Companies going through national security reviews traditionally hold off on engaging with regulators until fairly late in the game. It’s time to reconsider that strategy
If you had to choose one in-house lawyer who has experience with deals publicly going through Investment Canada’s national security reviews, it would have to be Paul Beauregard. And in the early days, it wasn’t always a pleasant experience for Manitoba Telecom Services’ (MTS) Chief Corporate and Strategy Officer, who is responsible for legal.
On Oct. 7, 2013, for example, he was walking from one meeting to the next in downtown Toronto talking on his cell when he heard a beep. Another call was coming in.
That call was from MTS’s external counsel. It was bad news: They had just been informed that Ottawa had turned down the proposed $520-million sale of MTS’s Allstream unit to Egyptian investment group Accelero Capital Holdings.
MTS acquired Allstream, created out of the AT&T restructuring, in 2004. Nearly a decade later, it wanted to divest itself of the business and, after conducting a sale process, it had its buyer.
Accelero was founded by Egyptian telecom magnate Naguib Sawiris, who bankrolled the launch of Wind Mobile, a small wireless company that operates in Canada.
While the Canadian Radio-television and Telecommunications Commission turned down Sawaris’s proposal to buy the spectrum for Wind, the Harper government overturned the CRTC decision, making it clear that foreign investment was welcome in Canada’s telecommunications industry.
There was to be no such intervention this time. Allstream carries data for 43 Canadian departments and agencies, including the Ministry of Defence and the RCMP. Following a 136-day review under the Investment Canada Act, all the government said was that the proposal was being denied due to unspecified national security concerns. “I was stunned,” says Beauregard. “I was in total shock.”
His next call was to then-CEO Pierre Blouin, who did not blow a gasket. He may have been too dazed. “I think we were all just profoundly surprised and shocked.”
Beauregard says as recently as three years ago, transactions involving a foreign buyer or investor that fell under the Investment Canada Act were routinely stickhandled by acquirer’s counsel.
Dany Assaf, who was advising acquirer Accelero, did everything he was supposed to. He travelled to Ottawa for “several normal-course meetings” with Industry Canada to discuss any potentially problematic issues. Security was never raised, says Assaf, who now co-chairs the competition and foreign investment review practice at Torys LLP in Toronto. “There were no indications in the meetings that there was any concern.”
That made the rejection of the Allstream acquisition on security grounds that much more difficult to understand, he says.
If the lawyers were shocked, Sawiris was livid. “I am finished with Canada,” he said at the time. “It’s totally unacceptable to have foreign investors waste their time and money, hold their capital captive, and then come up with a comment like that.”
MTS was not thrilled either, having spent “considerable resources” on the deal, says Beauregard.
Shuli Rodal, a partner at Osler, Hoskin & Harcourt LLP in Toronto, says in the past couple of years “people have really noticed an uptick in the use of national security review and it’s a lot of really small things.
“In the first couple of years after the provisions came into effect [in 2009] there were very few national security reviews and now, from our own experience and what you hear from people who practise in the area, we’re seeing more.
“It’s too early to say whether under the Harper administration there was more of an interest in these types of issues. Whether that will continue under the Trudeau government we don’t yet know.”
Behind the scenes—with the Harper government still in power — MTS didn’t give up on a possible sale. But this time, Beauregard decided to handle the situation completely differently.
He took an approach he feels every in-house counsel whose client company may deal with a prospective foreign buyer or investor should pay close attention to: He decided MTS itself would work with Industry Canada (since renamed Innovation, Science and Economic Development Canada, or ISED) right from day one.
The thing is, it’s an approach that may run contrary to what some external lawyers are telling their clients.
Traditionally, when a company is working on a transaction, its legal advisors on Bay Street will advise management not to engage with regulators at all until they know exactly what it is they are selling. The process has historically been perceived as preparing for an us-versus-them war.
The notion of going to the regulator to say: “Hey, this is what we’re thinking, can you help guide us through that?” was – and to some lawyers still is – a spectacularly ill-conceived idea.
But the old model that regulatory approval needs to be antagonistic “is a broken model,” says Beauregard, a former vice-president, law, mergers and acquisitions at BCE-Bell Canada and partner at Davies Ward Phillips & Vineberg LLP.
So when MTS went to sell Allstream the second time, Beauregard went directly to the relevant officials not just early, but often. Often because, behind the scenes, MTS had lined up a small cotillion of interested financial and strategic buyers from multiple countries.
Far from keeping it secret from ISED, Beauregard worked with the department to help narrow the field. “We were open all along about the entire range of potential buyers, and they were able to provide us, without knowing that there would be a successful acquirer, guidance that helped shape our thinking in terms of who ought to be in that field of potential bidders.
“By personal experience, we found the early engagement with ISED to be invaluable in achieving our end objective and preventing us from making mistakes.”
In November, MTS announced it had a deal to sell Allstream to Colorado-based Zayo Group for $465-million cash.
It sent ISED the 45-day pre-review notification required under the Investment Canada Act, which automatically sparks a look at whether a security review is warranted. The approval was granted with no objection or request for delays on the government’s part. “There was some misinformation reported after the fact that this meant they had not conducted their security review,” says Beauregard. “To the contrary, they had been really diligent in the months, weeks and even years leading up to the sale process.
“ISED had been with us doing their security review alongside us every step of the way so that when the 45-day period elapsed, they found no need to extend it. Their work was done.”
Paul Halucha, ISED Associate Assistant Deputy Minister, who is also Deputy Director of the Investment Canada Act, says it is enormously useful when companies embroiled in transactions come in early — and that can mean before they have all their ducks in a flock, much less a row.
“It’s helpful for us and I think it’s fundamentally helpful for the Canadian business or the foreign investor,” she says. “The phrase people in Ottawa use to talk about it is ‘socializing the idea,’ which means coming in to give us a sense of what the transaction is, what the target is.
“Sometimes it can be an early-stage introduction to see what the government’s view could be on a topic. Other times it can be more involved where a company is going through a sales process and keeps us in the loop on who the bidders are and what’s happening, so it can take different forms.
“But we’re always clear about this: The way the regime is set up there’s no point at which we can clear companies without having all the information pertaining to that investment. So we’re never in a position to say: ‘You’re good to go, we guarantee you a green light.’ But we do have the ability to signal areas that can be of concern, or whether the investment may have challenges — and I think that’s proven effective to companies.”
ISED gets notifications of more than 700 transactions a year involving foreign investors — some sales, some control investments and some just minority investments. A little over half are US investors, unlikely to move into a full-fledged national security review, while only about a dozen are large enough to be “reviewable” under the Act’s net-benefit provision.
But large or small, they all need to be screened for security.
The foreign-investment group that quarterbacks national security reviews and net benefit tests only comprises about 15 people, says Halucha.
“Six or seven, I’d say their principal job is the net-benefit test, three or four are market watchers — we do a watch to try and understand what’s happening around transactions both in Canada and internationally to try and provide perspective to the Minister. Then we have a group of three or four people whose role is to interface with public safety and security and intelligence agencies that are obviously the backbone of national security in Canada, including for this Act.
“So I don’t have a spy agency here. I don’t have the competent authority from an intelligence-gathering perspective. But we interact with those organizations readily.”
Halucha, who has been in his current position for three years, says while his group doesn’t have a ton of experience in helping guide potential targets with multiple bidders, it can indicate which deals might be more challenging to get through a security review. “We can’t throw out red flags but we are in a position to effectively signal easy, medium or hard.”
Will buyers or investors from one of the so-called “Five Eyes” countries (Canada, the United States, Australia, New Zealand and the UK) automatically get an easier ride on security than their counterparts from other countries?
“I can’t really say yes but intuitively, it makes sense. Obviously the US and European countries invest heavily in Canada. I wouldn’t say they get an easier ride from the perspective that they’re not analyzed, but from an outcome’s perspective there’s just a longer history with those countries and we’re very comfortable with those investors in the Canadian economy.”
Assaf says there were some important lessons learned from the initial Accelero rejection.
The first is “that with national security reviews, there is an international component and it’s tied to what we all know is important national security cooperation between Canada and its major allies. Within that, we learned about this alliance called the Five Eyes.
“So when you’re looking at these deals you have to think of how national security is integrated between these allies and others and how any part of your deal may impact the national security concerns of any one of those countries. You have to assume they’ll talk to one another and that will be a relevant consideration.”
The challenge, he says, is “you don’t know whether there’s a question raised out of that alliance that becomes relevant to your deal. You don’t know whether there’s something that happens internationally in real time in a relevant country, or where the investor’s from, that raises questions. Its relationships with the Canadian government, services to the Canadian government, to the defence establishment — those are the kinds of things you look to and see whether there’s anything to deal with.”
Assaf says “you really do have to think creatively about what may impact national security. You have to think about it from the top down, the bottom up and across relevant geographies with major allies. You have to think: Who are the customers and the users of these products and services and how do they directly or indirectly connect into the Canadian security or defence apparatus, or provide exposure to somebody into those areas? That’s a big lesson here.”
The second one, he says, is to look at your relationship with ISED as only part of the puzzle. “They’re often going to be the coordinator of the other relevant departments — not necessarily the decision maker or the only decision maker in some cases. So, again, look beyond the traditional process at who are the key players and look at how to connect with them in a different way.
“This is all evolving, you deal with ISED, but maybe issues get identified and isolated and you talk directly with those relevant departments. We don’t know who they are but we assume it’s Defence and CSIS and the intelligence services.
“There may also be relevant industry departments. If it’s a resource transaction it may be the Ministry of Natural Resources, if it’s telecoms obviously you have to deal with the telecoms folks, if it’s agriculture you maybe deal with the Agriculture Department. That’s the creative part, to think of other government departments who would have an interest in this from a national security perspective. They may be consulted for their perspective to see if there are any risks there, so they may be indirectly involved.”
If Assaf were to pick up the phone and call someone at the Defence Department about a prospective deal, would anyone talk to him? He says no.
“That’s the other thing, you have to work within the process but get directly to the issues that are going to make a difference. The people at ISED are very good, but this is evolving deal by deal.”
With only a dozen or so of 700 prospective foreign sales or investments a year becoming public due to the need for Ministerial review, there are presumably dozens that are turned down on national security grounds and no one but the parties involved ever knows. That has led to complaints the process is far too opaque.
John Bodrug, a partner at Davies Ward Phillips & Vineberg LLP in Toronto, points out that “nobody knows the full extent of reviews blocked, or why, because if it is not a ‘reviewable’ transaction it never becomes public.”
One that did, though, was a Chinese company’s 2014 plan to invest $30 million to build a massive fire-alarm manufacturing plant in St. Bruno, Q ue. Almost a year after the official ground-breaking ceremony, attended by high-level local and provincial officials, La Presse reported Ottawa had rejected the location as too close to the Canadian Space Agency.
The deal was too small to require Investment Canada pre-notification, so the transaction had closed before the company was ordered to find another property if it still wanted to go ahead.
Another example was China’s O-Net Communications (now O-Net Technologies), which bought a Saint-Laurent, Que., firm that specialized in the manufacture of fibre components and modules.
The government said after the transaction closed that the $5-million acquisition was harmful to Canada’s national security and gave O-Net 180 days to divest itself of the business.
O-Net applied for a judicial review, saying that, for one thing, the previous company was owned by a French entity, and for another, that when it went bankrupt “there were no Canadian investors or investors from anywhere in North America that were willing to invest.”
Bodrug says sometimes the problem involves only a very small part of the acquirer or investor’s business, “and that maybe somewhere there could be some room for dialogue [with ISED]. Maybe that part of the business could be spun out.
“It might be helpful to initiate a clearance procedure. In Canada, unless you’re a reviewable transaction or it’s considered a control investment, there isn’t a mechanism to go and get clearance ahead of time.”
Oliver Borgers, a partner at McCarthy Tétrault LLP in Toronto, says there is “absolutely” angst among lawyers like him when clients are doing transactions involving a foreign party.
“The uncertainty of a potential outcome raises concerns so you attempt to mitigate it to the best of your abilities. But ultimately, because of the very nature of national security, much of the decision-making and even information may not be known to the advisors or the merging parties — classified information may be coming to the Canadian intelligence and security community that gives the reviewing officials information and insight that you as counsel may not even have.
“You don’t want to be ambushed on the eve of closing after having spent months and months and millions of dollars on deal preparation only to find out that you can’t do the deal. So it is critical in any deal where there is any degree of risk to deal with that upfront and quickly.”