Stewart Estate V Taqa North Ltd: Three Alberta Court Of Appeal Justices Weigh In On Critical Oil And Gas Lease Issues

In Stewart Estate v TAQA North Ltd (Stewart Estate), (found here)1 the Alberta Court of Appeal reversed the decision of Justice Romaine in Stewart Estate v TAQA North Ltd (found here);2 and made findings on a number of significant oil and gas issues.

This case has something for everyone interested or involved in freehold oil and gas development, including academics, lessors, lessees, top-lessees, working interest owners, well operators and gross overriding royalty interest (GORR) holders. In a lengthy decision with each Justice issuing separate reasons, the Court of Appeal addressed these important issues:

The general principles and standard of review applicable to the interpretation of oil and gas leases, in light of the Supreme Court of Canada decision in Sattva Capital Corp. v Creston Moly Corp, 2014 SCC 53 (see our earlier blog posts about this case (found here and here); The application of provisos in oil and gas leases which allow lease termination to be avoided where production is "interrupted or suspended" as a result of a lack of or an intermittent market or any cause whatsoever beyond the lessee's reasonable control, in circumstances where the operator had determined that the relevant well had become uneconomic and then ceased producing the well for over five years; The application of the torts of trespass and conversion to sub-surface mineral rights; The range of potential remedies for trespass and conversion, including the (i) royalty approach; (ii) the "mild" compensatory or disgorgement of benefits approach, or (iii) the "harsh" compensatory or disgorgement of benefits approach. The date from which the accounting for trespass and conversion should be calculated, having regard to limitations as well as the possibility that the acceptance of royalties or shut-in payments constitute consent or leave and licence to continue production after lease termination; The obligation of GORR owners to account where the GORR holders receive a portion of production revenues after lease termination; The nature of the interests of top-lessees, including whether they have a direct claim against working-interest owners who continue production after lease termination, and whether litigation funding by top-lessees constitutes champerty and maintenance; and The ability or desirability of the Court making in rem declarations relating to interests in land and the validity of leases where there is a dispute as to who is the lessor. Each of these items is summarized below.

THE BACKGROUND

The lessees of natural gas underlying section 25-27-1W5M (section 25) pooled their interests to form a one section production spacing unit and the 7-25-27-1W4M well (7-25 Well) was drilled during the primary term of the leases. The 7-25 Well produced until July 1995 when it was shut-in and production suspended for over five years. At the time of the shut-in, much of the infrastructure was removed. The 7-25 Well was placed on production again in February 2001 in a different formation and continued producing until January 2011, when it was shut-in by a court order unrelated to the issues in this case.

A number of factors affected the economics and production of the 7-25 Well, including that it was a sour gas non-unitized well close to Calgary and other production in the area was preferentially nominated under long term sale contracts in order to deplete the reserves in advance of urban growth. Further, the primary processing facility had capacity restraints and the lessees had no working interest in the processing facility and paid a premium for processing. The plaintiffs/appellants maintained the shut-in terminated the leases and the top-leases were the valid leases.

At trial, Justice Romaine concluded that a five-year cessation in operations and production of the 7-25 Well did not terminate the leases. Justice Romaine found three of the five leases valid, notwithstanding the shut-in, because of the interpretation of the third and fourth proviso in the leases. The other two leases she refused to opine on as not all interested parties were before the Court. Justice Romaine concluded that the 7-25 Well was shut-in "for causes beyond the Lessees' reasonable control, in that it was uneconomical to produce during the shut-in period given the low price of gas and the relatively high costs of production and processing, effectively the lack of an economic market." In the event that the leases had terminated, Justice Romaine noted that the appropriate award of damages would be based on the royalty method. (para 568)

THE COURT OF APPEAL DECISION

Each of the justices of the Court of Appeal (Rowbotham J.A., McDonald J.A., and O'Ferrall J.A.) provided their own Reasons for Judgment, suggesting that the issues were controversial and capable of various interpretations. There were surprisingly few issues on which the Court of Appeal was unanimous. The key findings of interest to the oil and gas industry are summarized below.

1. Interpretation of Oil and Gas Leases

   In Sattva Capital Corp v Creston Moly Corp, 2014 SCC 53 (found here), the Supreme Court of Canada held that contractual interpretation involves issues of mixed fact and law as it is an exercise in which principles of contractual interpretation are applied to the words of the written contract, considered in light of the factual matrix. This characterization would normally lead to deference being given to first instance decision-makers, unless an extricable question of law is identified.

   Notwithstanding Sattva, and the significant number of cases that have followed it and applied a deferential standard, the majority in Stewart Estate applied the standard of...