Beyond “Magic Words”: Alberta Court of King’s Bench Clarifies Test to Determine Whether a Gross Overriding Royalty is an Interest in Land

Introduction

The Alberta Court of King’s Bench’s recent decision in Durham Creek Energy Ltd v Chimera Management Group Ltd., 2025 ABKB 246 brings some much-needed clarity to the test for when a Gross Overriding Royalty (GORR) is an interest in land.

While the law has been clear for some time that a GORR can be interest in land if the parties intended it to be, there remained confusion in the GORR case law around how to determine what the parties intended and significant debate regarding the emphasis that should be placed on the inclusion of “sufficiently precise language” or “magic words” in the parties’ agreement.

Durham Creek cuts through the confusion by reconciling the leading GORR case law (which appears to emphasize the importance of particular legal language used in the agreement in determining the parties’ intention) with contemporary principles of contractual interpretation.

The takeaway is that whether a GORR is an interest in land should not turn on, or place undue emphasis on, the inclusion of particular words in the agreement. The issue of whether a GORR was intended to be an interest in land is one of contract interpretation and, as such, the modern principles of contractual interpretation (as set out in Tercon and Sattva) apply. In this case, as there was no evidence of intent submitted by the parties (beyond the text of the agreement), the economics of the underlying transaction became the critical factor that allowed the Court to determine intent.

Significance of a GORR being an interest in land vs mere contractual interest

A GORR is a common arrangement in the oil and gas and mining industries in which the owner of the GORR receives a percentage of gross production revenues from the mineral property. While they may be created for many reasons, they are commonly used as part of farm out agreements between mineral lessees and companies with the capital and expertise to drill wells, or as financing tools, granted over a working interest in order to raise capital.

A GORR can either be a contractual right (i.e., existing only between the parties to the contract that created the royalty) or a proprietary right that binds the world. If the GORR is an interest in land, it gives the GORR-holder significantly greater protection, including in the case of the grantor’s insolvency or in enforcing the GORR against successors to the original grantor.

Confusion in the prior GORR Case Law

That a GORR could be a proprietary interest in land was first affirmatively recognized by the Supreme Court of Canada (SCC) in Bank of Montreal v. Dynex Petroleum Ltd.^[1] This decision affirmed the decision below of the Alberta Court of Appeal^[2] but did so in a way that left confusion about what factors should be considered in determining whether a particular GORR was an interest in land or merely a contractual interest.

The Court of Appeal listed three indicia that should be used to determine whether a GORR was an interest in land:^[3]

1. The underlying interest is an interest in land (corporeal or incorporeal);
2. The intentions of the parties, as evidenced by the language of the grant and any admissible evidence of the surrounding circumstances or behaviour, indicate that it was understood that an interest in land was created/conveyed; and
3. The interest is capable of lasting for the duration of the underlying estate.

Although the SCC affirmed the Court of Appeal decision, it did not reference any of these indicia directly. Instead, the SCC referenced an old decision of the Alberta Court of King’s Bench that focused on whether “the language used in describing the interest is sufficiently precise to show that the parties intended the royalty to be a grant of an interest in land, rather than a contractual right to a portion of the oil and gas substances recovered from the land.”^[4]

The SCC offered no further commentary or explanation, leaving lower courts and industry commentators to question whether the SCC had rejected the contextual analysis described in the second indicum of the Court of Appeal’s test in favor of a more textual approach.

The correct approach must be in line with modern principles of contract interpretation

After reviewing the confusion in GORR case law following the SCC’s Dynex decision, the Court in Durham Creek concluded that the correct approach to determine whether the parties intended a GORR to be an interest in land is one that is in line with the contemporary approach to contractual interpretation. As such, the indicia set out in the Court of Appeal Dynex decision is the proper test (only the second indicum was at issue in this case).

In so deciding, Justice Feasby observed that the search for “sufficiently precise” language referenced in the Dynex SCC decision was “unhelpful” and a distraction from the task of determining the objective intention of the parties.^[5] 

Commercial context key deciding factor in this case

Notably, the language of the agreement in Durham Creek contained only two clues (which were inconclusive on their own) as to what the parties intended:

1. the fact that the GORR originated in the same paragraph as the working interest to which it attached supported the view that the GORR was the same type of interest as the working interest (i.e., an interest in land); and
2. the use of the words “subject to” could be interpreted to mean that the GORR is an interest in land (because the working interest was subordinate to the GORR) but could also be interpreted to mean that the GORR is a contractual right that burdens the working interest.

When considered alongside the economics of the transaction entered into by the original parties to the agreement, however, the Court was able to conclude that the GORR in question was an interest in land. Key facts included that:

• The GORR had originally been created by a Letter Agreement between Hudson’s Bay Oil and Gas Company Limited (HBOG) and Pacific Petroleum Ltd.;
• HBOG was the lessee of the petroleum and natural gas rights and farmed out a working interest in the lease to Pacific in exchange for the GORR; and
• HBOG had received no up-front compensation in this transaction.

Justice Feasby reasoned that “[p]rudent and informed parties entering a farm out arrangement in the place of Pacific and HBOG would recognize the risk that HBOG (or its successors) may be denied the deferred and contingent consideration by unanticipated future events and would want the GORR to run with the underlying leasehold interest to protect against that risk.”^[6]

The economics and balance of risk of the transaction were the most important points for determining intention. As neither of the parties involved were the original parties to the agreement, there was no evidence of intent submitted beyond the text of the agreement.

Key Takeaways

• There is no special test applicable to determining the parties’ intentions when it comes to GORRs—the analysis does not turn on inclusion of language in the agreement that is “sufficiently precise” to connote the GORR being an interest in land.
• Whether the parties objectively intended a GORR to be an interest in land is a question of contract interpretation that is to be determined in accordance with contemporary principles of contract interpretation.
• In this case, common sense and economic logic supported the conclusion that the GORR was an interest in land and, importantly, the language used in the agreement also permitted this interpretation.