Canadian companies are exposed to a number of forms of legal risk when they do business in other countries. There is a risk, for example, that another jurisdiction’s court system may not offer a fair mechanism of dispute resolution. But as the recent experience of Magma Energy Corp (TSX:MXY). in Iceland has demonstrated, companies must also be wary of another, less obvious, form of legal risk: political incongruity.
Political incongruity is the potential for disconnect between the policies and actions of a government and the wishes of its electorate – the most evident result of such disconnect being strong local opposition to a particular business deal or project. Such local opposition can be distinguished from classic forms of material adverse change in the general political conditions of a jurisdiction (for example, war, general strike, etc.), as a movement which tends to be reactive in nature and is directed at a specific issue, company or investment.
As Cantech Letter readers may be aware, Magma Energy recently completed a share purchase of a 98.53% interest of HS Orka, an Icelandic geothermal power company. In the months following the initial share purchase, Björk, a famous singer-songwriter from Iceland, led a grassroots movement to rescind the transaction on the basis that geothermal energy is a matter of strategic importance to the Icelandic people. The movement has received significant, if not overwhelming, support from Icelandic citizens and several prominent politicians. Almost 50,000 Icelandic citizens (in a nation with a population of just over 320,000) have signed a petition to demand that the government to open the issue of foreign investment in geothermal energy to a national referendum.
Put yourself, for a moment, in the shoes of Magma CEO Ross Beaty. You run a major company in an industry deemed, almost universally, to be socially and environmentally friendly. You have negotiated in good faith with Icelandic governmental authorities, and, following due process, have relied on a decision by an Icelandic parliamentary committee that was subsequently reviewed and affirmed on two occasions regarding the legality of your company’s investment. In addition, Iceland had, in July 2009, entered into a Free Trade Agreement with Canada in order to encourage free trade and foreign investment in that country by Canadian firms. Most likely, you would, with considerable justification, feel as though such investment was safe.
Enter political incongruity.
Was the Icelandic government oblivious to the concerns of a segment of its population regarding control of geothermal resources, did it misjudge the level of such concern, or did they simply choose not to pay attention? Whatever the case, Magma Energy has incurred unanticipated transactional costs from a risk it was likely not fully aware of.
Critics may point out that Canada has, in the recent regulatory dissuasion of Australian mining giant BHP Billiton from acquiring the Potash Corporation of Saskatchewan, like Iceland, sent an inconsistent message to foreign investors. But the two situations are not analogous. BHP Billiton withdrew its takeover bid when it became clear that it would not meet the “net benefit” test imposed by the Canadian government; whereas, in the case of the HS Orka share purchase, the Icelandic government has bowed to local political pressure subsequent to completion of the transaction.
Local opposition does not make good business. It is, however, worth noting that the risk of nationalization based on a referendum is remote and Magma Energy is now contemplating a sale to divest a minority portion of its shareholding in HS Orka (through Magma Energy Sweden, a fully owned subsidiary of Magma Energy Corp.) to a group of Icelandic pension funds.
Unfortunately for Magma Energy, the company may be the on the hook for legal costs, project delays and public relations expenses, not to mention the surrender of a portion of its majority holding in HS Orka. Political incongruity in Iceland has been an expensive lesson for Magma Energy, and a story that any Canadian company with global aspirations should be following closely.
Timothy W. Murphy, LL.M, is the principal of Murphy & Company, a business law practice based in Vancouver, Canada, that delivers comprehensive legal advice in the technology and finance sectors. Mr. Murphy articled with a leading national law firm, has international experience with Freshfields Bruckhaus Deringer LLP in Paris, France, and, until September 2010, acted as in-house legal counsel for a multinational software company. Mr. Murphy holds a master’s degree in law from McGill University.