When investments are made in the private sector sophisticated financial models are developed, complete with multiple inputs, all designed to predict a range of best and worst case scenarios. If a significant model input strays beyond its originally anticipated value range for example, if customer demand for a business’s products collapses then the financial model for the business may fail. If so, stakeholders in the business will likely face a restructuring of their investments. 

The chances of a restructuring are far less likely when government is the main customer of the business, not only because governments are presumed to have deep pockets, but also because, in those businesses where government acts as an intermediary between the business and the ultimate consumers of the business’s products, the government’s intermediation tends to insulate the business from model failure and its usual consequences. Nevertheless, if model failure is severe and persistent enough, history in Canada suggests that governments may be tempted to impose a restructuring even on these sorts of businesses. 

In the years leading up to Ontario’s Feed-in-Tariff (FIT) program, it was generally accepted that Ontario was approaching a near-term shortage of electricity as surging demand threatened massive brownouts.  Government financial models, no doubt, assumed that the cost of developing renewable energy infrastructure involving long-term power purchases at prices significantly above market could be recouped by steadily increasing electricity rates over time, all without unduly reducing customer demand.¹ However, subsequent experience seems to suggest that Ontario’s electricity demand may have been more elastic than anticipated, especially as many urban and rural electricity consumers have reacted to increasing prices by switching some of their electricity needs to lower-priced natural gas and propane. Moreover, as price increases in the Province have outpaced those in neighbouring jurisdictions (leaving Ontario’s electricity prices 30-60% higher than in those jurisdictions), some large commercial users have reacted by moving their operations out of Ontario, further depressing overall demand.²  In fact, far from remaining steady, electricity demand in the Province is now projected to decline until at least 2021.³

Even as electricity demand has declined, Ontario’s generating capacity has increased.  Overall generating capacity in Ontario has increased by 13% since 2003, while demand has decreased by 10% since 2005.⁴ The end result has been a large and continuing surplus of generating capacity, with Ontario’s generating capacity expected to exceed forecast (normal weather peak) demand this summer by 25-50%.⁵  Partly as a consequence, electricity spot prices in the Province have plummeted, sometimes falling to $0.025/kWh.⁶  Higher-priced, surplus Ontario electricity is sometimes resold to neighbouring jurisdictions at a substantial discount⁷ and the Global Adjustment amount charged to Ontario consumers has now risen to record levels.⁸

In summation, some of the model inputs in the Province’s original financial models may already have strayed beyond their initially anticipated value ranges, suggesting at least the possibility that model failure has occurred in the sector or that it may be imminent.  If so, then recent entrants into Ontario’s energy sector, otherwise dependent on the continuance of long-term government purchases, are quite right to be concerned about the possibility of a government-imposed restructuring in their sector.

Unlike private sector restructurings which typically involve a court process, government-imposed restructurings generally take the form of confiscatory legislation or some other form of negative governmental action.  It should come as no surprise that governments in Canada have from time to time engaged in various sorts of negative governmental action, invariably with the intent of modifying (or even abrogating altogether) undesirable government obligations.  Such action has even occurred previously in Ontario’s utility sector.⁹ For example, in the 1930’s, successive Ontario governments enacted several pieces of legislation abrogating various contractual commitments to private sector power producers, all with the intent of assisting the then-fledgling, and government-owned Ontario Hydro to become the dominant power producer and distributor in the Province.  Indeed, overall, scholarly research suggests that negative governmental action usually occurs (if it occurs at all): (a) when technological change in a given industry sector is occurring rapidly, (b) when pricing, demand or other important financial variables cannot be perfectly forecast, and (c) when governments have entered into long-term contracts that cannot easily be altered.¹⁰ In other words, the restructuring risk increases on model failure occurring within this context.  

Negative governmental action can take many forms, including specifically, the passage of legislation modifying government payables, authorizing or curing contract breaches, limiting court access, amending or cancelling contract commitments, and even expropriating completed projects. A recent, well publicized, example of negative governmental action in Canada occurred in the early 1990s when the federal government summarily cancelled several long-term contracts with private sector participants for the redevelopment of Toronto’s Pearson Airport.¹¹ Bill C-22, passed by the House of Commons provided that: (a) all contracts relating to the redevelopment were declared not to have come into existence or to have had any legal effect, (b) all obligations, rights and interests arising out of the contracts were declared not to have come into existence, (c) no action or proceeding, including for damages for breach of contract, could be brought against the government, and (d) every action against the federal government was summarily dismissed.  Bill C-22 also authorized the relevant federal Minister, for a period of 30 days, to enter into agreements with aggrieved stakeholders to pay compensation in such amounts as the Minister considered appropriate.  Notably, compensation for lost profits was expressly prohibited under the legislation. 

Using Bill C-22 as an example, it may appear at first blush that governments in Canada hold all the cards when it comes to negative governmental action. However, stakeholders should note that there are various countervailing influences that will moderate the actual exercise of such extraordinary power. For example, government will be mindful of reputational concerns.¹² Specifically, international credit rating agencies may react to negative governmental action by downgrading the subject government’s public debt due to increased “country risk”, thereby increasing future borrowing costs for the subject government. Foreign governments may impose “tit-for-tat” sanctions on projects in their jurisdictions that are intended to hurt nationals of the expropriating state. Judgments rendered by sympathetic foreign courts may be executable against the subject government’s assets located in foreign jurisdictions. And finally, equity investors in non-related sectors may avoid investment in the jurisdiction altogether for fear of falling victim to similar governmental action.

Aside from reputational concerns, some jurisdictions offer constitutional safeguards against negative governmental action without due process. The Fifth and Fourteenth Amendments to the US Constitution are good examples.  Unfortunately, no such constitutional protection currently exists in Canada.¹³ Specifically, Canada’s Charter of Rights and Freedoms contains no express provision for the protection of property, economic, or even contract rights.¹⁴ And based on a string of Charter cases decided by the Supreme Court of Canada, it is unlikely that any general protection of this nature will be implied any time soon.¹⁵ Instead, stakeholders in Canada will have to derive comfort from the fact that Canadian courts will generally construe confiscatory legislation very strictly against the subject government, straining if at all possible to find that the legislation does not exclude the payment of appropriate levels of compensation or review by the judiciary. Nevertheless, if the legislation is sufficiently precise, even a strict constructionist approach will be of little use to an aggrieved stakeholder.

In such circumstances, Canada’s free trade agreements may assist, but only if the stakeholder is a national of a treaty-protected country. As is well known, Canada is a signatory to a number of free-trade and foreign investment protection agreements, some of which prohibit confiscatory action without payment of appropriate compensation.  For example, under Article 1110 of the North American Free Trade Agreement (NAFTA), no federal or provincial government is permitted to “nationalize or expropriate an investment of a [US or Mexican] investor…or take a measure tantamount to nationalization or expropriation”, unless such action is: (a) for a public purpose, (b) effected on a non-discriminatory basis, (c) effected in accordance with due process, and (d) carried out upon payment of compensation equivalent to the fair market value of the expropriated investment.  

Particularly instructive here is the case of Metalclad Corporation v. Mexico¹⁶, a NAFTA case brought by an American company against the state of Mexico in 2000.  In that case, an arbitral tribunal ruled that, as a result of numerous laws and other negative governmental actions passed and undertaken by Mexican state and municipal authorities, Mexico had effectively expropriated Metalclad’s newly-constructed waste facility in Guadalcaza. The tribunal awarded Metalclad US$16,685,000 in damages representing Metalclad’s sunk costs of the investment.¹⁷ While damages awarded against Mexico did not include an amount on account of discounted lost profits, such damages are thought to be sustainable under NAFTA in certain circumstances.

Equally instructive is a 2012 NAFTA case brought against Canada by the Abitibi-Bowater group and involving certain confiscatory legislation passed by the Province of Newfoundland. In this case, the provincial legislation provided for: (a) the expropriation of significant Abitibi-Bowater properties used for hydroelectric generation and transmission, (b) the cancellation of various hydroelectric contracts between the Abitibi-Bowater group and the Province, and (c) the termination of certain timber and water rights. While the legislation provided for compensation for the expropriated properties, no compensation was to be forthcoming for the terminated timber and water rights. The Abitibi-Bowater group brought a NAFTA claim asserting that the Newfoundland legislation constituted an expropriation of its assets without appropriate compensation contrary to NAFTA Article 1110. Faced with the prospect of an uphill fight, the Canadian government opted to settle the claim for $140 million.  

Besides NAFTA, and as indicated above, several bilateral trade arrangements exist which contain similar foreign investor protection.¹⁸ Importantly, the proposed multilateral Trans-Pacific Partnership currently being negotiated with several Asia-Pacific countries and the proposed Canada-European Union Comprehensive Economic and Trade Agreement (not yet in force) will also contain similar investor protection. Once implemented, these new trade arrangements will significantly expand the list of treaty-protected countries and the range of foreign stakeholders that will be able to benefit from investor protection.  Notably however Canada’s trade agreements cannot be used by Canadian nationals to protect themselves against negative governmental action occurring within Canada in relation to their domestic investments.   

With the recent re-election of Ontario’s Liberal government, stakeholders in Ontario’s energy sector are, no doubt, breathing a little easier, as putative threats to tear up the Province’s FIT contracts are now much more clearly off the table.¹⁹ Most assuredly, the restructuring risk has subsided.  Still, the issues here are as much financial as they are political, and history in Canada suggests that negative governmental action can never truly be ruled out.  If financial model failure occurs and is considered severe and persistent enough, then negative governmental action will remain a distinct (even if remote) possibility.