Mastering the art of the cross-border deal

Even now, when documents cross Chris Johnston’s desk, she sometimes still sees the names “Constellation” and “Taurus” crop up. 

TransCanada Corporation announced its $13-billion acquisition of Houston-based Columbia Pipeline Group in March 2016, and as the Calgary energy firm’s vice president of law and corporate secretary, she had been involved from the beginning, many months before that. Her description of the process sounds like something from a John Le Carré novel, including a secret team that could talk about the entire negotiation only in code.

Merging with or acquiring companies in the energy sector can be difficult enough domestically, but a cross-border deal like TransCanada’s carries even more layers of complexity. There are regulatory issues to consider at all levels of government, ranging from securities through to anti-trust. Some of them are rigid and well defined while others are political and highly subjective. Even the best in-house lawyer will need a team of experts behind her.

Secrecy was necessary because as with all public company cross-border acquisitions, negotiations are sensitive. Information couldn’t get out before the announcement was made. “It could potentially throw your deal off the rails, because it could drive up the share price,” she recalls.

Every time someone new joined the team, they were given a note with the code names for the different parties. “Taurus” was TransCanada’s moniker, while “Constellation” was the name of the project.
Columbia called itself “Capricorn.” Staff was so conditioned to think about the companies in code names that they still tend to stick.

TransCanada’s deal is one of several cross-border energy M&A in the past couple of years, following the wild ride in the oil and gas sector. Enbridge’s $37-billion deal with Houston-based Spectra Energy, announced in early September, punctuated a string of energy deals by Canadian companies. Canadian firm Emera bought U.S.-based TECO Energy for US$10.4 billion. Smaller deals included Gran Tierra Energy’s acquisition of three Columbian properties, while TSX-listed Bankers Petroleum Ltd. sold off Albanian assets to Chinese Geo-Jade Petroleum for $575 million.

Gregory Turnbull, partner at McCarthy Tétrault LLP’s business law group, explains the motivation for both buyers and sellers in a volatile energy market. The first group is doubling down. “We have a number of clients who have managed to raise equity in the last few months and go on a spending spree,” he says.
They may buy overseas companies in consolidation transactions or those that enable them to exploit their technical skills.

The second group is driven by debt holders, Turnbull says. The oil and gas sector in particular is driven by debt, much of which was taken on when oil was at $100 per barrel. Now, with banks getting antsy and calling in loans, some companies are being forced to divest selected assets to cover those payments and avoid sinking into protection under the Companies’ Creditors Arrangement Act.

“As long as there’s change, there’s transactions, so there are lawyers on different sides of all these deals,” Turnbull says. “You’re acting for the banks, you’re acting for the management team, for the consolidator or for the employee.”

Lawyers also have to help their clients through some hard decisions and tough times. Legal professionals should also be prepared for a painful process in the boardroom.

Canadian firms are often lured across the border in an industry where assets are often highly tied to particular locations. TransCanada wanted to expand its access to gas basins, for example. Columbia was a good fit, with its 24,000 kilometres of pipeline network and access to basins in areas including Appalachia.

Going across borders typically muddies already complex legal processes, though, so lawyers like Johnston have to balance the need for secrecy and expertise. “The confidential nature of transactions means keeping the deal team as small and tight as possible, but there’s an inherent tension because you’re trying to do it under deadline and you want to throw as many resources on to your diligence team as possible,” Johnston says.

Diligence
Diligence is the first of three phases in an M&A deal. The second, closure and compliance, is followed up by integration. Each of them is rendered more complex by cross-jurisdictional issues, and the nature of the energy sector brings its own additional demands.

Due diligence is of particular importance to Canadian companies, especially when it comes to U.S. acquisitions. The rate of post-acquisition litigation is mind-boggling, warn experts.

“Whenever there’s a public company deal, there’s often a question of value. Value tends to be in the eye of the beholder, which in this case is often the judge,” Turnbull says.

“If you can show that the highest value was not achieved or that the deal was approved too quickly without enough due diligence, there may be a case to argue that damages should be paid.”

Such ambiguity over value leads to litigation following large numbers of public company acquisitions, he says.

In many cases, this litigation isn’t even instigated by shareholders, says Johnston. There are law firms that often mine the public announcements of transactions and issue news releases arguing that there’s a case to investigate the value. Consequently, the more that an acquirer can do at the due diligence stage to stave off such cases, the better.

U.S. legislation
During these diligence practices, Canadian acquirers must be acutely aware of specific U.S. legislation, which applies across many sectors but can have particular significance in energy deals.

For example, they must protect themselves from liability under the U.S. 1977 Foreign Corrupt Practices Act that renders them vulnerable to prosecution if the company they acquire has been engaged in illegal conduct. In June 2016, the SEC issued new FCPA-related disclosure rules for payments made by energy companies in exchange for oil and gas commercial development rights.

Canadian companies must also pay attention to the U.S. Hart-Scott-Rodino Antitrust Improvements Act, says Turnbull. “You always have to be aware when there are two companies in the same industry transacting,” he says. “What’s the size of the deal? What’s the size of the market? Are you creating a competition problem?”

The third big issue that may come up in U.S. legislation is satisfaction of requirements of the Committee on Foreign Investment Review, a cross-sector agency established when concerns were mounting over OPEC investments in U.S. assets. This assesses the impact of foreign investments on U.S. national security.

There’s a similar degree of rigour in Canada, where the Investment Canada Act requires government approval for foreign acquisitions of Canadian energy sector companies. Jennifer Kennedy, a partner at Norton Rose Fulbright Canada LLP, explains that things tightened up in 2012 following the government’s approval of two foreign bids: the Chinese National Offshore Oil Corporation’s $15.1-billion acquisition of Nexen Inc. and the $5.2-billion acquisition of Progress Energy by Malaysian-owned Petronas.

“Those particular transactions led to changes introduced with respect primarily to the Investment Canada Act, which really imposed limitations on the ability of state-owned enterprises to acquire specifically oilsands assets,” she says.

The revised Investment Canada guidelines broadened the definitions of state-owned enterprises and said that acquisitions by SOEs would satisfy a critical “net benefit” test only under exceptional circumstances.

“The issue at hand was that the then-federal government viewed the oilsands as a strategic asset of Canada and wanted to impose limitations on the ability of foreign acquirers,” says Kennedy.

Political machinations can extend to the top level of government at the due diligence phase. When negotiating the Columbia deal, TransCanada was in the middle of federal court and NAFTA lawsuits with the White House, who had rejected its Keystone XL pipeline in November 2015 on the basis that it didn’t serve the U.S. national interest.

“It led to a number of interesting conversations with Columbia’s management on what if any impact this could have on a merger successfully closing, and in a timely manner,” says Johnston. “They wanted to be sure that they were working with an acquirer that could get the deal done.” U.S. government regulators acted professionally, as it turned out.

Environmental concerns
Lawyers typically find themselves conducting due diligence in other key areas to avoid unexpected hiccups. “There would be a lot of focus on the evaluation of the reserve, the land tenure, the licences, the royalties and the statuses of the joint ventures, permitting, environmental compliance and then the assessment of all the liabilities, whether they’re accrued or contingent,” says Philippe Tardif, a business law partner in the Toronto office of Borden Ladner Gervais LLP. “They’re usually the hot buttons in terms of surprises.”

Of those, environmental issues can be one of the biggest surprises for acquirers of Canadian companies, says Vivek Warrier, partner and head of oil and gas at Bennett Jones LLP.

“It’s allocation of risk with respect to environmental liabilities, particularly as it relates to asset transactions in the oilpatch,” he says.

Traditionally in Canada, purchasers in energy deals were assumed to take on all environmental liabilities retroactively assuming that there was no misrepresentation on the part of the seller, says Warrier. “That’s sometimes a tough pill to swallow for an inward-coming investor.”

Environmental and political factors are closely linked, according to Grant McGlaughlin, a corporate and securities partner at Goodmans LLP, who warns that conditions are changing in the Canadian market.
“The carbon reduction plans internationally and the provincial governments who are enacting plans to deal with meeting those goals leads to political risk,” he says. “And then particularly in Alberta, with the transmission and distribution regime, which means pipelines.” Alberta’s new carbon reduction initiative will be one of the most stringent in Canada.

Securities laws on both sides of the Canadian/U.S. border can also throw up some strange speed bumps.

For example, Canadian securities law has a three-part test to determine if an acquisition is significant.
TransCanada’s was, which meant that it had to get Columbia’s financial statement translated into French.
Helping the U.S. general counsel understand this unfamiliar Canadian requirement was one of many tasks. “We had to co-ordinate with the target’s auditors, hire translators, file various consents, all of which affects the time for the prospector’s filing,” says Johnston.

This compliance and due diligence to-do list was part of a two-track process, the other being financing.
This draws on a whole other set of legal skills. TransCanada financed its deal in an all-cash transaction rather than giving shares to Columbia shareholders. It raised the money using a mixture of instruments including asset sales, bridge credit finance and also subscription receipts. Buyers of these receipts were able to convert those receipts to common TransCanada shares, but only if the Columbia deal closed.

Juggling these processes can be daunting for a general counsel, even one with an external firm to help, which is why it is vital to have experts in various areas of law on the team, enabling you to handle a diverse range of issues as they come up.

A well-fleshed-out team can include everyone from tax and securities lawyers through to benefit and pensions experts prepared to handle compensation issues. Typically, that team will have a quarterback as the primary representative to the client, says John Macfarlane, corporate partner at Osler Hoskin & Harcourt LLP, who advised Emera on its acquisition of TECO Energy.

“Often the longest and deepest relationship with the client will be through a corporate lawyer,” says Macfarlane. This lawyer will usually be the key point of contact but will bring in other lawyers in particular practice areas as necessary. This role is critical, as it will be this person who identifies issues early on and routes them through to the right people.

This team will need a central data room to help them navigate the due diligence process, enabling them to collect and evaluate the appropriate data in all of these areas. This asset should be set up early in the process, but it isn’t always possible, points out Macfarlane, especially if the bid is hostile, for example.

 “It makes it difficult obviously, but you have to do the best you can, with industry resources you may have, or maybe you have someone working with the organization that was previously with the entity,” he says.

Closure and compliance
When the deal has been signed and the announcements made, there is a period before it passes the necessary compliance hurdles and closes. This is not the point at which to relax, as other inter-jurisdictional regulatory surprises may crop up.

When negotiating an acquisition of a U.S. firm, for example, Canadian operators will quickly run into regulatory issues with the federal government. After the Columbia transaction closed, the U.S. financial regulator, FINRA, sent Johnston a list of people who had traded shares prior to the announcement of the deal. She had to find any matches between the FINRA list and people at TransCanada that knew about the deal.

“We don’t do a lot of large public deals, and I was thankful that one of my outside counsel had told me from the get-go to keep a good list of everybody who knows,” Johnston says. She had a list of everyone involved in the transaction, along with the dates when they became involved. 

“It wasn’t so much of a concern about any trading violations. It was just the onerous task of putting all the information together.”

Things can get far more political at a local government level, says James Reid, a partner in the capital markets, M&A, corporate and energy practices at Davies Ward Phillips & Vineberg LLP. The U.S. is a patchwork of state-level regulations.

“In Canada, those regulators are relatively independent of politics. In the U.S., you can find a range,” says Reid. Municipal politicians, competitors and ratepayers groups can all get in the way, and because many regulators in the U.S. are elected officials, local elections can complicate the timing of a deal. The regulator who was your friend yesterday may be replaced by a tougher negotiator tomorrow. 

“These regulatory approvals are a time for everyone to come out of the woodwork and try to get something,” says Reid. So Canadian lawyers need a good “ground game.” Typically, they’ll need to work with local lawyers who understand the formal and informal landscape there.

This issue came up for Ontario-based renewable energy firm Biox Corporation, which bought a 50-million-litre biodiesel facility in Sombra, Ont. from Methes Energies Canada. The deal was a cross-border transaction because the vendor was owned by Methes Energies International, a Nevada corporation, which acquired Methes Energies Canada in 2007, a year before the construction of the Sombra plant.

“When we did the Sombra deal, I don’t think we actually appreciated until we were midway through this deal that there was this Nevada component, and we had to go and get Nevada counsel to weigh in and do the analysis,” says Biox CEO Alan Rickard.

Many jurisdictions will have a test to see if the sale of an asset is substantial enough to require shareholder approval, says Charlie Malone, partner at Wildeboer Dellelce LLP, who advised Biox on the deal. Nevada corporate law uses different language, resulting in a test with a lower standard.

“It took time to ensure that we were all agreed that there wasn’t a shareholder approval requirement on that transaction,” Malone says. “It’s coming up more and more because you’re seeing more Nevada-incorporated companies especially in energy or mining. Nevada seems more relaxed even than Delaware, which is one of the more friendly jurisdictions that we know.”

North America may have a patchwork of state-level regulatory frameworks for energy M&A, but at least they’re well defined. “Two-thirds of the world doesn’t have that, and they’re making up the rules as they go along,” says Turnbull. “You’re always going to have a curveball thrown at you somewhere in the deal.
The more you’re outside the rule of law, the more important political currency becomes.”

As lawyers at North American companies venture further into these waters, they must ask themselves more politically nuanced questions, Turnbull says. Is their company creating jobs and tax revenue with its acquisition? Is it a better operator than the outgoing one? What is its reputation as a purchaser?

Lawyers can find themselves adrift culturally when dealing with companies further afield. In China, says Turnbull, there’s an inherent distrust of legal service providers in many areas. “In other countries, accountants run transactions,” he says. When working in these other areas, Canadian lawyers need a solid cultural grounding and a strong head for diplomacy.

Integration
After the deal has been approved, the participants will be on to their last phase: integration. This is where they unify their resources and processes to operate smoothly together. Keeping in touch with key stakeholders is crucial at this point, but the external counsel that had been helping guide the acquirer may not be as involved from here on, says Osler’s Macfarlane.

“This is more the bailiwick of in-house counsel working with their various business units to integrate the acquired business into the existing business,” he says. “The success of the transaction ultimately will depend on the post-deal integration and there will be a tremendous amount of resources put into that by the companies.”

The acquirer faces issues from the board room downward, warn legal experts. “On day one, you have to be ready to run a new company and have all their employees,” says TransCanada’s Johnston.

Lawyers at TransCanada had to tie together many operational loose ends, such as arranging the appropriate legal and financial signing authorities, and putting spending thresholds in place. Insiders had to be identified and notified of trade reporting obligations, and annual disclosure processes had to be defined in accordance with Sarbanes-Oxley rules. All appropriate lawyers also had to be in contact with the appropriate business units to ensure that they had the right legal support.

“You also want some sensitivity to the organization you’re working with. You don’t want to march in and change all their policies,” says Johnston. “That’s where a cultural alignment between the two companies was very helpful and important.”

Integration issues can also vary according to the subsector, says  Reid. In acquisitions of rate-regulated utilities, companies are typically buying standalone businesses rather than trying to consolidate, meaning that management is unlikely to be making a lot of people redundant, he says.

In consolidation transactions, acquirers will become acutely aware of differences in labour laws, according to Turnbull.

“Americans are much more fungible with people, and they have lower requirements for paying people if you terminate them, whereas Canada is more employee-friendly than the U.S. is,” he says. This will have ramifications for the acquirer, who must take this into account when planning post-integration consolidation.

The signals are mixed for cross-border M&A in Canada. On one hand, strong buyers and forced sales are setting the scene for an excess of M&A activity in the sector over the next few years, according to Goodmans’ McGlaughlin. “There’s a lot of debt out there that will become due in the next couple of years, and who knows if there will be debt to replace it with?” he says. “That will drive M&A by necessity.”

On the other hand, regulatory changes are making things harder. The Alberta Energy Regulator recently increased the liability management ratio required for acquiring companies to 2.0 or higher, which means that the value of a company’s producing wells must be twice the cost of abandonment. That decision, resulting directly from a case involving a bankrupt producer earlier in the year, could have a chilling effect on M&A activity in the region.

Regardless of coming deal volumes, such conditions make cross-border energy M&A an exciting and challenging process. Whether you’re taking a company into a new geography, picking up assets at bargain-basement prices or simply saving your firm from the bankruptcy courts in a debt-ridden, depressed market, the stakes are high. It’s high-octane stuff.