Since the Leduc No. 1 oil well was drilled in 1947, the petroleum and natural gas industry has grown to become a cornerstone of the Alberta economy and a major industry for the Canadian economy. The oil and gas industry is active in 12 of 13 Canadian provinces and territories,1 and Canada is the fifth-largest producer of natural gas and the sixth-largest producer of crude oil globally. 2
Royalties are central to the financing, development, and operation of oil and gas projects and other mineable resources in Canada. Traditionally, royalties allowed resource owners to participate in and reap the benefit of production from their properties, and also to raise funds to finance exploration and production activities. In Alberta alone, royalty revenues from natural gas, conventional oil, and oil sands production were over $500 million, $700 million, and $1.4 billion, respectively, for 2016–2017. In 2013–2014, these revenues were even higher, totalling $1.1, $2.5, and $5.2 billion, respectively. 3 Given the significant value associated with these royalties, ensuring the viability of such interests is paramount to industry participants. In response to this need, the industry developed a practice whereby parties would attempt to create royalties that would "run with the land" 4 with the intention that the resulting royalty survives for so long as the underlying interest from which it was granted survives, binding successors in interest to the underlying leasehold or freehold estate. The benefit of this designation is clear: a royalty that runs with the land can provide its owner with certainty as to their rights and interest, regardless of what happens to the original grantor. In fact, it was this very industry practice that led to the Supreme Court of Canada's groundbreaking decision in Bank of Montreal v. Dynex Resources Ltd., which recognized that mineral lessees could carve out real property interests in the form of royalties. 5 Dynex was revolutionary in recognizing a new property right and changing the common law.
Almost two decades after Dynex, there are now public and private companies with oil and gas royalties as the principal or sole focus of their business. For example, PrairieSky Royalty Ltd. (PrairieSky) and Freehold Royalties Ltd. (Freehold Royalties) are two public companies that focus primarily on obtaining royalty interests and payments. PrairieSky's 2017 royalty revenues alone topped $265 million, 6 and, as of 1 August 2018, it had a market capitalization of $5.8 billion. 7 Similarly, Freehold Royalties's 2017 royalty revenues reached $133 million, 8 and its market capitalization is $1.4 billion. 9 In recent years, royalty interests that are interests in land have been created by working interest owners and then sold to third parties for values of up to $250 million. 10 These examples clearly illustrate the magnitude and importance of royalties in the oil and gas industry and the need for commercial certainty in dealing with these valuable interests.
Despite guidance from the Supreme Court of Canada and the obvious commercial importance of royalties, the law in this area remains unsettled. Recently, however, the Ontario Court of Appeal's decision in Third Eye Capital Corporation v. Ressources Dianor Inc/Dianor Resources Inc. 11 and the Alberta Court of Queen's Bench's decision in Manitok Energy Inc (Re) 12 have apparently simplified the understanding of royalties as property interests. In this article, we explore the overriding royalty, its common law evolution, the uncertainties surrounding its proper legal characterization, the implications of such legal uncertainty, and the shift that the Dianor and Manitok decisions represent. Throughout our discussion, we will consider the nature of the interests that royalties represent, the manner in which industry has attempted to protect those interests, and the efficacy of such attempts.
II. ROYALTIES AND THE IMPORTANCE OF AN "INTEREST IN LAND"
A. WHAT IS A ROYALTY?
Royalties come in many forms in the natural resources sector. For example, a particular set of mineral rights may be encumbered by a lessor royalty, a net profits interest, a gross overriding royalty (GORR), or a combination of these. Each of these is a royalty, but each operates in a different manner. A lessor royalty is reserved by the lessor from the minerals leased to the lessee, and paid by the lessee as a fraction of production to the lessor. 13 The lessor royalty is, in effect, a payment for the right to extract mineral or petroleum resources, and may be payable to a private freehold mineral owner pursuant to a lease or, if the Crown is the mineral owner, the government in accordance with a legislated royalty scheme. A net profits interest is payable by the working interest owners, and is often a percentage of the net proceeds of production. 14 Generally, a GORR signals a percentage ownership in production or production revenues before the costs of production are deducted (though such deductions are subject to negotiation). GORRs are paid to the GORR owner by the grantor, which may be a current or former lessee or one of potentially many working interest partners.
Depending on the negotiated terms, a royalty may be payable in kind (by a share of the physical product produced) or payable in money (based on the price received) and calculable at any point from the wellhead to the point of sale. How the royalty is described in the royalty agreement will determine what sort of royalty it is. To that end, it is up to the parties to determine whether a royalty will be an interest in land or not, and to give effect to such intention. If the royalty is not an interest in land, it is merely executory and only exists as between the parties to the contract that created the royalty. If the royalty is an interest in land, however, it will attach to the underlying leasehold or freehold interest from which it was created, binding successors in interest and securing the interest of the royalty holder. Owners of a royalty expressed to be an interest in land are afforded the ability to register a caveat on the subject land title, thereby giving notice to potential purchasers and protecting the royalty against third parties and successors in interest. 15
As the Alberta Court of Queen's Bench has surmised, royalties are granted for a wide variety of reasons each and every day in the oil and gas industry. 16 Commonly, a lessee will farmout certain lands to a company with the capital and expertise to drill a well in exchange for a working interest subject to a GORR. This royalty structure ensures the lessee can retain an interest in and benefit from the lands it has acquired rights to, despite the fact that it was not equipped to conduct the drilling operations itself. GORRs are also granted as remuneration for geological expertise or obtaining a particular lease.
In our experience, a new royalty mechanism and practice has developed over the past two decades in which industry participants manufacture a royalty to sell in exchange for capital investment. These royalties typically take the form of a GORR over the grantor's working interest and have become an important component of the financing structure in oil and gas development. Given the risks inherent in upstream resource development, the investing party will seek to protect its interest to the greatest extent possible, generally by ensuring the agreement characterizes the GORR as an interest in land.
B. ROYALTIES IN THE INSOLVENCY CONTEXT
The characterization of a royalty becomes a crucial issue in the event of a royalty grantor's insolvency. Whether or not the royalty runs with the land may have a dramatic impact on the economics of the estate. In an insolvency proceeding, the question becomes whether the receiver or trustee must attempt to sell the underlying mineral interest subject to the royalty or whether it can rely on the court's power to vest property in a purchaser "free and clear" of the encumbrances of the debtor. This "interest in land" issue is directly related to the vesting issue, and is of the utmost importance to the parties. As discussed herein, these issues have recently collided in Dianor, and remain before the Ontario Court of Appeal and, potentially, the Supreme Court of Canada. 17
Whether a royalty is an interest in land will impact insolvency proceedings generally, and, more specifically, will impact: (1) the solicitation process by the court officer or debtor, (2) potential purchasers, (3) the purchase price for the assets, (4) the recovery for creditors, and (5) the royalty holder. These impacts have been particularly pronounced throughout the most recent downturn experienced in the Canadian natural resources sector.
Oil and gas and mining industry insolvencies are already complex given the nature of the assets, the business, and the current regulatory environment. In normal course dealings between solvent parties, if a particular royalty is an interest in land, it is an incident of the underlying estate and binds the purchaser of such estate. Conversely, if the royalty is only executory and the agreement is not assigned to the purchaser, the vendor retains the payment obligation (notwithstanding that it no longer owns the interest on which the royalty is payable), or, at the very least, is liable under the contract that created the royalty. In both cases, the royalty holder has legal recourse to enforce the payment of the royalty, though the creation of an interest in land provides greater certainty. In an insolvency, however, the receiver, bankruptcy trustee, or debtor in possession can disclaim executory contracts, leaving the contractual royalty owner with only an unsecured claim against the estate. For example, a British Columbia court recently concluded that a particular GORR was a mere contractual royalty and the assets in a restructuring could be sold and vested in the purchaser free and clear of the royalty agreement. 18 This determination allowed the debtor in possession to terminate the royalty agreement to enhance the prospects of restructuring. 19 Had the Court concluded that the royalty was an interest in land, it would have survived the insolvency and the payment obligation would have bound the purchaser. It is therefore clear why the characterization of the royalty is of critical importance to the royalty holder: an interest in land will always protect its right to payment.
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1 Canadian Association of Petroleum Producers, "Industry Across Canada," online: capp.ca/canadianoil- and-gas/industry-across-canada.
2 Canadian Association of Petroleum Producers, "Canada's Energy Resources," online: capp.ca/ canadian-oil-and-natural-gas/canadas-petroleum-resources.
3 Government of Alberta, "Historical Royalty Revenue Data," online: alberta.ca/historical-royaltyrevenue- data.aspx.
4 Strathcona (County) v Half Moon Lake Resort Ltd, 2013 ABQB 405 at para 50.
5 2002 SCC 7 [Dynex SCC], aff'g 1999 ABCA 363 [Dynex CA].
6 PrairieSky Royalty Ltd, "Consolidated Financial Statements for the Year Ended December 31, 2017" (26 February 2018), online: prairiesky.com/files/galleries/2017_Annual_PSK_Financial_Statements_ Sedar.pdf.
7 S&P Capital IQ, "PrairieSky Royalty Ltd.: Public Company Profile," online: capitaliq.com/CIQDot Net/company.aspx?companyId=262030211.
8 Freehold Royalties Ltd, "High Risk Low Performer: Annual Report 2017" (8 March 2018), online: freeholdroyalties.com/sites/ default/files/uploads/reports-filings/fru_annual_report_2017_final.pdf.
9 S&P Capital IQ, supra note 7.
10 PrairieSky Royalty Ltd, "PrairieSky Announces Royalty Acquisition and Concurrent Bought Deal Equity Financing," Globenewswire (14 December 2016), online: globenewswire.com/news-release/ 2016/12/14/1323979/0/en/PrairieSky-Announces-Royalty-Acquisition-and-Concurrent-Bought-Deal- Equity-Financing.html; Athabasca Oil Corporation, "Athabasca Oil Corporation Announces a $129 Million Contingent Bitumen Royalty and Repayment of US$221 Million Term Loan," Globenewswire (20 June 2016), online: globenewswire.com/news-release/2016/06/20/975948/0/en/Athabasca-Oil- Corporation-Announces-a-129-Million-Contingent-Bitumen-Royalty-and-Repayment-of-US-221- Million-Term-Loan.html; BlackPearl Resources Inc, "BlackPearl Announces the Sale of a Royalty Interest on Its Onion Lake Property for $55 Million," Globenewswire (1 December 2016), online: globenewswire.com/news-release/2016/12/01/1299856/0/en/BlackPearl-Announces-the-Sale-of-a- Royalty-Interest-on-Its-Onion-Lake-Property-for-55-Million.html.
11 2018 ONCA 253 [Dianor CA].
12 2018 ABQB 488 [Manitok].
13 Dynex CA, supra note 5 at para 30.
14 Schlumberger, Oilfield Glossary, sub verbo "net profits interest," online: glossary.oilfield.slb.com/ Terms/n/net_profits_interest.aspx; Dynex CA, supra note 5 at para 32.
15 Note that the current law in Alberta is unclear as to the proper forum for registration in circumstances where the overriding royalty interest is granted by the lessee of Crown-owned mines and minerals (as opposed to freehold). Section 202(a) of the Land Titles Act, RSA 2000, c L-4, prohibits registration of a caveat or encumbrance affecting Crown mineral interests. The Mines and Minerals Act, RSA 2000, c M-17, provides for a limited exception applicable generally only to financial institutions.
16 Bank of Montreal v Dynex Petroleum Ltd (1995),  6 WWR 461 at para 84 (Alta QB).
17 On 21 June 2018, the Supreme Court of Canada granted an order extending the time for serving and filing an application for leave to appeal to 30 days following the Court of Appeal for Ontario fully disposing of the matter. The Court of Appeal has yet to release its decision on this matter. For further details, please see Supreme Court of Canada, "Docket 38106: Third Eye Capital Corporation v. Ressources Dianor Inc./Dianor Resources Inc., et al." (4 May 2018), online: scc-csc.ca/case-dossier/ info/dock-regi-eng.aspx?cas=38106.
18 Walter Energy Canada Holdings, Inc (Re), 2016 BCSC 1746 at para 72 [Re Walter].
19 Ibid; Companies' Creditors Arrangement Act, RSC 1985, c C-36, s 32.
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