Get Your Priorities Straight – Case Law Update on the Intersection of Creditor Claims and Environmental Obligations

The Supreme Court of Canada’s Redwater[1] decision, rendered in January 2019, provided clarification on the treatment of environmental clean-up obligations in context of insolvency proceedings. In Redwater, a summary of which can be found here, the Court held that proceeds flowing from the sale of oil and gas assets must be used to satisfy regulatory abandonment and reclamation obligations before any distribution can be made to secured creditors.

Redwater has since been followed and expanded on by courts across Canadian jurisdictions. The most recent of these decisions, Re Mantle Materials Group, Ltd. (“Re Mantle”),[2] sheds further light on the issue of whether certain assets may be exempt from the environmental obligation super-priority established in Redwater. Another recent Alberta decision, Qualex-Landmark Towers Inc. v 12-10 Capital Corp. (“Qualex”),[3] addresses whether super-priority may apply to environmental cleanup obligations owed to a private party as opposed to under the legislation as established in Redwater.

Recent Case Law Developments

The applicant in Re Mantle, Mantle Materials Group, Ltd. (“Mantle”), operated 24 gravel pits on public and private lands across Alberta. In order to acquire equipment to be used in its gravel site operations, Mantle obtained a loan in the amount of $1.7M from Travelers Capital Corp. (“Travelers”), a third party capital provider. Travelers was granted a purchase-money security interest over the equipment and ultimately became a secured lender under the Bankruptcy and Insolvency Act (“BIA”).[4]

Shortly after obtaining the loan Mantle encountered a variety of operational problems, which were compounded by the significant reclamation obligations placed on Mantle under several Environmental Protection Orders (“EPOs”) issued by Alberta Environment and Protected Areas (“AEPA”, formerly called Alberta Environment and Parks). These EPOs required Mantle to address the end-of-life abandonment steps to be taken at its gravel-producing sites, and to otherwise perform any necessary work towards the conservation and reclamation of those lands. On July 14, 2023, at which time the Travelers loan had been paid down to approximately $1.1M, Mantle filed a notice of intention to make a proposal in to bankruptcy under section 50.4 of the BIA.

One of the issues before the Court was whether all of Mantle’s assets, including those not directly related to its gravel site operations, could be used to satisfy its end-of-life environmental obligations prior to any distribution to secured creditors such as Travelers. Mantle, with support from AEPA, took the position that Travelers should not be permitted to realize on its security prior to the completion of the reclamation work. In doing so, Mantle emphasized the finding in Redwater that a company’s environmental remediation (or reclamation) obligations must be satisfied prior to distributions to creditors, and that any of the assets of the insolvent entity may be used to satisfy such obligations. Travelers, conversely, argued that Redwater stood for the principle that end-of-life obligations need only be satisfied using those assets specifically encumbered by or related to that obligation. In other words, Travelers argued that an exception to the Redwater principle arises for any assets that are unrelated to the environmental condition (which Travelers said was the case here). As a result, Travelers contended that it had priority with respect to the security in the equipment and that its claim should be paid out without delay.

The Court ultimately ruled in favour of Mantle and AEPA, concluding that the secured equipment did in fact form part of Mantle’s gravel business and was thus related to the environmental conditions and resulting end-of-life obligations. Accordingly, the reclamation and abandonment obligations took priority over the Travelers security interest in the equipment, and would be paid for first. In reaching this conclusion, Justice Feasby relied on a decision of the Alberta Court of King’s Bench[5] issued under similar circumstances which found that because the operator had only one business – namely oil and gas exploration and production – all of the operator’s assets were legitimately encompassed by the environmental obligation, including those assets not specifically involved in oil and gas production (for example, real estate used to store the operator’s equipment).

While the Court in Re Mantle was able to reach its decision based on the finding that the assets in question did indeed relate to Mantle’s gravel site operations, it did not go so far as to comment on how to determine whether assets are “related” or “unrelated” to a business’ operations, or if such an assessment should be conducted at all. While the case law suggests that a generous interpretation in favour of prioritizing environmental obligations is to be preferred, this distinction, according to Justice Feasby, “can be left for another day”.[6]

In Qualex, the plaintiff, Qualex-Landmark Towers Inc. (“QLT”), commenced an action against a neighboring property owner, 12-10 Capital Corp (“Capital Corp”), for damages alleged to have been caused by contamination flowing from Capital Corp’s lands onto QLT’s. An application was brought by QLT seeking an attachment order that would have the effect of putting its claim for environmental remediation to rank in priority over other creditors, including secured creditors, upon the planned sale of Capital Corp’s lands. For the purposes of this application the Court considered Capital Corp to be insolvent as of the date of the decision Capital Corp had not yet entered insolvency proceedings.[7]

QLT took the position that remediation of environmental contamination is a public, statutory duty under Alberta legislation.[8] Capital Corp on the other hand argued that QLT’s claim is just a common law tort action between private real estate developers, and only the government regulator enjoys a super priority for the benefit of the public.[9]

Ultimately, the Court granted the application and issued the attachment order in excess of $2M for any sale proceeds arising from Capital Corp’s sale of its lands. In reaching this conclusion, the Court made the following noteworthy findings:

• Where an insolvent corporation has environmental remediation obligations, it is “reasonably likely” that it does not matter if it has entered into formal insolvency proceedings or not.[10]
  
• Environmental remediation obligations of a polluter or responsible party are an intrinsic part of that entity. The absence of an accrual of environmental remediation obligations on the polluter’s books is not determinative. Environmental remediation obligations form part of the valuation of an asset. It is a liability that ought to be accounted for.^[11]
  
• The obligation of the polluter to remediate is a duty owed to its fellow citizens. As a result, when a polluter is found responsible for nuisance or negligence for failure to remediate environmental contamination in the context of private civil litigation, the nature of the underlying obligation is a public duty to all citizens. If there is a breach, the polluter can be held accountable because of the existing legislative framework that invokes environmental remediation obligations. Obligations to remediate contamination are a creature of the regulation and arise independent of a regulator’s enforcement.[12]
  
• A plaintiff does not need to be a “regulator” in order to advance its claim for super-priority status as compared to other creditors.[13]
  

While Justice Nixon’s findings in Qualex are significant and in some ways novel, they are made in the context of an interlocutory application. Justice Nixon was clear that there has been no final determination on the merits of many of the issues in the proceedings.[14] Moreover, Justice Nixon’s decision is under appeal.[15]

Takeaways

Practically, Justice Feasby’s decision in Re Mantle provides some further clarity on the law in this developing area, but also serves as a caution to financial institutions and third party lenders where reclamation and abandonment liabilities may arise. Due diligence processes should consider the risks and costs associated with the super-priority of environmental obligations when lending on an operation where those obligations my arise. Additionally, Re Mantle is a reminder that super-priority in an insolvency or bankruptcy context applies to environmental obligations beyond those found in the oil and gas context, as was the case in Redwater and other significant prior cases.

The findings in Qualex represent a significant development in the law. The lack of enforcement action by regulatory authorities as a prerequisite and potential granting of super-priority status in a private civil action may cause pause for lenders and creditors. These findings, if upheld on appeal, would create a degree of concern and uncertainty in the current lending system.

If you or your company have questions regarding the above article or any related issue, please do not hesitate to contact a member of our Environmental and Energy or Bankruptcy, Insolvency and Restructuring practice groups.