“Alberta, Alberta: What Is a Secured Lender/Noteholder To Do with Canadian O&G Collateral?”
Prior to May 19, 2016, enforcing security against a financially-troubled O&G borrower in Alberta was a difficult proposition because the Alberta Energy Regulator (AER) had promulgated regulations to the effect that it would not license acquirers of producing wells unless potential environmental liabilities for the costs of abandonment, remediation and reclamation for non-producing wells were covered, either by the acquirer assuming the liabilities or posting the necessary R&R bonding. And because security enforcement typically occurs precisely when the borrower is in financial difficulty, the regulations scared away some buyers altogether, led to the continuing buyers to lower their purchases prices (because they had to assume the liabilities) and sometimes even required the foreclosing creditors themselves to provide the necessary bonding.
That all changed on May 19. Or did it?
The provincial AER regulation was contrary to the federal Bankruptcy and Insolvency Act (BIA), which permitted receivers (who are often the enforcing agents for creditor security) and bankruptcy trustees to renounce (reject) licensee liability for abandoned or non-producing wells. In its May 19, 2016 decision in Redwater Energy Corporation (Re), 2016 ABQB 278 (available here), the Alberta Court of Queen’s Bench resolved the conflict in favor of the paramountcy (supremacy) of the BIA over the AER’s incompatible regulations.
Very good news indeed for lenders and noteholders secured by Alberta O&G assets, so why the caveat “Or is it?”
The Redwater decision could be reversed on appeal and the issue might not be finally resolved until the Canadian Supremes ultimately sing, once the Alberta Court of Appeal has played its own tune. It is also possible that Parliament could amend the BIA to provide an exception for provincial environmental regulations. But that will be then and this is now, so, so far, so good.
Of much greater immediate concern is that those wascally wabbits at the AER were not content to pin all their hopes on their appeal. Instead, on June 23, the AER revised its regulations to shift the economic risk of most non-producing well liabilities back to the asset acquirers and, therefore, indirectly back to the secured creditors.
The AER’s Bulletin 2016-16 (available here) announced the following three regulatory changes, effective immediately:
First, the AER changed the application process for new licenses. New license applications will be considered “non-routine” so that AER may exercise its discretion to impose terms and conditions on approval based on the facts and circumstances of each particular case. Applicants will face heightened scrutiny, uncertainty and delays, which means that lenders/noteholders will need to wait longer until their collateral can be monetized, assuming the would-be acquirers are even approved for licenses to begin with.
Second, the AER will take a second look at applications already eligible for approval. The AER will require holders of previously unused license eligibility approvals (including approved transfer applications) to prove that there have been no material changes since approving the license eligibility, including proof of adequate insurance and evidence that the directors, officers and/or shareholders of the licensee have not substantially changed since granting eligibility. More delay, more uncertainty.
Third – and here is the clincher – the AER doubled the liability management ratio (LMR) required of a transferee for approval of license transfers. The AER will only approve transfers of existing licenses, approvals and permits to transferees who have a LMR of 2.0 or higher immediately following the transfer. The AER suggests several ways for transferees to increase their LMR (posting security, addressing existing abandonment obligations, and transferring additional assets). Nonetheless, the same reason that licensees are seeking protection under the BIA will likewise prevent certain transferees from increasing their LMR—they’re overleveraged and under-capitalized.
To put the LMR change into perspective in the words of the Calgary Herald: “[W]ith only 28 per cent of 788 companies in Alberta’s oilpatch now within that higher [LMR] threshold by the AER’s own count, it doesn’t take a genius to understand what the fallout might be. Any sort of transactional liquidity that had begun to take place — in the context of asset sales or corporate deals — is going to stop dead.”
And what effect will this have on new financings in Alberta, given that, after default, collateral may not actually be worth what it is worth given the substantial reduction in the universe of potential buyers, not to mention the greater delays in monetizing?
Being secured in Alberta is still better than being unsecured, of course, but actually monetizing that security after a default is a whole ‘nother issue. The BIA may have prevailed over the original regulations, but there isn’t anything in the BIA about the rights of acquirers to obtain operating licenses, so query whether we are back to square one after all, Redwater notwithstanding.
In the words of Eric Clapton, “Alberta, Alberta, ain’t had no loving such a great long time.”