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| Why
FHOA Exists » Lessee-Lessor Relationship
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| THE OIL COMPANY-LESSEE / FREEHOLD OWNER-LESSOR RELATIONSHIP | |
| In
'kinder and gentler' days, western Canadian oil and gas exploration
and development was dominated by major oil companies. For the
most part, the majors were well-financed and could afford to take
a long-term view in conducting their business affairs. Today,
most of the majors have 'rationalized' their western Canadian
operations by disposing of 'non-core' assets and shifting their
exploratory efforts to other areas deemed more likely to yield
significant long-term growth. This rationalization has resulted
in the formation of hundreds of new oil companies in western Canada.
The vast majority of these new companies lack the financial stability
of the majors and must constantly look to financial markets for
the capital necessary to acquire, explore and develop oil and
gas properties.
In 1995, the Calgary
Herald suggested that the Canadian oil and gas industry's main
focus had shifted from doing business well to posting quarterly
results pleasing to shareholders, and that the 'lean-and-mean'
doctrine pervading the industry had turned into an obsession
having consequences for the community1. The consequences
referred to were the human consequences of the lay-offs which
prevailed during the mid-1990's and the abandonment of any pretense
of employee loyalty on the part of oil companies intent on currying
favour with financial analysts. A less obvious consequence
of an excessive focus on leanness and meanness or 'economic
efficiency' by oil companies involves their relationship with
freeholders under oil and gas lease agreements. In 'kinder and gentler'
days, what has been described by legal writers as the 'Sanctity
of Promise' theory of contract law prevailed. Under this theory,
contracts are binding both in natural law and in morality. In
the past, a major oil company confronted with evidence that
it had breached its lease agreement with a freehold owner could
be expected to remedy the situation quickly and appropriately.
The pursuit of profit motivated the majors to the same extent
in the past as it motivates all oil companies today, but in
the past the fear of public exposure of wrongdoing was a greater
motivator. Foreign-controlled majors intending to continue to
do business in western Canada were reluctant to risk being portrayed
as lacking in business ethics. Today, constant media
exposure of atrocious behaviour has dulled the public's capacity
for outrage. When school children plan and conduct massacres
with mail order assault rifles, who cares if an oil company
breaches a lease agreement with a freehold owner? Furthermore,
an alternate view of contract law known as the 'Needs of Trade'
theory2 is now being championed by certain laissez-faire
economists and jurists. Economic efficiency is the social value
underlying this theory. The leading proponent of this theory,
a former United States Supreme Court judge, asserts that only
in 'opportunistic breach' situations, where nothing happens
subsequent to execution of the contract to raise the cost of
performing the contract, should the legal remedy for breach
of contract exceed the damages suffered by the victim of the
breach. In particular: In the United States,
the possibility of a court awarding massive punitive damages
against a party that has breached a contract deters economically
efficient breach of contract. In Canada, punitive damages are
seldom awarded in breach of contract cases. If the relationship
between an oil company-lessee and a freehold owner-lessor is
strictly contractual, and if the legal remedy for breach of
a lease contract is the damages suffered by the freehold owner-lessor
rather than the profit made by the oil company-lessee as the
result of the breach, then an oil company-lessee can breach
a freehold lease agreement with impunity in situations where
the gain to be made by the breach exceeds the damages to be
suffered by the freehold owner-lessor. Further, if no greater
duty exists, in conflict of interest situations it can be argued
that the oil company-lessee should breach the lease agreement
because the company's duties and obligations to the freehold
owner-lessor are subordinate to the company's fundamental duties
and obligations to its shareholders to make a profit. Further
still, most freehold owners don't understand the oil and gas
business and, in many circumstances, a freeholder may never
discover a breach of his or her lease agreement. Whereas the legal remedy
for breach of contract in Canada is typically limited to the
damages suffered by the injured party, the legal remedy for
breach of fiduciary duty is typically the disgorgement of the
profit made by the fiduciary as a result of the breach. The
Supreme Court of Canada has adopted a three part test to identify
whether a fiduciary duty exists in a relationship4:
Mr. John B. Ballem,
whose writings have been extensively cited, quoted and relied
upon by the Canadian courts, in discussing the Supreme Court
test in the context of whether the unitization clause in CAPL
leases gives rise to a fiduciary relationship, has stated: In FHOA's view, the
entire relationship established under a freehold lease gives
rise to fiduciary duties, not just the unitization clause in
CAPL leases to which Mr. Ballem was referring. A finding by a Canadian
court that fiduciary duties are owed by an oil company-lessee
to its freehold owner-lessor under the terms of a freehold oil
or gas lease would go a long way towards addressing the imbalance
in power between freehold owners and the oil companies that
lease their mineral interests. Some oil company lawyers argue
that a Canadian court would never find fiduciary duties to exist
under a freehold lease for fear of 'opening the floodgates of
litigation'. Others argue, as did Mr. Ballem in 19646
, that freehold owner-lessors are adequately protected because
"the oil and gas industry is a highly regulated industry and
one of the objects of the legislation is to promote equitable
sharing among the owners of the resource."7 If freehold owner-lessors
were ever afforded protection from the actions of their oil
company-lessees by the legislation which regulates the oil and
gas industry in the Province of Alberta, this is not the case
today ("The Role of Regulatory Authorities").
End Notes:
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