Faced with little prospect of ever being able to sell their flailing wireless business, Mobilicity's original investors are suing the Canadian government for $1.2-billion, alleging it broke promises made to entice them to invest in the first place.

Mobilicity's story goes back to the fall of 2006, when a government official approached Canadian businessman John Bitove about investing in a new wireless venture, according to the lawsuit.

Ottawa had just conducted a review of the competitiveness of the industry, which was dominated by three large national players, and was preparing for an auction of radio spectrum, the airwaves used to offer cellular services.

Story continues below advertisement

Mr. Bitove was already well known for his development of satellite radio provider Sirius XM Canada.

The lawsuit alleges Industry Canada encouraged him to put together a business plan and seek financial backers based on assurances that the government would establish conditions to support the growth of new entrants to the wireless market, including rules mandating roaming on the incumbents' networks and sharing their cell towers.

Mr. Bitove and New York-based private equity firm Quadrangle Group LLC eventually did invest, purchasing spectrum licences worth $243-million in the 2008 auction, building a network and launching a retail wireless business in large urban centres in Ontario, British Columbia and Alberta. But the company has struggled since then and has been under creditor protection for almost a year.

Lower cellphone prices and increased competition have become a critical plank in the government's pro-consumer platform, but some say what is viewed as its inconsistency on policy has left potential investors wary.

The lawsuit claims that despite making promises that the investors would be able to sell their spectrum licences to one of the incumbents after a five-year period, the government has since blocked three attempts by Mobilicity to sell its airwaves to Telus Corp.

"Having caused the plaintiffs to lose substantially all of their investment, Industry Canada broke its final promise by refusing to allow the sale of the business after five years," reads the statement of claim, which was filed Thursday by both Quadrangle and Mr. Bitove's company Data & Audio-Visual Enterprises Investments Inc. (DAVE), which owns and operates Mobilicity.

DAVE invested $44-million while Quadrangle invested $217-million in equity and provided a further $95-million in debt financing. They are seeking damages for, among other things, negligence, breach of contract and loss of goodwill for a total of $1.204-billion.

Story continues below advertisement

Bob Richardson, a spokesman for the private equity firm, said Quadrangle did not rush into the decision to commence litigation against Industry Canada. "They took this action because they felt that all other opportunities to deal with the government had been exhausted," he said. A representative for Mobilicity declined to comment.

Jake Enwright, press secretary for Industry Minister James Moore, said he would not comment on specific issues raised in the statement of claim because the matter is before the courts. "Our government is committed to protecting Canadian consumers and we will continue to support policies that lead to more choice and greater competition in the wireless sector," he said Friday.

The lawsuit alleges that Industry Canada did not live up to its promises but rather, "always intended to make decisions based on what it considered to be expedient at the time."

Telus has also launched legal action, filing a claim last year for judicial review of Ottawa's spectrum transfer policy, which the company argues indefinitely extended what was supposed to be a five-year ban on transfers to incumbents. (It already lost one court battle over the rules for this year's spectrum auction.)

At an industry conference in July, Rogers Communications Inc.'s vice-president of regulatory affairs, Ken Engelhart, said when the rules for the 2008 auction were announced, an Industry Canada official similarly assured him in person that if the new entrants were insolvent five years down the road, large carriers such as Rogers would be able to buy them.

Canaccord Genuity analyst Dvai Ghose said in a research note the lawsuit appears to be another barrier to persuading new investors to take a chance on Canada's wireless market.

Story continues below advertisement

VimpelCom Ltd., which owns fellow new entrant Wind Mobile, has been unable to find a buyer for its Canadian asset.

"In particular, we wonder why any financial or strategic investor would be interested in being a wireless new entrant without any obvious exit strategy," Mr. Ghose wrote.

The statement of claim alleges that Industry Canada entered into a contractual agreement with DAVE and Quadrangle when the department offered to establish and enforce rules to support a new entrant in Canada's wireless market. It says the investors accepted that offer by purchasing the spectrum licences.

Quadrangle said in a statement Friday that Industry Canada "breached its assurances that it would enforce foreign-ownership rules, require incumbent carriers to provide roaming and access to cell towers at reasonable rates and terms, prevent unfair and anti-competitive practices and allow spectrum to be transferred."

It added that "the prospect of any meaningful foreign investment in Canadian wireless industry for the foreseeable future has been lost."

Industry Canada must file a statement of defence or notice of intent to defend within 20 days of receiving the claim.