On 23rd July, the Bank of Canada released its quarterly Monetary Policy Report. It contained some welcome good news: Canada’s recession was over. After three quarters of contraction, the economy was expected to grow by 1.3% in the second quarter of 2009. “We are on track for the recovery,” Bank governor Mark Carney declared.
It was not a total surprise. As early as October 2008, the IMF predicted that of the G7 countries, Canada would be least affected by the recession. The core drivers of the economic crisis were largely absent in Canada. Its real estate market was less overheated than elsewhere; its mortgage market, tightly regulated and heavily insured, suffered no US-style collapse; and its banks, too, had been kept from risky investments and borrowing by a tight regulatory environment.
“A combination of more robust regulatory oversight and inherent Canadian conservatism has meant there’s been much less turmoil in the financial system here than in the USA and UK,” says Brock Gibson, chair of one of Canada’s larger firms, Blake, Cassels & Graydon. No government bailout of Canadian banks has been necessary.
At the same time, Canada’s consumer debt is lower than many other developed countries, and its national debt has been decreasing for some years thanks to government surpluses (although the government has admitted that deficits are likely for the next few years). The fundamentals of the economy, as John McCain might say, are sound.
But while Canada may not have been a direct victim of the financial crisis, it has suffered a certain amount of ‘collateral damage’. Its sheer interdependence with the USA – the destination for 76% of its exports – has left it suffering reduced demand in its manufacturing and resource industries. And its once-thriving oil sands industry, based in Alberta, was thrown into turmoil last year by the precipitate plunge in the oil price. “We missed the rock hitting the pond, but we’re still getting buffeted by the ripples,” says Brock Gibson.
The result has been a time of mixed fortunes for Canada’s lawyers. Transactional lawyers have not seen the collapse in deal activity seen in the USA and UK, but neither have they benefited from the same degree of restructuring work. Litigators have seen only mixed benefits from the recession. And projects lawyers have seen widely varying levels of activity across the 3000-mile breadth of the country.
A crisis narrowly averted
Canada’s closest brush with the financial crisis happened, not in September 2008 as in the USA, but in August of 2007. As concern deepened about the subprime mortgage crisis growing in the USA, the market in Canada for asset-backed commercial paper (ABCP) collapsed. ABCP is way of packaging up consumer debt obligations, like an asset-backed security or CDO, but designed for short-term (typically one-year) use. Gaps in Canada’s otherwise tough financial regulatory regime made ABCP easier to sell there and a large market developed. In August 2007 confidence in ABCP – some of which was backed by subprime US mortgages – collapsed and prices plummeted, prompting major investors to agree a freeze on sales of ABCP in order to plan a restructuring. “Essentially it created an industrywide insolvency, the largest in Canadian history,” explains Philip Henderson of Stikeman Elliott.
Industry players – and their law firms – spent the remainder of 2007 and much of 2008 trying to piece together a plan to unfreeze C$33 billion of frozen debt. Following months of court dispute with smaller investors, the Supreme Court of Ontario finally approved a plan in January 2009 which offers refunds to smaller investors and long-term notes in exchange for the ABCP to larger investors. Goodmans advised the investors’ committee set up to iron out the settlement, ultimately convincing the Supreme Court of Canada not to hear objections to the deal raised by smaller investors.
While the ABCP settlement was being ironed out, business carried on largely as usual. Then the credit crunch, in Canada as elsewhere, began to bite. “M&A and corporate finance largely continued through early 2008,” recalls Philip Henderson. “Credit was drying up, the more leveraged deals stopped, and everyone was nervous, but things ticked along reasonably well.” Following the events of September 2008, however, activity tailed off dramatically. “Credit simply stopped,” says Brock Gibson. Not only leveraged deals, but “any transaction that required a renegotiation of existing obligations” – including most mergers – “was immediately on hold.”
By the start of 2009 confidence was beginning to return. Philip Henderson characterises late 2008 as “an aberration of navel-gazing. By the end of the year there was confidence we’d be less affected than other jurisdictions.” Nevertheless, credit has been slow to unfreeze, and so has the flow of transactions. While 2008 saw a succession of multibillion-dollar deals occupying the nation’s largest transactional teams – the biggest deal of the year, mining company Teck Cominco’s takeover of Fording Canadian Coal, clocked in at US$14.1 billion – such major dealsin 2009 have been few, largely limited to the resource sector, and with a cross-border element.
For example, Fasken Martineau advised Switzerland-headquartered, Toronto-listed Addax Petroleum in its C$8.3 billion sale to Sinopec International Petroleum Exploration and Production Corporation, the Chinese stateowned oil exploration company; Osler advised the board of directors of Addax, while Sinopec IPEPC was advised by Stikeman Elliott and the USA’s Vinson & Elkins.
For a few big firms, the shortage of credit has created the opportunity for some innovative transactions. Blake, Cassels & Graydon acted for oil company Suncor in its merger with Petro- Canada to create a C$43 billion energy giant (Macleod Dixon and Torys advised Petro- Canada). Brock Gibson, who worked directly on the deal, says it was a challenge to carry out such a mega-merger in the current credit climate.“ Most mergers require a renegotiation of outstanding credit facilities. The challenge with this deal was to structure it in such a way that such a renegotiation wasn’t necessary. In the current circumstances it was an important factor in getting the deal done.”
A mixed picture for insolvency
Many transactions in the last year have stemmed from distress in the wider economy, and insolvency practitioners have been busy. Although the financial sector escaped the crisis relatively intact, in the ‘real economy’, the knock-on effects of the US recession have been keenly felt. The hardest-hit region has been Ontario, the home of Canada’s substantial car and car-parts industry, which has suffered directly from the woes of the ‘big three’ US carmakers.
The Canadian government and Ontario provincial government contributed C$14.5 billion to the US bail-outs of GM and Chrysler to ensure the troubled giants would not close their Canadian facilities, but analysts still expect Canada’s car production after the recession to end up at least a third below its 1999 peak. “The high price of the Canadian dollar against the US dollar, and increasing competition from Mexico, were already placing the industry under pressure before the US recession destroyed demand,” explains David Wingfield, a partner at WeirFoulds in Toronto.
And in addition to foreign car manufacturers’ Canadian operations, hundreds of smaller parts-manufacturing businesses are also suffering: Ontario’s largest carparts company Linamar announced a quarterly loss of C$48.4 million in August following a 40% drop in production from last year. A host of smaller businesses have simply collapsed.
But the country’s other provinces are also suffering. Montréal’s manufacturing base is more diversified than Ontario’s, with major pharmaceutical, aeronautical and tech companies based in the province, and has consequently seen less unemployment than its neighbour. But in the West, British Columbia’s forestry industry has been, as one Vancouver practitioner puts it, “brought to its knees” by a combination of the recession, a slump in demand from the US housing industry and the global newspaper and magazine industry, a long-running dispute with the USA over import tariffs – and even the destruction of forests by an infestation of pine beetles.
The scarcity of credit means that the number of distressed M&A transactions is much lower than usual for a recession. Observers say the forestry industry, for example, is ripe for consolidation, but transactions have been thin on the ground so far. “There was a small wave of consolidation in the industry in 2004-5, which we thought would prove to be the tip of the iceberg,” says Valerie Mann, a partner at Lawson Lundell in Vancouver. “But it hasn’t materialised yet, because of the shortage of financing.”
In addition, the dearth of finance prevents major debt restructuring. “The credit crisis has made it much more difficult for companies under stress to restructure their financing,” says David Wingfield of WeirFoulds. “Far fewer companies are going through the CCAA [Companies’ Creditor Arrangement Act, Canada’s equivalent of Chapter 11] process than you would expect in a recession; more are going into out-and-out liquidation.” This means less of a boom for insolvency lawyers, as liquidation produces less scope for negotiation and disputes than restructuring.
One mammoth insolvency, however, is providing plenty of work: the bankruptcy of communications firm Nortel. Once Canada’s biggest company, it finally filed for bankruptcy protection in January after years of decline following the dotcom bubble. It is being advised by Ogilvy Renault, while Goodmans is advising the administrators, Ernst & Young; Osler Hoskin & Harcourt is advising Nortel’s boards of directors, and Thornton Grout Finnigan is acting for Flextronics Telecom Systems Ltd, a key creditor.
The company’s assets are being sold off piece by piece: most notably, Sweden’s Ericsson successfully bid to buy Nortel’s wireless business, the largest single component of the company, for US$1.13 billion. At the time of writing, the deal still faced regulatory hurdles in the face of widespread public opposition to Nortel’s assets leaving Canada.
Class actions growing
Like insolvency lawyers, litigators have seen mixed benefits from the financial crisis.“Many of the key drivers of litigation in the USA have been absent in Canada,” explains DavidWingfield of WeirFoulds. “The Madoff scandal, for example, largely passed Canada by.” Larger firms are making do with a range of class actions relating to the financial crisis and companies’ responses to it. One growth area is class actions. Such cases were authorised across Canada in the 1990s, and have been growing in popularity since. Canadian Imperial Bank of Commerce is currently fighting a class action, brought by shareholders regarding its statements in 2008 about its exposure to subprime losses. The case has been brought by New York’s Coughlin Stoia, the legendary class action shop formerly led by Bill Lerach (see article, Client Report 22).
If that case could be seen as an example of the USA taking on a Canadian giant, then the US Steel dispute is the opposite. In July, the government applied to the Federal Court of Canada (the country’s constitution splits business cases between the provincial and federal courts in a similar system to the USA) to compel US Steel to adhere to the terms of its 2007 acquisition of Ontario steel company Stelco. The government argues that US Steel made various commitments at the time of the takeover regarding future production, research and capital expenditures in Canada. In March 2009 US Steel announced the shutdown of two Ontario plants.
The recession, say lawyers, has raised concerns about the number of Canadian jobs dependent on foreign companies. “One factor affecting the levels of restructuring work is the increasing ownership of Canadian businesses by foreign parents,” says William O’Reilly of Davies Ward Phillips & Vineberg. “The last time Stelco faced a crisis it restructured; now it’s simply been closed down. We’ve seen this story repeat itself across the country.”
While major bank litigation has been thin on the ground, the recession has brought the usual in smaller contract disputes as activity slows down. “People are using litigation for financing purposes,” says Michael Barrack of restructuring and litigation boutique Thornton Grout Finnigan. “We’ve reached the stage where the amounts companies are refusing to pay each other are large enough that the cost of litigation becomes a worthwhile price for recovery.” Or, as Brock Gibson puts it, “some deals don’t work as smoothly in reverse as they do in fifth gear.”
Alberta: state of shock
Perhaps no province has seen such a sharp change in fortunes as Alberta. In the summer of 2008 the home of Canada’s oil and gas industry was, in the words of Robert Anderson of Osler in Calgary, “white hot.” Canada’s Athabasca oil sands are notoriously expensive to extract oil from, but with crude selling at over US$140 a barrel, even the most elaborate projects were viable. Then, in a few short weeks, both the global financial system and the oil price collapsed – and near-chaos ensued.
“Everyone was in a state of shock,” recalls Robert Anderson. “Spending on major capital projects simply stopped.” Oil sands extraction requires an oil price of at least US$60 per barrel to be profitable, higher for new projects. The collapse in the price to below that level, combined with the unavailability of financing, meant major projects were frozen or scaled down in late 2008.
For example, VCI BA Energy had already begun construction of a C$4 billion plant near Edmonton, designed to upgrade heavy oil to crude, when it quietly pulled the plug on the project in September. Now, with the oil price rising again, there’s still reluctance to restart projects activity. “The current oil price of around US$70 is high enough to justify activity,” says Christa Nicholson, also of Osler’s Calgary office. “But these are some of the biggest projects in the world, some totallingC$100 billion or more. Boards are cautious about spending that kind of money until it’s clear we’ve hit the bottom of the general downturn.”
If the last year has been a time of uncertainty for Alberta’s projects lawyers, though, it’s been a busier time for insolvency lawyers. Like Silicon Valley after the bursting of the dotcom bubble, Alberta has been left with highly leveraged growing companies, still at the development stage with minimal income, simply unable to survive the recession. The aforementioned BA Energy became the first oil sands company to file for bankruptcy protection in January. It had, in the words of one lawyer involved in the insolvency, “a huge balance sheet, lots of debt and absolutely no income.” An article in Canada’s National Post newspaper in May declared insolvency lawyers “Alberta’s new hot commodity.”
Building the recovery
While oil sands projects may remain frozen for a few months more, projects lawyers across the country are busy on a range of public infrastructure projects including hospitals, schools and highways. Most provinces had already begun programmes of infrastructure upgrade when the federal government announced further funding for infrastructure as part of its stimulus package. Public-private partnerships have become a common means of financing. “After the UK and Australia, Canada is the other jurisdiction where PPP has become a key way of funding public projects,” says Bill O’Reilly of Davies Ward Phillips & Vineberg.
In northern Alberta, for example, a private consortium is building a 21-km stretch completing the ring road around Edmonton, and will maintain the road for the province until 2141. The consortium is managed by PPP specialist Bilfinger Berger; the contractor, itself a joint venture between US construction companies Parsons and Flatiron and Canada’s Graham Infrastructure, is being advised by national firm Borden Ladner Gervais.
In British Columbia, projects lawyers are also coming to the end of a long period working on the preparations for the 2010 Winter Olympics, to be held in Vancouver in February.
A stable legal market
As with the economy, Canada’s legal market has endured the recession with little of the turmoil seen in the USA and UK. Total lawyer redundancies by major Canadian law firms number in the single figures. In part this reflects the fact that Canadian law firms have historically employed very low leverage by the standards of large US and UK firms. “A ratio of 1:1 or perhaps 1:1.5 is normal for Canadian firms,” says Grant Weaver, a partner at Vancouver’s Bull, Housser & Tupper. “Everyone would love to enjoy the profits that come with the kind of leverage you have in London, but the Canadian business base simply won’t justify it.”
This conservatism has stood law firms in good stead through the recession. The same could be said about Canada’s broad-based economy: it may not have delivered the same riches as the USA or UK’s love affair with high finance in recent years, but it has spared Canada much of the recent turmoil. This has meant less of a drop-off in transactions for Canada’s law firms, but fewer benefits in litigation and restructuring as well. As Canada looks again towards growth, its law firms hope that transactions quickly revert to pre-crisis levels.