DATE: 20050218

DOCKET: C43081(M32171 & M32205)

COURT OF APPEAL FOR ONTARIO

WEILER, GOUDGE AND GILLESE JJ.A.

IN THE MATTER OF THE COMPANIES’ CREDITORS ARRANGEMENT ACT, R.S.C. 1985, c.C.-36, AS AMENDED

AND IN THE MATTER OF ANDROSCOGGIN ENERGY LLC

Justin R. Fogarty and Renée Brosseau for Pengrowth Corporation and Canadian Forest Oil Ltd., Appellants

Robert Frank for AltaGas Ltd., Appellant

Joseph M. Steiner, Steven G. Golick and Nancy Roberts for Androscoggin Energy LLP, Respondent

Douglas S. Nishimura for Credit Suisse First Boston, Respondent

Barbara L. Grossman and David W. Mann for International Swaps and Derivatives Association, Intervenor

David R. Byers for KPMG as Information Officer

Heard: February 14, 2005

On appeal from the order of Justice James M. Farley of the Superior Court of Justice, dated January 26, 2005.

WEILER J.A.:

[1] This appeal, like the prior steps in this proceeding, has been conducted as “real time” litigation. Parties depend on the court system to be able to respond, as it has here, despite the inevitable time pressures.

[2] The facts giving rise to this appeal are relatively straightforward. The applicants/appellants (“the appellants”) entered into certain long‑term contracts to supply gas to the respondent, Androscoggin Energy LLC (Androscoggin), who operated a cogeneration plant near Jay, Maine. On November 26, 2004, Androscoggin filed a voluntary petition pursuant to chapter 11 of title 11 of the United States Code (US Bankruptcy Code) with the United States Bankruptcy Court, District of Maine (US Bankruptcy Court). On the same date, Androscoggin obtained an ex parte order in Ontario under s. 18.6 of the Companies’ Creditors Arrangement Act, R.S.C. 1985, c. C‑36 (CCAA) recognizing the proceeding in the United States as a “foreign proceeding”. In addition, the November 26, 2004, order stayed all actions against Androscoggin in Canada and, specifically, the appellants’ rights to terminate the gas supply contracts or to enforce other contractual rights. Androscoggin’s single most valuable asset is the gas supply contracts. It is common ground that the contract price at which the appellants agreed to supply gas to Androscoggin is below the current market price.

[3] On January 6, 2005, the Ontario Superior Court of Justice and the US Bankruptcy Court held a joint hearing. Each court issued orders and a hearing was scheduled before the US Bankruptcy Court for February 22, 2005, to determine, among other things, the jurisdiction of the US Bankruptcy Court over the appellants and whether the US Bankruptcy Court might allow the assignment of the gas supply contracts.

[4] Before the February 22, 2005 hearing, the appellants brought a motion before Farley J. to lift the stay under the CCAA arguing that the contracts were “eligible financial contracts” (EFCs) within the meaning of s. 11.1(1) of the CCAA. Characterizing a contract as an EFC can significantly impact the proceedings. During the period the debtor has to file its proposed plan of compromise under the CCAA, the rights of the non-defaulting counterparty to enforce the terms of the contract are stayed. If, however, the contract is an EFC, s. 11.1(2) provides that no order can be made staying or restraining the exercise of any right of termination under the contract. Thus, the characterization of the contract as an EFC does not automatically allow the counterparty to avoid the effects of the stay and to terminate the contact. The rights of termination contained in the contract are determinative of whether the counterparty can end the contract.

[5] The appellants’ motion seeking a declaration that the contracts in issue were EFCs was heard on January 24, 2005. On January 26, 2005, Farley J. held that these contracts were not EFCs and dismissed the appellants’ motion. He further held that, even if the contracts in issue were EFCs, the appellants could not terminate the contracts as a result of Androscoggin’s insolvency because under the terms of the contracts, the appellants could terminate the contracts only for non-payment and the respondent was not in default of payment.

[6] On February 8, 2005, on the basis of urgency, the appellants moved before Feldman J.A. for an order that the leave to appeal motion be scheduled before a panel of this court on an expedited basis, and that the appeal be heard by the same panel at the same hearing if leave was granted. At the same time, the International Swaps and Derivatives Association (ISDA) brought a motion seeking leave to intervene in any appeal from the order of Farley J. Both the leave motions and the appeal were expedited. On February 14, 2005, the motions and appeal were heard in this court. All parties want to resolve the issues before the February 22, 2005 hearing before the US Bankruptcy Court.

[7] Having regard to the urgency and the significance of the issues for this proceeding and for the marketplace, I would grant leave to appeal and leave to the ISDA to intervene. I would, however, hold that Farley J. did not err in refusing to issue the declaration sought and would dismiss the appeal.

[8] Although I agree with Farley J. that the gas supply contracts should not be characterized as EFCs, I would not subscribe to the reasons given by Farley J. for his conclusion. Insofar as the terms of the contract are concerned, I agree with Farley J. that even if the contracts are characterized as EFCs, the appellants are not entitled to terminate them. Some elaboration on both these determinations is required.

[9] Farley J.’s conclusion that the contracts were not EFCs is based on his holding that the primary thrust of the contracts was for the physical supply of gas and not financial risk management. In so holding, Farley J. states that he favours the interpretation of LoVecchio J. in Re Blue Range Resources Corp. (1999), 1999 ABQB 1064, 245 A.R. 172, to that of the Alberta Court of Appeal which reversed LoVecchio J. at (2000), 2000 ABCA 239, 266 A.R. 98.

[10] At para. 30 of his reasons LoVecchio held:

A distinction between “physical” and “financial” contracts has pervaded the discussion in this case. The question whether contracts are one or the other is to be resolved by the intention of the parties. Simply put, if the purpose of the contract is to lead to the actual delivery of the commodity then you do not have a contract which is financial in nature but one which is physical and it should not be found to be an “eligible financial contract”. If the purpose of the contract is only financial in nature and is not intended to lead to the actual delivery of the commodity, then you have a contract which is financial in nature not physical and it should be found to be an “eligible financial contract”.

[11] In a carefully considered and instructive judgment for the court, Fruman J.A., rejected the notion that all contracts to be settled by the physical delivery of the commodity are not EFCs. She noted that risk management companies offer a wide range of cash settled and physically settled commodity instruments to customers, who may be producers, end-users, or other financial intermediaries, and that market participants placed little emphasis on the distinction between physically and financially settled transactions. Although some end-users eventually take delivery of the gas, trades along the way are normally settled by title transfers. Systems such as the NOVA Inventory Transfer System play a role similar to a security depository and facilitate the title transfers. Importantly, the definition of eligible financial contracts in s. 11.1(1) of the CCAA includes contracts that can be settled only by physical delivery, not financial payment. That definition includes spot contracts, which provide only for immediate physical delivery of a commodity. The definition also includes repurchase contracts. These are contracts to sell a security combined with a simultaneous agreement by the original seller to repurchase the security at a later date thus contemplating the physical return of the security for cash.

[12] Fruman J.A. further held that an interpretation of s. 11.1(1) that rejected a distinction between physically settled and financially settled contracts as the basis for determining whether a contract was an EFC made commercial sense. If all physically settled instruments are not EFCs, an important part of the derivatives market would be vulnerable to insolvency, weakening the Canadian risk management structure.

[13] The appellants and the ISDA submit that Fruman J.A. was correct in not drawing a distinction between physically settled and financially settled transactions as the basis for characterizing EFCs. I agree with Fruman J.A.’s analysis of the interpretation of s. 11.1(1) and, as a result, I would accept the submission of the appellants and the ISDA on this point.

[14] Recognizing that not all forward commodity contracts, that is, contracts for the sale of a specified amount of a commodity at a specific price in the future, are EFCs, Fruman J.A. held that the commodity in question must be a fungible commodity in a volatile or liquid market. Such an interpretation was fair, she held, because it allowed the non-defaulting party to terminate the contract and net out its position thereby crystallizing its losses and enabling it to avoid further losses likely to arise in a volatile gas market by dealing with its exposure through further rehedging. She stated at para 20 that,

In order to further hedge their risk, many gas producers enter into a series of agreements with the same gas marketing and risk management companies, providing for the sale of gas at different prices, on different dates and at different points of delivery. Each of these contracts has its own calculable value. At any point in time, some of these will be “in the money”, others “out of the money”. Termination and netting out or set-off provisions permit the purchaser to terminate all the agreements upon a triggering event. The purchaser may then “calculate the value of all the transactions as of the termination date and…net the positive and negative values to determine a lump sum termination amount payable by one party to the other.” : M.E. Grottenhaler and P.J. Henderson, The Law of Financial Derivatives in Canada (Toronto: Carswell, 1999) at 5.1.

[15] The appellants submit that their contracts are EFCs within s. 11.1(1) of the CCAA as interpreted by Fruman J.A. in Blue Range, supra. I disagree. The contracts in issue before Fruman J.A. served a financial purpose unrelated to the physical settlement of the contracts. The reasons in Blue Range indicate that the contracts Fruman J.A. examined enabled the parties to manage the risk of a commodity that fluctuated in price by allowing the counterparty to terminate the agreement in the event of an assignment in bankruptcy or a CCAA proceeding, to offset or net its obligations under the contracts to determine the value of the amount of the commodity yet to be delivered in the future, and to re‑hedge its position. Unlike the contracts found to be EFCs in Blue Range, supra, the contracts in issue here possess none of these hallmarks and cannot be characterized as EFCs. However, mere pro forma insertion of such terms into a contract will not result in its automatic characterization as an EFC. Regard must be had to the contract as a whole to determine its character.

[16] I now turn to the second basis on which Farley J. dismissed the appellants’ motion, namely, that the terms of the contract did not entitle the appellants to terminate them except for non-payment.

[17] The terms of the contracts define an event of default as including a petition to reorganize that is not dismissed within 60 days. Under the terms of the contracts the appellants cannot, however, terminate the contracts for an event of default so long as Androscoggin makes payment of the sums due, something Androscoggin continues to do. The appellants have further compromised their ability to terminate the contracts for insolvency by their consent to assignments to Credit Suisse First Boston, a lender to Androscoggin. Androscoggin submitted that, as a result, this proceeding was moot, because the appellants can point to no right to terminate that they could exercise if the stay under the CCAA was lifted.

[18] Before us, the appellants accepted that they could not terminate the contracts on account of the insolvency of Androscoggin so long as payments were made. The appellants submitted, however, that the appeal was not moot because Farley J. erred in holding that non-payment was the only basis on which the contracts could be terminated. They submitted that they were entitled to terminate the contracts at common law for fundamental breach. By way of example, the appellants submitted that if the contracts were assigned without their consent, which they say is a real possibility, the assignment would be a fundamental breach of the contract. The contracts provide that the agreements cannot be assigned without the consent of the appellants, such consent not to be unreasonably withheld.

[19] Androscoggin objected to the argument of fundamental breach being raised for the first time on appeal. However, having regard to the extent of submissions made by both sides respecting the substance of the argument, I propose to deal with it.

[20] There are several answers to the appellants’ submission. The first is that the appellants cannot point to any breach of the contracts. The second is that even if there were an existing breach, that breach would not necessarily entitle the appellants to terminate the contracts. Only if successful litigation resulted in a court order declaring that the appellants were entitled to terminate the contracts could they do so. No such order exists. The third is that although the contracts provide that the failure by a party to perform fully any material provision of the agreement is an event of default, the “Seller has no right to terminate this Agreement on account of an Event of Default on the part of Buyer so long as Buyer makes payment of sums due to Seller under this Agreement”. Thus, under the terms of the contract, the appellants are not entitled to terminate the contracts even if the assignment provision is a material or fundamental term and it were violated. (In connection with the assignment provision I would point out that at the hearing before Farley J., Androscoggin represented to the Court, on the basis of sworn evidence, that, before the US Bankruptcy Court would authorize it to assign the contracts, Androscoggin would be required to satisfy the US Bankruptcy Court that there was “reasonable assurance of performance” of the contracts by a proposed assignee and that, as a practical matter, the assignee would be required to post letters of credit with the appellants that met the requirements of the contracts. Farley J. acknowledged the submission in his reasons and observed that if for some reason the assignee did not have the financial resources to make the payments Androscoggin would have a problem getting a vesting order in Canada to effect the assignment.)

[21] Farley J. was correct that in this case the rights of the respondents and the appellants are not affected by the characterization of the gas supply agreements as EFCs because the terms of the contracts do not entitle the appellants to terminate the contracts. I would dismiss the appeal.

[22] Inasmuch as the respondents were successful on the appeal, I would order the appellants to pay the respondents the costs of the appeal including costs of the motion for leave to appeal which I would fix on a partial indemnity scale at $24,000 for Androscoggin and $8,000 for Credit Suisse First Boston both inclusive of disbursements and GST. I would make no other order as to costs.

RELEASED: February 18, 2005 (“KMW”)

“Karen M. Weiler J.A.”

“I agree S. T. Goduge J.A.”

“I agree E. E. Gillese J.A.”