Long May You Run: Ontario Court of Appeal Clarifies the Treatment of Mineral Royalties in Insolvency Proceedings

On June 19, 2019, the Ontario Court of Appeal (Appeal Court) released its long-anticipated decision in the second phase of the appeal in Third Eye Capital Corporation v. Ressources Dianor Inc./Dianor Resources Inc., following an earlier decision of March 15, 2018, granted in respect of the first phase of the appeal.

The two decisions, taken together, provide helpful guidance on the following issues:

  • When does a gross overriding royalty (GOR) constitute an interest in land and what are the factors to be considered in that determination?
  • What is the analytical framework for determining whether third-party interests in land should be vested out by a court?
  • What is the proper appeal period to appeal an approval and vesting order (AVO) granted in receivership proceedings commenced pursuant to section 101 of the Courts of Justice Act (Ontario) (CJA) and section 243 of the Bankruptcy and Insolvency Act (Canada) (BIA)?

This most recent decision of the ONCA confirms the jurisdiction of superior courts supervising receivership proceedings to grant an AVO and to vest out third-party interests in land. In doing so, it reduces existing uncertainty among the Canadian insolvency bar. It also provides guidance to royalty holders on critical elements necessary to ensure their royalty agreements will be upheld as interests in land, which should not be vested off title in an insolvency sale.

In its decision, the Appeal Court sets out factors for when courts may grant vesting orders, including when third-party interests in land can be extinguished. While the Appeal Court found there was authority to vest certain interests in land off-title, it held that given the nature of the gross overriding royalty interest in issue, it was not appropriate for a court to extinguish this interest.

BACKGROUND FACTS

Dianor Resources Inc. (Dianor) was an insolvent exploration company focused on the acquisition and exploration of mining properties in Canada. On application by Dianor’s secured lender, the Ontario Superior Court of Justice [Commercial List] granted an order appointing a receiver over all the property and assets of Dianor. Dianor’s main asset was a group of mining claims in Ontario and Quebec. The mining claims at issue were claims in Ontario that were subject to a GOR held by the appellant and royalty rights held by another party.

The sale process in the receivership proceedings generated two bids for Dianor’s Ontario mining claims, both of which contained a condition that all GORs be terminated, or otherwise extinguished. The receiver applied to the receivership court for an order approving a sale to one of the bidders and vesting out the GOR and other royalty interest. The consideration for the transaction included a payment of C$250,000 to the holder of the GORs and C$150,000 to the holder of the royalty rights, which amounts were based on an expert evaluation of the fair market value of the royalties.

The holder of the GOR did not oppose the sale but took the position that its GOR was an interest in land, which could not be vested out by the AVO. The purchaser took the position that the GOR was merely a contractual right and that, even if the GOR was an interest in land, it could be vested out pursuant to an AVO, provided that the holder received fair compensation for the extinguishment of its rights.

RECEIVERSHIP COURT DECISION

The receivership court decided that: (i) the GOR did not amount to an interest in land or grant the holder an interest in the land over which Dianor held mineral rights, and (ii) pursuant to the BIA and CJA, the receivership court had the jurisdiction to order Dianor’s property to be sold on terms the receivership court considered appropriate. The receivership court also went on to note that it saw “no reason in logic” why it would not also have the jurisdiction to vest out the GOR, even if it were an interest in land.

In arriving at its decision and determining that the GOR amounted to a mere contractual right, the receivership court first looked to the leading Supreme Court of Canada (SCC) decision in Bank of Montreal v. Dynex Petroleum Ltd. (Dynex), which applied the following test to determine whether a GOR or royalty interest could be an interest in land:

  1. Is the language used in describing the interest 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 resources recovered from the land?
  2. Is the interest, out of which the royalty is carved, itself an interest in land?

The receivership court then went on to review the 2013 Quebec Court of Appeal decision in Anglo Pacific Group PLC v. Ernst & Young Inc. and the 2009 Ontario Court of Appeal decision in St. Andrew Goldfields Ltd v Newmont Canada Limited and concluded that a requirement for a GOR to qualify as an interest in land was that it also grant a corresponding right to the holder to enter the property, and explore or extract minerals. In the view of the receivership court, a right to share in revenues produced from minerals extracted from land was not, on its own, sufficient to amount to an interest in land.

ONTARIO COURT OF APPEAL DECISIONS

The GOR holder appealed the receivership court’s decision and sought to have the Appeal Court set aside the AVO and obtain an order that the GOR constituted an interest in land.

First Stage of the Appeal

In the first stage of the appeal, the Appeal Court overturned the receivership court’s determination that the royalty holder’s GOR did not amount to an interest in land.

The Appeal Court accepted the position that the GOR constituted an interest in land. The Appeal Court noted that prior to the SCC decision in Dynex, the common law dictated that a precondition to a party having an interest in land was its ability to enter and extract resources from such land. Dynex amounted to a deliberate shift away from such requirement in response to market realities and commercial practice. The result was that GORs and other royalty interests could amount to an interest in land even if they did not contain an attendant right to exploit resources.

Applying the Dynex test to the facts of the case, the Appeal Court held that:

  1. The first element of the test (intention of the parties to create an interest in land) was satisfied based upon (a) express language in both the Crown Land Agreement and the Patented Land Agreement of an intention for the GOR to create an interest in and run with the land, and (b) the surrounding circumstances, including steps taken to register the GOR on title; and
  2. The second element of the test—underlying interest out of which the royalty is carved—was also satisfied since Dianor’s interests in the mining claims were working interests or profits à prendre—which are clearly recognized as an interest in land—and the GORs were carved out of such interests.

Having found that the GOR was an interest in land, the Appeal Court requested further submissions on whether the receivership court had the jurisdiction to vest out a third-party’s interest in land.

Second Stage of the Appeal

At the second stage of the appeal, the Appeal Court considered whether a third-party interest in land could be extinguished by an AVO granted in a receivership proceeding, and, if so, whether the receivership court properly exercised such jurisdiction in the circumstances.

The Appeal Court reviewed the history of vesting orders and the interim and national receivership provisions of the BIA and concluded that section 243 of the BIA provides receivership courts with jurisdiction to authorize a receiver to enter into an agreement to sell property, and grant an order vesting the purchased property in the name of the purchaser in order to give effect to the sale. The Appeal Court noted that while the jurisdiction for vesting orders stems from section 243 of the BIA, the exercise of this jurisdiction is not unbounded and third-party interests should not be inappropriately violated. As such, it was also concluded that courts have the jurisdiction to vest out royalty interests in certain circumstances, so long as the terms of the AVO are appropriate and accord with the principles of equity.

The Appeal Court considered the appropriateness of the receivership court’s decision to extinguish the appellant’s GOR—which was an interest in land—from title. The Appeal Court established the following analytical framework to determine whether third-party interests in land should be extinguished:

  1. What is the nature and strength of the interest that is proposed to be extinguished and is such interest more akin to (a) a fixed monetary interest that is attached to real or personal property, such as a mortgage or a lien for municipal taxes, or (b) a fee simple that is an ownership interest in some ascertainable feature of the property, which is tied to the inherent characteristic of the property itself? Is it the reasonable expectation of the owner that the interest be continuing in nature and cannot, without consent, be extinguished in the ordinary course through payment in lieu?
  2. Have the parties—whose interests are being vested out—consented, either at the time of the sale or through prior agreement?
  3. If the factors set out above are ambiguous or inconclusive, a court may then engage in a consideration of the equities to determine whether granting an AVO is appropriate in the circumstances, and, in doing so, may consider the following non-exhaustive list of factors: (a) whether there is prejudice to the third-party or the third-party may be adequately compensated for its interest from the proceeds of sale, (b) whether based on evidence of value, there is any equity in the property being sold, and (c) whether the parties are acting in good faith.

In applying the foregoing analytical framework, the Appeal Court held that, although the GOR could not be said to be a fee simple interest, it was more than a fixed monetary interest attached to the property and was, in substance, an interest in a continuing and inherent feature of the property itself, being the extraction of minerals. Given the nature of the GOR and the absence of any prior consent or agreement to have the interest vested or otherwise subordinated to the purchaser, the Appeal Court found it unnecessary to consider the equities and held that the receivership court improperly exercised its jurisdiction to vest out the GOR.

Despite this finding, the Appeal Court ultimately disallowed the appeal on the basis that it was filed outside of the applicable 10-day appeal period under the BIA. The Appeal Court decided that the appeal period provided for in the BIA—10 days—and not that provided in the CJA —30 days—governs an appeal of an AVO granted in a receivership proceeding commenced pursuant to both section 101 of the CJA and section 243 of the BIA, since the BIA is a federal statute. The jurisdiction to grant the AVO is squarely within section 243 of the BIA. Therefore, the doctrine of federal paramountcy requires that the BIA appeal mechanism govern. As such, the Appeal Court determined that the appeal was out of time.

Interestingly, the Appeal Court also reviewed the receiver’s conduct and enunciated that, generally, a receiver should await the expiry of the BIA 10-day appeal period before closing a transaction approved pursuant to an AVO granted in receivership proceedings. The Appeal Court went on to note that generally, as a matter of professional courtesy, “a potentially preclusive step ought not to be taken when a party is advised of a possible pending appeal.”

Therefore, although the GOR holder was successful on the substantive issues appealed, it was not successful on a key procedural issue and was not entitled to a remedy in the circumstances as the Appeal Court found its appeal to be out of time.

COMMENTARY

These decisions provide clarity for royalty holders, court-appointed receivers and purchasers of assets in insolvency proceedings that are the subject of royalties. As a result of these decisions, the following elements should be considered:

  • When negotiating and implementing royalty agreements, royalty holders should consider:
  • The importance of clear drafting to reflect an intent to create an interest in land, not a mere contractual right, and that the royalty is not intended to secure a monetary obligation;
  • The ability to demonstrate that the royalty interest is carved out of an interest in land;
  • The importance of registering the royalty on title;
  • Providing for the manner in which the parties intend to deal with the royalty in case of insolvency; and
  • Where subordination and postponement of royalty interests have been provided, consideration should also be given to whether an implied consent has been provided in case of an insolvency sale.
  • Aggrieved parties should raise their intention to appeal a court-approved sale without delay.
  • Receivers should consider whether, in the circumstances, it would be prudent to wait out the applicable appeal period before closing a court-approved transaction.

For further information, please contact:

Kelly Bourassa                          403-260-9697

Charles Kazaz                           416-863-4003

Kevin Kerr                                 403-260-9746

Ben Rogers                               403-260-9702

James Reid                               403-260-9731

Aryo Shalviri                              416-863-2962

or any other member of our Restructuring & Insolvency, Energy or Mining Law groups.

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