Striking oil: Opportunities for law firms in Canada

In this penultimate article in our series
on international expansion strategies
for law firms, we consider Canada as a
target destination.

Canada is one of the world's most developed nations, with a diversified and highly developed economy. With a highly regulated banking sector, post-recession triple-A credit rating, political stability and an evolved judicial system, Canada has a strong foundation for investment. It also provides a particularly attractive foothold for a firm considering an expansion into North America.

Legal landscape

While the 'knowledge economy' provided by law firms is unlikely to ever surpass the abundant oil and gas sector, law firms are playing an ever greater role in wealth and employment generation in Canada.

The GDP of Canada's professional service sector was C$87.1bn in 2014, compared to C$85.3bn in 2013, accounting for 5.3 per cent of the country's GDP, while the legal sector alone accounted for C$10.9bn in the year to November 2014, according to its national statistics agency. Canadian professional service firms are bucking the trend and benefitting from growth in the labour market, with the number of practicing lawyers growing at a faster rate that the general population.

This growing environment for law firms has piqued the interest of international firms who are looking to get a foothold in the North American market. In recent years, domestic law firms in Canada have benefited from foreign direct investment as overseas legal practices have looked to grow top-line revenue, exploit new markets and increase global brands and footprints. As a result, the Canadian legal sector has been experiencing a transition from national to international law practices, following a spate of high-profile merger and acquisitions of Canadian law firms, such as Norton Rose Fulbright and Dentons' recent moves.

More recently, PricewaterhouseCoopers has entered the Canadian legal market following the acquisition of Toronto-based immigration law firm Bomza Law Group. But, while Canadian law firms are attractive targets for big international law firms, there is still room for specialist boutique practices to service Canada's buoyant sectors. Successful practices include Dolden Wallace Folick, Litwiniuk & Co and Stockwoods.

While the broader picture appears bright, law firms looking to expand into Canada should be aware of one of the biggest stories in Canada's legal foray in 2014 - the collapse of Heenan Blaikie. The demise of one of the country's first national law firms, after 40 years of service, with more than 500 lawyers, is a reminder of the difficulties of running a profitable law firm. Though no one factor could be singled out as the reason
for the firm's failure, and it still made a profit of C$75m in 2013, many pointed out that that its failure was largely attributed to a loss of trust.

Market overview

Canada is the world's second-largest country by total area, consisting of ten provinces and three territories. Ontario, Quebec, Alberta and British Columbia dominate the legal sector, mirroring its
major population centres.

Canada's geography will impact on
a law firm's decision on where and how
many office locations to hold. The majority
of businesses operate close to the US border and, given the spatial density,
many favour smaller offices that are more widely spread to reflect the linear nature
of Canada's settlement.

Given that Alberta holds the majority
of Canada's oil sands, it might be an attractive location for foreign law firms
with an interest in natural resources
looking to enter the local market.

Alberta's oil sands are also the third-largest proven crude oil reserve in the world. The western province of Canada contributed to a third of the country's economic growth in 2014. Whilst tumbling oil prices present a challenge for oil sands companies to remain profitable, they also offer law firms the opportunity to assist oil sands producers in mergers, acquisitions, restructurings and debt financings. Accessing new markets and mitigating the environmental implications will be high on these companies' agendas.

Akin to the US, Canada's tax regime is split into provinces and territories, with each levying a range of taxes in addition to the federal tax system that applies throughout Canada. However, overall, Canada's tax regime is considered competitive following a decade-long initiative to lower corporate income taxes.

For example, a key benefit for UK firms investing in Canada is the relatively low cost of repatriating funds, with the 25 per cent withholding tax reduced to five per cent through a tax treaty.

Growth opportunities

The optimistic outlook for the professional services sector and, in turn, the legal sector, gives overseas law firms plenty to sink
their teeth into, especially those that are sector-led.

The foundation of the Canadian
economy is foreign trade, driven by its booming primary sector - the oil, gas and mining industry - which contributed C$139bn or 28 per cent to Canada's GDP in the goods-producing industry sector and 8.5 per cent across all industries in 2013 (Statistics Canada). Energy exports, worth C$113bn, accounted for about 24 per cent of Canada's exports, according to the Canadian Energy Pipeline Association.

However, given the recent decline in oil prices (by 50 per cent since September 2014), the IMF has recently revised its growth estimates for Canada's economy by cutting growth rates by 0.1 per cent to 2.3 per cent for 2015, and by 0.3 per cent to 2.1 per cent for 2016.

Canada, as a major oil-exporting country, is exposed to cheap crude prices and this, if they persist, will discourage investment in the sector. For many energy companies, the cost of oil production now outweighs the market price for their commodity, leading them to cut on projects and capex.

Canada's proximity to the United States also has significant influence, with the US representing by far the nation's largest trade partner (US goods imports from Canada totalled C$358.5bn in 2014). Three quarters of Canada's exports end up in the US. In the third quarter of 2014, Canada recorded its largest trade surplus since the global financial crisis, largely due to rising exports of cars, forest products and machinery to the US. Benefitting from a low Canadian dollar (and an expanding US economy) the trade surplus of C$2.2bn in March 2015 was up from C$1.9bn in February.

While 2013 was a slow year for M&A deals, the first three quarters of 2014 were dominated by big energy-sector activities, before the fall in oil prices. M&A activity involving gas companies are likely to proceed in 2015, whilst transactions involving oil assets are likely to stall for the first half of the year. Spectators are likely to keep an eye on oil prices before making a move. With commodity prices at their lowest level in years, big players may be presented with the opportunity to get some deals at a discount.

At the beginning of 2015, the Bank of Canada made the decision to cut interest rates by 25 basis points, from one per cent to 0.75 per cent, as a means of countering the negative effects of cheaper oil prices on economic growth, inflation and to avert the risk of a possible downturn in the housing market. The cut has also caused the Canadian dollar to fall sharply against the US dollar. With the former being in decline already over the past year, US and global buyers may take advantage of the discount on acquisition prices in Canadian dollars over the next few months.

Coupled with the Canadian government's planned $70bn New Building Canada Plan, a public infrastructure plan that will span ten years, this low-interest environment may lead to more M&A deals within the real estate sector, in particular, among real estate investment trusts (REITs) and other commercial real estate related operations.

According to the Bank of Canada, both the export market and business capital investment are two pivotal areas in sustaining Canada's post-recession recovery, while the Canadian financial services sector is one of the most stable in the world, according to the World Economic Forum's Global Competitiveness Report (2008-2014).

Practice establishment

Canada has the eighth highest per capita income globally, a high standard of living and economic growth was 2.5 per cent in 2014, up from 1.7 per cent in 2013.

Currently, non-lawyer ownership of law firms in Canada is rare (although permitted in Ontario for multidisciplinary practices as long as lawyers maintain control), but demand for new capital and the increased need to manage financial and other risks may create interest in altering existing regulations such as alternative business structures and publicly-traded firms, particularly as global trends migrate to Canada as markets become more closely connected and competition increases. For corporates, the Canadian tax system attempts to achieve integration between corporations and their shareholders, meaning that income passing through a corporation should not attract any additional taxation than income received by an individual directly.

That said, many law firms in Canada are set up as a traditional limited liability partnership. Under this structure, the partners of the firm are subject to tax on their share
of the taxable income. In order for non-residents of Canada to avail themselves
of the beneficial withholding tax rate, they
could invest through a corporate partner
into the LLP.

In our final article, we visit Hong Kong, where the service sector accounts for a remarkable 90 per cent of GDP.

Tim Neathercoat is partner at BDO  (www.bdo.co.uk)

---