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Dr. Janis Sarra is Presidential Distinguished Professor and Professor of Law, Peter A. Allard School of Law, University of British Columbia.

On Thursday, the Supreme Court of Canada issued a highly anticipated decision in a case that pitted a bankrupt energy company’s obligations to pay its creditors against its environmental responsibilities to clean up the oil wells left in its wake. The court judged that Alberta’s rules compelling companies to remediate spent wells take priority.

While many insolvency law professionals are upset at this apparent shift in reasoning, a careful look at the judgment, delivered by the Chief Justice on behalf of five of seven members of the court, builds on and clarifies the scope of previous rulings in areas relating to environmental law and federal paramountcy.

With the rapid growth in the number of stranded assets in the oil and gas sector, the judgment in what’s known as the Redwater case offers an analysis of the interplay between bankruptcy law and the provincial regulatory regime to address “end-of-life liabilities” for oil wells and pipelines. The Supreme Court held that Alberta has devised a complex regulatory apparatus to address important policy questions concerning how environmental costs associated with oil-and-gas extraction are to be paid. The Alberta Energy Regulator will not grant a licence to extract, process or transport oil and gas unless the licensee assumes “end‑of‑life responsibilities” for plugging and capping oil wells to prevent leaks, dismantling surface structures and restoring the surface to its previous condition.

When a company becomes bankrupt, the federal Bankruptcy and Insolvency Act governs the administration of a bankrupt estate and the orderly and equitable distribution of property among its creditors. While the Alberta Court of Appeal held that federal bankruptcy law trumped the Alberta law, the Supreme Court disagreed. The Supreme Court held that the regulator’s use of its powers does not create a conflict with the bankruptcy law so as to trigger the doctrine of federal paramountcy. There is no operational conflict and it does not frustrate the purposes of federal bankruptcy law. The court held that the section of bankruptcy law in dispute is concerned with protecting trustees from personal liability when they are liquidating the bankrupt company and selling off its assets to pay creditors, but it does not allow them to ignore the company’s environmental liabilities. It found that the regulator was not asserting any claims that had crystallized in the bankruptcy, such that secured creditors would be paid out first.

The court held that bankruptcy is not a licence to ignore rules, and that trustees and their lawyers must comply with valid provincial laws during bankruptcy. They must comply with non‑monetary obligations that are binding on the bankrupt company’s estate, which cannot be reduced to provable claims and thus do not conflict with the bankruptcy act.

This compliance is necessary despite the consequences for secured creditors. The court held that where there is a genuine conflict between provincial laws concerning property and civil rights and federal bankruptcy legislation, the bankruptcy act prevails. The court held that the bankruptcy act provision allowing a trustee to disclaim ownership and walk away from property when there is an order to remedy any environmental condition or damage affecting that property is aimed at the protection from personal liability, not aimed at protecting the company from liability. The court found no paramountcy concern where the regulator requires the trustee, which has stepped into the shoes of the company’s management, to expend estate assets on abandoned wells or the regulator’s ability to decide transfers of licences. The end‑of‑life obligations binding on the trustee are not claims provable in the Redwater bankruptcy.

The Supreme Court held that its test, set out in a previous case in Newfoundland, must be applied to determine whether a particular regulatory obligation amounts to a claim provable in bankruptcy. For one, there must be a debt, liability or obligation to a creditor. Second, the debt, liability or obligation must be incurred before the debtor becomes bankrupt. And third, it must be possible to attach a monetary value to it.

In this case, in seeking to enforce Redwater’s end‑of‑life obligations, the regulator was acting in a bona fide regulatory capacity in the public interest and for the public good in issuing the abandonment orders and enforcing the licensing requirements. While that was sufficient to dispose of the case, the court went on to give guidance as to when environmental claims become “provable” under bankruptcy law, such that they come second to the priority claims of secured lenders.

Secured lenders should take careful note of this judgment when they are lending into a situation where there are potential liabilities for stranded assets and price their credit accordingly.

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