Does a Royalty Agreement Constitute an Interest in Land?

In a recent decision, the Alberta Court of King’s Bench clarified the law around royalties as interests in land. The case serves as a reminder for companies involved in Alberta’s oil and gas industry to be extra diligent in transactions involving Crown leases. Further, it highlights the importance of a well-drafted royalty agreement.

Royalties in the oil and gas industry

Royalties play an important role in Alberta’s oil and gas industry. When a company takes an interest in land under a Crown lease, the land will often be encumbered by one or more royalties. The idea is that, in exchange for the right to explore and extract resources from the land, the company pays a portion of the profit it derives from the resources to whoever owns an interest in the land.

When a Crown lease changes hands, the new holder of the lease must respect any royalty agreements attached to it. However, in Alberta, there is no way for a royalty holder to publicly register their interest. This can lead to situations where a company acquires a lease without notice of a royalty agreement encumbering it. Such was the case in PrairieSky Royalty Ltd v Yangarra Resources Ltd.  

Both parties had an interest in a royalty agreement on Crown lease land

PrairieSky Royalty Ltd involved a Crown petroleum and natural gas lease originally granted in 1979. Over the years, the lease changed hands several times. In 2011, the then lessee, Home Quarter, entered into a royalty agreement with Range Royalty. Under the royalty agreement, Home Quarter granted an 8% royalty to Range Royalty. 

In 2013, Home Quarter conveyed 100% of its interest in the Crown lease to Relentless Resources. In 2016, Relentless sold its interest in the Crown lease to Yangarra. However, the royalty agreement was missed in the due diligence for the transaction, and it was never formally assigned to Yangarra.  

In 2014, PrairieSky acquired Range Royalty and assumed its rights, obligations, assets, property, and liabilities. As a result, it became a successor to Range Royalty’s interest in the royalty agreement. 

Plaintiff seeks to enforce royalty agreement terms against defendant

When PrairieSky started working on the land, it discovered that Yangarra hadn’t been paying the 8% royalty. PrairieSky demanded that Yangarra pay the royalty, and started a claim seeking:

• a declaration that the 8% royalty constituted an interest in land, and
• judgment for the outstanding royalties owing under the royalty agreement.

Accordingly, the Court had to address three questions:

• Does the 8% royalty constitute an interest in land?
• Does the royalty have priority over the defendant’s interest in the Crown lease?
• What remedy is appropriate?

Court applies a two-part test to characterize the royalty agreement 

To decide whether the royalty constituted an interest in land, the Court turned to the test set out by the Supreme Court of Canada in Bank of Montreal v Dynex Petroleum Ltd. For a royalty attached to an oil and gas lease to constitute an interest in land, two requirements must be met:

• The language used to describe the interest is precise enough to show that the parties intended the royalty to be a grant of an interest in land, not a contractual right to a portion of the oil and gas substances extracted from the land.
• The interest, out of which the royalty is carved, is itself an interest in land.

Court identifies two “core indicia” of an interest in land

Applying the two-part Dynex test, the Court found that the second part was easily met. The 8% royalty was carved out of the interest in the Crown lease, which the common law recognizes as an interest in land.  

The Court then identified two “core indicia” that may be enough to satisfy the first part of the Dynex test:

• the presence of a clause that expressly states that the royalty is an interest in land, and
•  whether the royalty is capable of lasting for the duration of the underlying estate.

The Court must still examine the entire contract and surrounding circumstances. But where these two core indicia are present, other factors must “significantly contradict” the indicia to find that the royalty isn’t an interest in land.

Court finds that the 8% royalty did constitute an interest in land

In this case, the Court noted that the royalty agreement did include a clause stating that the royalty constituted an interest in land. Further, circumstances surrounding the execution of the agreement suggested both parties intended this to be the case. There were no factors to rebut this presumption. It was also clearly stated in the royalty agreement that the 8% royalty would last for the duration of the underlying Crown lease. 

The Court examined the other terms of the agreement and concluded that there was nothing to significantly contradict the presumption that the parties intended the royalty to be an interest in land. Accordingly, they found that the 8% royalty did constitute an interest in the Crown lease land. 

Defendant claims it was bona fide purchaser for value without notice

An argument raised by the defendant was that it was a bona fide purchaser for value without notice of the 8% royalty. This is a concept from the law of equity, effectively codified in Alberta’s Law and Equity Act. With some exceptions, the Law and Equity Act states that a purchaser of land isn’t bound by any prior unregistered interests or claims.

However, the Court found that the rules of priority under the Law and Equity Act didn’t apply in this case. That’s because the Crown lease lands were unpatented, and no certificate of title had been issued for them. So instead, the Court had to apply the principles of common law and equitable rules of priority. 

Court finds that the parties held legal, not equitable, interests

To decide which rules of priority to apply, the Court needed to characterize the parties’ interests as legal or equitable. Because the plaintiff’s 8% royalty satisfied the first part of the Dynex test, the Court held that it gave the plaintiff in rem rights. It also met all the requirements of a valid conveyance (offer, acceptance, consideration, and a signed written agreement). As such, it determined that the plaintiff held a legal interest. 

The Court also found that the defendant held a legal interest, as a working interest in a Crown lease confers an in rem right in land.

Court applies the common law rules of priority

Where there are two competing legal interests in the same property, priority is determined based on chronology. Also, the maxim “neo dat quad non habet” applies: a seller can’t give greater title than that which they hold.

At the time the defendant purchased its interest in the Crown lease, it was already encumbered by the 8% royalty. Therefore, the defendant could only acquire its interest subject to the plaintiff’s royalty. The defence of bona fide purchaser for value without notice failed, as it only applies in disputes involving a prior equitable interest and subsequent legal interest. 

Court grants relief sought by plaintiff

Ultimately, the Court decided that the plaintiff’s 8% royalty interest took priority over the defendant’s interest in the Crown lease. Accordingly, judgment was granted in favour of the plaintiff.

The Court declared that the royalty agreement was enforceable against the defendant and any future owners of an interest in the Crown lease land. The plaintiff was awarded damages for the outstanding royalties owing under the agreement.

Contact the Oil and Gas Lawyers at DBH Law in Calgary for Guidance on Leases and Royalty Agreements

The experienced oil and gas lawyers at DBH Law are intimately familiar with this ever-changing industry. They provide exceptional advice to clients operating in the energy and natural resources sectors around the world. To speak to a member of our team regarding your legal needs, contact us online or by phone at 403-252-9937.