Interests in land - gross overriding royalties Third Eye Capital Corporation v. Dianor resources Inc.

The recent Ontario Court of Appeal ("Court") decision in Third Eye Capital Corporation v. Dianor Resources Inc.^[1] is important for several reasons.  It provides confirmation to gross overriding royalty ("GOR") holders that a GOR constitutes an interest in land and it also clarifies the test to apply when determining whether a GOR constitutes an interest in land. That being said, as part of a second phase of the appeal the Court has invited further submissions in order to determine whether a court has the authority to vest out certain interests in land when granting a vesting order meaning the relief currently felt by GOR holders could be temporary.

Facts

A receiver was appointed for Dianor Resources Inc. ("Dianor"), whose assets included mining claims obtained under a Crown land agreement and patented land agreement which were subject to a GOR held by 2350614 Ontario Inc. ("2350614"). Both agreements stated that the parties intended the GOR to create an interest in, and to run with, the land and both were registered on title.

Following a bidding process for Dianor's assets the offer from Third Eye Capital Corporation ("Third Eye"), which included a condition that the royalties be terminated or their value reduced, was successful and a vesting order was granted that extinguished the GOR. 2350614 requested that the mining claims be transferred subject to the GOR but the motion judge held that: (i) the GOR did not run with the land or grant 2350614 an interest in the lands over which Dianor held the mineral rights; and (ii) the court had jurisdiction under the Courts of Justice Act to transfer the land free of any GOR.

2350614 successfully appealed the decision. The Court overturned the motion judge's decision, finding that a valid interest in the land was created by the GOR. In their reasoning, the Court relied on and clarified the test for determining the nature of the GOR set out by the Supreme Court of Canada in Bank of Montreal v. Dynex Petroleum Ltd.^[2] ("Dynex").

Dynex Test

In Dynex, the Supreme Court of Canada confirmed that a GOR can constitute an interest in land if the following conditions are satisfied:

1. The language used in describing the interest is sufficiently precise to show that the parties intended the royalty to be a grant of interest in land, rather than a contractual right to a portion of the oil and gas substances recovered from the land; and,
2. The interest out of which the royalty is carved, is itself an interest in land.

In applying Dynex, the Court determined it was clear these conditions were met by:

1. The royalty agreements expressly stating the GOR constituted an interest in land that should run with the land;
2. The parties registering the GOR on title; and,
3. The fact that the GOR was carved out of Dianor's working interest in the mining claims, which the common law already recognised as an interest in land.

The Court determined that the motion judge made three legal errors in his analysis:

1. Not examining the parties' intentions in respect of the royalty agreements, or the circumstances surrounding them;
2. Holding that it was necessary for a GOR holder to have a right to enter the land to explore the minerals before an interest in land could be constituted; and,
3. Holding that the interest out of which the royalty was carved was not an interest in land because the agreements it came from expressed it only as a right to share in the revenues produced from the minerals extracted.

The Court's opinion on the first error is addressed above.

With regard to the second error, the Court found that the approach of the Supreme Court of Canada and the Court of Appeal in Alberta in Dynex was to step away from the requirement that a royalty right had to have the incidents of a working interest or a profit-à-prendre in order to constitute an interest in land, so that royalty rights could play their useful role in financing the oil and gas industry and spreading risk. That is the commercial reality of royalty rights.

With regard to the third error, the Court held that even if a GOR is calculated based on production it can constitute an interest in land if the intention of the parties is clear.

Conclusion

For now, holders of a GOR that satisfies the test set out above are recognised as having an interest in land. Despite that, the Court may still determine in the second phase of the appeal that the courts in insolvency proceedings have the power to vest out interests in land. That would mean the GOR holders would no longer be deemed to have an interest in the land. In the interim, lenders taking security over property subject to a registered GOR should, as with other interests in land registered in priority to the lender's charge, consider how they want those interests dealt with. For example they may, seek to have the registered GOR postponed to their security or have the royalty holder agree to a capped value for the royalty.