Written by Adam Kalbfleisch and Imran Ahmad
Investment Canada Act amended and Draft Regulations released
Key legislative changes to the Investment Canada Act (ICA)1 were recently introduced by Parliament pursuant to the "Budget Implementation Act" (Bill C-10).2
These changes include:
- Introduction of a national security review mechanism;
- Changing the basis for calculating the monetary threshold above which investments are reviewed from "gross assets" to "enterprise value";
- Changing the review threshold for WTO investors from $312 million in gross assets (the 2009 threshold) to $600 million in enterprise value, rising progressively to $1 billion over a four-year period; and
- Eliminating lower review thresholds for transactions in the transportation services, uranium production and financial services sector.
Draft Regulations to implement the amendments were published for comment on July 11, 2009.3 The 30-day public comment period expired on August 10, 2009. The government is expected to introduce final regulations in the coming weeks.
National Security Review
Bill C-10 introduced a new national security review mechanism that allows the Canadian government to review, block, or restrict a broad range of investments by non-Canadians on the basis of national security concerns.4 By introducing a national security review mechanism, Canada has followed the example of countries such as the United States (CFIUS), Germany, France, China, Japan, United Kingdom, Poland and Russia. Bill C-10 does not define the expression "national security", thus its scope remains unclear. It remains to be seen whether the government will interpret it to include elements of economic security.
The Draft Regulations set out timelines for the Canadian government to invoke the national security review mechanism. To a large extent, these timelines are triggered by the review and notice processes already in place under the ICA. The national security review process commences when the Minister of Industry conducts a preliminary review of the investment to assess whether it raises any national security concerns. If it does, then he refers the investment to Cabinet to determine whether a full review should be ordered or not. If Cabinet orders such a review, then the Minister will, with the assistance of other concerned departments and agencies, conduct the review and make recommendations to Cabinet. If, at the end of the full review, the Minister is of the view that the investment is "injurious to national security", then Cabinet may issue an order blocking, restricting or, if already implemented, unwinding the investment. While the duration for each step of the review process may vary depending on the specific circumstances of a given investment, the maximum duration should not exceed approximately 130 days.
Investors will be interested to know that once the review timelines have expired, the Canadian government cannot challenge a reviewable foreign investment on national security grounds. Investors should, however, be cautioned that, in respect of non-reviewable transactions, the Canadian government may initiate a national security review 45 days after the implementation which can give rise to a risk that the transaction may be unwound or restricted. This same ability to engage in a post-closing review also extends to minority investments in Canadian businesses.
Under the ICA, the Minister is required to approve transactions that exceed certain monetary thresholds on condition they are of "net benefit to Canada". In light of the recent changes to the ICA and once the Draft Regulations come into force, the new review threshold for direct acquisitions of Canadian businesses under the ICA would be increased from the current $312 million in "book value of assets" of the target Canadian business to $600 million in "enterprise value". This minimum threshold will gradually increase to $1 billion over the subsequent four years.
The ICA amendments change the basis for calculating the monetary threshold above which investments are reviewed from book value of assets of the acquired business to "enterprise value". The rationale for the shift to "enterprise value" was articulated in the 2008 Final Report of the Competition Policy Review Panel which suggested that the "concept of enterprise value better reflects the increasing importance of our modern economy of service and knowledge-based industries in which much of the value of an enterprise is not recorded on its balance sheet because it resides in people, know-how, intellectual property and other intangible assets not recognized in a balance sheet by current accounting methods." 5
Interestingly, the Draft Regulations make a distinction between how enterprise value is to be calculated for publicly and non-publicly traded companies:
- Publicly Traded Companies. In the case of a publicly traded company, the Draft Regulations provide that the enterprise value of assets of a Canadian business is the market capitalization of the entity plus its liabilities minus its cash and cash equivalents. Market capitalization will be based on the actual traded value of the company's securities during a specific trading period (20 days) which period is set out in the Draft Regulations.
- Non-Publicly Traded Companies. In the case of an acquisition of a non-publicly traded company, or where there is an acquisition of all or substantially all of the assets of a business owned by either a public or private company, the enterprise value shall be calculated by using the same book value-of-assets formula that is currently applied under the ICA (i.e. the book value of the Canadian business as at the end of the last fiscal year, as reflected in the most recent annual financial statements). The continued use of book value for asset and private company acquisitions has come under extensive criticism since the draft regulations were released. It is possible that the final regulations will take a different approach that better reflects the enterprise value concept adopted in the amendments.
Recent Enforcement Under the ICA
Recent enforcement actions taken by the Minister of Industry against Vale Inco and US Steel are significant and demonstrate an increased willingness to scrutinize commitments made by foreign corporations wanting to invest in Canada.
Foreign investors seeking acquisitions in Canada often agree to undertakings whereby they promise to maintain production and employment levels in order to obtain regulatory approvals pursuant to the ICA. While these undertakings are legally binding, the Canadian government has traditionally steered clear of strictly enforcing them when a foreign investor is unable to meet its undertakings as a result of adverse economic circumstances. The recent enforcement activities in relation to Vale Inco and, in particular, US Steel, appear to indicate a departure from past practice.
In the case of Vale Inco, Companhia Vale do Rio Doce's acquisition of Inco in 2006 required the newly formed company to maintain certain employment levels. When the company announced in April 2009 that it would be idling its operations in Sudbury, the Minister demanded that Vale Inco respect its 2006 commitments and if it failed to do so, Industry Canada would consider all options to redress the situation. Subsequently, in June 2009, after further review, the Minister stated that he was satisfied that Vale Inco had lived up to its commitments. The situation in the case of US Steel is similar. In 2007, US Steel acquired Canadian steel maker Stelco. The Pittsburgh-based company undertook to increase production and maintain certain employment levels. However, in 2008 and 2009, it cut production and laid off a significant portion of its work force. In that case, not only did the Minister demand that US Steel respect its commitments, he took the exceptional measure of bringing a case against US Steel before the Federal Court for breach of undertakings.
These enforcement actions come on the heels of Industry Canada's unprecedented May 2008 decision to block a proposed $1.3-billion acquisition of MacDonald Dettwiler and Associates Ltd. by U.S.-based Alliant Techsystems Inc. on the basis that it was not satisfied that the transaction would be of net benefit to Canada.
Canada has always been a destination of choice for investors. However, the economic slowdown has left no country untouched. Investors should be alert to the Canadian government's new willingness to ensure that undertakings by foreign investors are respected. This new approach is evident from the more interventionist position the Minister has taken recently with US Steel, Vale Inco and MacDonald Dettwiler.
This recent vigilance is consistent with the Canadian government's amendments to the ICA that have introduced a national security review mechanism. It is also consistent with Industry Canada's issuance, in December 2007, of guidelines on the review of investments by foreign state-owned enterprises (Soes). These guidelines enumerate additional factors for the Minister to take into account when considering whether an investment by a non-Canadian S investor will be of "net benefit to Canada" and provide a basis for binding undertakings that Soes may be required to provide.
1. Investment Canada Act, R.S., 1985, c. 28 (1st Supp.).
2. Bill C-10, An Act to implement certain provisions of the budget tabled in Parliament on January 27, 2009 and related fiscal measures, 2nd Sess., 40th Parl., 2009 (as passed by the House of Commons on March 12, 2009).
3. Regulations Amending the Investment Canada Regulations, C. Gaz. 2009, I. 2064, online: Gazette ; National Security Review of Investments Regulations, C. Gaz. 2009, I. 2077, online: Gazette .
4. Investment Canada Act, supra note 1 at Part IV.1
5. Canada, Competition Policy Review Panel, Compete to Win – Final Report (Ottawa: Communications and Marketing Branch, 2008) at 31 (Chair: L.R. Wilson).