creditor, the entitlement of a creditor to seek an oppression remedy is not automatic (para. 184); and
- In order to be a “provable claim” a contingent claim must be capable of valuation (para. 224).
The justice was highly critical of PWC’s statement of claim that alleged public policy breaches and statutory illegality are causes of action. At paragraph 265 he concluded “the Trustee is fishing but it has neither a hook nor a net.” In fact, the Justice said the Statement of Claim failed to demonstrate that the aggregate transactions were illegal (para. 220).
While PWC and Perpetual awaited the ACA’s hearing of the first appeal, Perpetual and Rose had initiated a second application a month after the reasoning of the First Chambers decision. This decision to file a second application before even the hearing on the appeal strikes me as premature and the second appellate decision is highly critical of Riddell Rose and Perpetual.
Second Appellate Decision- March 2022
Both appellate decisions were consistent in forcing the parties back to a trial on the evidence ending the legal skirmishing. The memorandum of judgment noted that defendants Perpetual and Riddell Rose “twice applied to the same chambers justice to have the s 96 claim dismissed.” The judgment concerns the second decision where the Perpetual defendants were successful in having the petition of PWC summarily dismissed. The ACA panel found three errors of judgment. First, the Chambers judge “focused his analysis on whether end-of-life obligations could be defined as an “obligation due or accruing due”, but failed to analyse whether end of life obligations could have an effect on the value of the assets” (emphasis added). Second, although some of the end-of-life obligations were included in the valuation only 26 per cent of the abandoned wells were included! Third, “the second application for the same relief was an abuse of the court’s process and should never have been heard” (para. 3).
The judgment first analyzes section 96 of the BIA and the “balance sheet solvency test.” Section 96 is reproduced below
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96 (1) On application by the trustee, a court may declare that a transfer at undervalue is void as against, or, in Quebec, may not be set up against, the trustee — or order that a party to the transfer or any other person who is privy to the transfer, or all of those persons, pay to the estate the difference between the value of the consideration received by the debtor and the value of the consideration given by the debtor — if (a) the party was dealing at arm’s length with the debtor and (i) the transfer occurred during the period that begins on the day that is one year before the date of the initial bankruptcy event and that ends on the date of the bankruptcy, (ii) the debtor was insolvent at the time of the transfer or was rendered insolvent by it, and (iii) the debtor intended to defraud, defeat or delay a creditor; or (b) the party was not dealing at arm’s length with the debtor and (i) the transfer occurred during the period that begins on the day that is one year before the date of the initial bankruptcy event and ends on the date of the bankruptcy, or (ii) the transfer occurred during the period that begins on the day that is five years before the date of the initial bankruptcy event and ends on the day before the day on which the period referred to in subparagraph (i) begins and (A) the debtor was insolvent at the time of the transfer or was rendered insolvent by it, or (B) the debtor intended to defraud, defeat or delay a creditor. |
Insolvency is defined under section 2 of the BIA when the value of property of the insolvent “is not sufficient to enable payment of all his obligations, due and accruing due.” Liabilities to creditors must be “provable as claims” under the BIA.
Source: Women in Law- Leadership awards
The balance sheet solvency test in this case hinges on the legal status of “liabilities” and obligations.” While Justice Nixon took a narrow view of what is a liability, this panel formed a broader interpretation. The central question is how to evaluate end-of-life obligations, principally reclamation requirements. The court accepted that the (accounting) treatment of end-of-life obligations was dependent on its purposes. Evidence from CNRL to the effect that end-of-life obligations are “ incorporated into the market value of an asset for purposes of evaluating and negotiating an asset transaction but they are included in a licencee’s financial documents, including balance sheets, as a liability was included (para 36- emphasis added). This common sense approach contrasts to Justice Nixon’s view that such obligations did not count for inclusion in a balance sheet analysis of
of solvency.
Insolvency.
At paragraph 39 the panel noted:
The narrow framing of the legal issue led to error…. As Redwater and First Appellate Decision have made clear, end-of-life obligations are an inherent point of asse value. When they do not constitute a conventional debt payable to an identifiable creditor it will be appropriate to account for them as depressing values on the left-hand side of the balance sheet. The BIA claim would not necessarily crumble because the obligations did not amount to “obligations, due and accruing due” on the right-hand side.(para 38).
Further they add “the correct legal approach is not defined by the industry’s accounting practices or the accounting evidence” (para. 3– emphasis added). This is a clear indication from the province’s highest court that conventional industry treatment or accounting treatments will no longer will be taken as a given fact. This statement will have significant implications for securities and bank lawyers, audit firms and energy boards of directors, and their accountants. The court is signaling that it will not be browbeaten by claims that a broader definition of end-of-life obligations and will not simply accept what companies and their auditors claim they are. This was made clear in the following steps.
The first appellate regarded the end-of-life obligations as “contingent – “The only issue is when they will come into existence. A well may produce for decades. However, while the Abandonment and Reclamation Obligations may not crystallize for some time, they are inevitable; no well produces forever. (para, 44 -emphasis added).
Thus time becomes the key variable when this liability becomes clearer (crystallize) in terms of regulatory. financial, legal and operational certainties. In particular, the First Appellate Decision acknowledged that Abandonment and Reclamation Obligations (often known as Asset Retirement Obligations (AROs)) “ exist whether or not abandonment notices have been issued by the Alberta Energy Regulator” and “are routinely reported on the balance sheets of oil and gas companies, including those of Perpetual Energy Parent” (para 44).
In paragraph 50, the justices criticize the chambers judge ‘s understanding of end-of-life obligations arising from regulatory enforcement. The correct interpretation is that of Justice Nixon who “made clear that end-of-life obligations are an intrinsic part of a license, existing “whether or not abandonment notices have been issued by the Alberta Energy Regulator”.” This means that regulatory inaction does not nullify the obligation. This decision has has serious implications for both the AER and the government who might ultimately bear the costs of industry-wide insolvencies and failures to reclaim their abandoned sites.
The Court then tackles the claim by the Second Chambers judge that “including end-of-life obligations in the Balance Sheet Solvency Test would immediately render many of the oil and gas entities insolvent” (para 51). The Chambers Justice worried that collapsing all debt at a given moment should not be considered insolvency like in the case of mortgages. The appeal court rejected the analogy to mortgages. The judgement references Daishowa-Marubeni International Ltd v Canada, (2013 SCC 29) where the court ”considered the tax treatment of forest tenures subject to reforestation obligations.” The Supreme Court court specifically rejected the mortgage analogy and held the forestry company’s reforestation “obligations — much like needed repairs to property — are a future cost embedded in the forest tenure that serves to depress the tenure’s value at the time of sale”(para. 53). The court then adopts another analogy- that of asbestos in a home:
It will need to be rectified sooner or later, and someone will have to pay for it. If work is underway or complete, any outstanding payment for the work may be an obligation due or accruing due. Until then, however, the house is worth less than a similar asbestos-free house. The asbestos depresses the value of the house (para. 54).
This is definitely not an analogy the oil patch wants the public to take hold, especially oilsands producers.
Another error was the Chambers Judge’s acceptance of the value of the Goodyear assets without access to the full reserve reports and their methodologies (para. 61). These reports led to confusion about what non-producing wells were included in the valuation. According to Darby’s affidavit only 26 per cent of the 2,502 wells comprising the Goodyear assets were included in the reports! These disparities were noted in the August 2019 affidavit of PWC’s Paul Darby. The final transfer of “assets” included 652 wells which were “producing to some degree,” 910 shut-in wells, and 727 abandoned wells. PWC’s statement of claim that the value of the purchased company was negative $223-million, the failure of the Chambers Judge to not consider end-of-life obligations was an “analytical error” of great consequence.
Their last task was to consider how the chambers judge examined “obligations, due and accruing due” concluding the judge’s “strict construction” of section 96 was not warranted and that “an item must be “completely constituted and presently exigible” to factor into “obligations, due and accruing due” seemed unduly narrow” (para. 74).
Abuse of Process
The justices then go on to deal with abuse of process. PWC argued that the Second Chambers decision to halt the litigation was the wrong decision and the Appeal panel agreed. The legal approach adopted by Perpetual and Riddell Rose was an abuse of process since the parties “ have a duty to bring their whole case to the court’s attention and not to reserve some aspect of the matter against the possibility of a decision in the opponent’s favour as a means of preserving a way to come at the opponent again.” The Court citied a BC Supreme Court decision (para. 82). While the second Chambers judge saw no abuse of process, the ACA held that the judge allowed Riddell Rose and Perpetual to allow the them “a second shot at the same claim, a practice this Court has consistently discouraged” (para 86). Reviewing the case law, the Court found no remedy to permit an argument to be advanced that “could have been made and the first application and was not (paras. 91, 95). In harsh language the Court admonished the defendants calling the second attempt “a blatant attempt to relitigate, making arguments that were available and reasonably should have been made at the First Chambers” (para. 98).
Takeaways
The stinging rebuke to Perpetual and Riddell Rose and criticism of chambers’ judges’ process and reasoning will probably become a more significant case than the ACA’s majority opinion on two reference questions on the federal Impact Assessment Act. This judgment reasserts in a compelling way the Alberta judiciary’s purview over defining the meaning of terms and concepts like insolvent, an asset retirement obligation, and when an “end-of-life” obligation has monetary value. This leads to the fundamental question of whether the asset retirement obligations on the books of our largest oil and gas producers are realistic or not. As witnessed through Sequoia we have a casebook example of a “pretend” sale of assets- potentially hiding what the true liabilities were- and corporate officers and regulators entering into transactions or approvals while ignoring the “asbestos in the walls.” This case may become one of the most celebrated in Alberta’s judicial history.
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