Project Law Blog

Doing Indirectly What You Cannot Do Directly: ROFR’s and the Duty of Good Faith

Posted in Mining, Oil & Gas Law, Project Development, Project Permitting, Public Utility, Regulatory, Regulatory Compliance
Print Comment

Can you ever do indirectly that which you cannot do directly? The answer appears to be yes, in certain circumstances according to the Saskatchewan Court of Queen’s Bench decision in Northrock Resources v ExxonMobil Canada Energy, 2016 SKQB 188.  This case considers this issue in the context of rights of first refusal (“ROFR”) when dealing with oil and gas transactions.

Among other issues, this case looks at whether a ROFR obligation exists when interests are transferred to an affiliate and then that affiliate is sold to a third party. Specifically, if a ROFR is owed to Northrock in the event that ExxonMobil disposes of its interests, and then ExxonMobil enters into transactions whereby it transfers its interest to its wholly owned subsidiaries (“Affiliates”) and then sells the shares of Affiliates to Crescent Point without providing a ROFR notice to Northrock, is this a breach of contract or a breach of a duty of good faith?

In this case the ROFR provisions provided for an exception where a transfer is to an affiliate. The issue arose as to whether the subsequent sale of that affiliate to a third party is circumventing the ROFR obligation. The case looked at the issue in the context of both breach of contract and breach of the duty of good faith, but our review focuses mainly on the duty of good faith.

Breach of Contract

Justice Currie concluded that the agreements containing the ROFR provisions provided for an exemption for transfers to affiliates and did not speak to any subsequent sale of the shares of such affiliate. At paragraphs 42 and 54 he states:

[42] I conclude that I am to construe the ROFR provisions on a plain, straightforward interpretation consistent with the ordinary meaning of the words and consistent with the other provisions of the agreements. If the ROFR provisions are unambiguous, I am to construe them accordingly and not inject terms that the parties had not inserted into the agreements.

[54] In addition, an examination of the ROFR provisions reveals that the parties to the agreements did not intend that every circumstance of a party divesting itself of an interest would trigger a ROFR. In negotiating the ROFR provisions they chose which divestitures would be singled out for a restriction on the right of a party to deal with its own property.

It would appear then that unless expressly prohibited, a sale to an affiliate and a subsequent sale of the affiliate’s shares to a third party will not be construed as a breach of contract with regards to ROFR obligations in CAPL Operating Procedures and other ROFR clauses that provide an exception for a disposition to an affiliate but do not include a provision that a ROFR is triggered by a change of control. The fact that there was ultimately a change of control of the assets does not in itself constitute a breach of the ROFR provisions.

Duty of Good Faith

Justice Currie reviewed the case law regarding the duty of honest contractual performance and the duty of good faith. Reference was made to the concept of duty of honest contractual performance introduced by the Supreme Court of Canada in Bhasin v Hrynew, 2014 SCC 71, [2014] 3 SCR 494 which states in part at paragraph 93:

… a duty of honest performance, which requires the parties to be honest with each other in relation to the performance of their contractual obligations.

but further clarifies at paragraph 65 that:

While “appropriate regard” for the other party’s interests will vary depending on the context of the contractual relationship, it does not require acting to serve those interests in all cases. It merely requires that a party not seek to undermine those interests in bad faith.

Justice Currie then concluded at paragraph 66 of this case:

I conclude that a breach of a duty of good faith may be established where a party is shown to have lied or misled, thereby breaching the duty of honest performance.

In looking at the duty of good faith in the context of a ROFR Justice Currie reviewed a trio of cases: GATX Corp. v Hawker Siddeley Canada Inc. (1996), 27 BLR (2d) 251 (Ont Ct J); Glimmer Resources Inc. v Exall Resources Ltd. (1997), 35 BLR (2d) 297 (Ont Ct J); and Chase Manhattan Bank of Canada v Sunoma Energy Corp., 2002 ABCA 286, 317 AR 308. Together these cases provide that a breach of the duty of good faith will not be found if the structure of the transaction was chosen for reasons other than to avoid a ROFR. For example, in paragraph 71 of GATX it states:

It is well established that the grantor of a right of first refusal must act reasonably and in good faith in relation to that right, and must not act in a fashion designed to eviscerate the very right which has been given. This is an illustration of the application of the good faith doctrine of contractual performance …

Based on his review of the ROFR cases Justice Currie determined that:

[66] … a breach [of a duty of good faith] may be established where a party is shown to have structured a transaction for the purpose of avoiding a ROFR.

[67] If, on the other hand, a structure was chosen for reasons other than to avoid a ROFR, then the choice of that structure did not constitute a breach of a duty of good faith.

In this case Justice Currie concluded that:

[104] The defendants did not lie. The defendants did not mislead. The defendants did not use the busted butterfly structure for the purpose of avoiding the ROFRs. Rather, they used it for other legitimate purposes – albeit recognizing that it would have (in their view) the side effect of not triggering ROFR notices. Knowledge does not always translate into intention, and in this case it did not.

Justice Currie acknowledges that another possibility exists i.e. that the avoidance of ROFRs was not the sole reason but was a reason contributing to the choice of structure. As he did not find that situation to exist on these facts he did not address this issue.

This case provides some direct precedent (at least at a Saskatchewan QB level) as to whether a ROFR obligation is triggered, where there is an affiliate exception, in the event that interests are transferred to an affiliate and then the affiliate is sold to a third party. It reaffirms that a breach of the duty of good faith will not be found if the structure of the transaction that is chosen has the effect of avoiding a ROFR if that was not the purpose for which the structure was chosen. However, it remains to be seen whether the courts will find it to be a breach of the duty of good faith where the avoidance of a ROFR is a contributing factor in choosing the structure of the transaction.