In a series of announcements and statutory amendments over the last several years, the Canadian government has signalled its intent to limit reviews under the Investment Canada Act (ICA) to more significant transactions and to strengthen the ICA review and enforcement processes for those transactions that remain subject to review.
The ICA subjects direct and indirect investments by foreign investors to acquire control of Canadian businesses to review and approval if certain financial thresholds are exceeded. If its investment is subject to review, the foreign investor generally must not implement its investment until the Minister of Industry has determined that the investment is likely to be of "net benefit to Canada." All other foreign investments to acquire control of or to establish new Canadian businesses are subject only to notification under the ICA.
All foreign investments (including the acquisition of minority interests and the establishment of new businesses) that could be "injurious to national security" are also subject to a separate review process under the ICA, regardless whether the investment is subject to the “net benefit” review.
In 2007, the Canadian government convened the Competition Policy Review Panel to review Canada's laws and policies governing competition and investment matters to improve Canada's competitive environment and stimulate foreign investment. The panel determined that foreign investment generates positive benefits and is necessary for Canada's economic success in the increasingly globalized economy, and consequently made recommendations, among other things, to amend the ICA with the purpose of raising the threshold for review of foreign investments, lowering foreign ownership restrictions in certain sectors and improving the transparency, predictability and timeliness of decision-making under the ICA.
In 2009, the Canadian government amended the ICA with the stated intention of facilitating foreign investment in Canada. These amendments increased the financial threshold for review of direct and indirect acquisitions by WTO investors by eliminating the lower $5-million threshold for Canadian businesses engaged in certain historically protected sectors and introduced a "national security" review in respect of any investment in a Canadian business to assess whether it could be injurious to Canada. Amendments that are not yet in force would increase the general financial threshold for review from the current $330 million in gross assets by book value to $1 billion in "enterprise value".
Modified Financial Threshold
On June 2, 2012, the government issued draft regulations that will change the current financial threshold for review from a gross asset/book value test (the 2012 threshold is $330 million) to an enterprise value test, with an initial threshold of $600 million rising to $1 billion over a four-year period (and thereafter subject to annual indexing based on changes in Canada's GDP). The draft regulations are subject to a 30-day public consultation period. We expect that they will come into force in the very near future.
The government's intention in raising the financial threshold for review is to limit review to those investments that are more financially significant, in the belief that foreign investment in Canada is generally beneficial to Canada. While the increase in the limit is expected to reduce substantially the number of investments that will be subject to review under the ICA, the change in the financial threshold methodology from book value to enterprise value will capture certain transactions that would not otherwise be reviewable, because book value often understates the market value of the relevant business. For example, the sale of Nortel's patents for $4.5 billion in 2011 was not subject to review under the ICA, because the book value of the assets subject to the sale was less than the book value threshold.
The draft regulations provide that acquisitions of control of Canadian businesses by foreign investors from countries other than WTO member states will continue to be subject to book value tests.
The review threshold for the acquisition of control by a WTO investor of a publicly traded entity carrying on a Canadian business will now be based on the enterprise value of the target's assets, which will be equal to the market capitalization of the target plus its total liabilities, minus its cash and cash equivalents. Market capitalization will be calculated by using the average daily closing price of the target's quoted equity securities over a most recent 20 days of trading ending before the first day of the month immediately prior to the month in which the application for review is filed. For the target's securities that are not publicly traded, the value will be the amount that the governing body of the foreign investor, e.g., its board of directors, determines in good faith and certifies to be the fair market value of those securities. The target's liabilities will be equal to those stated in its most recently available quarterly financial statements released before the filing of the application for review, as will its cash and cash equivalents.
Where the target is not a publicly traded entity, its enterprise value will be the total amount of consideration payable for the acquisition of the business, where 100 percent of the voting interests are being acquired. Liabilities, cash and cash equivalents are included in the calculation and determined in the same manner as they are to be determined in respect to publicly traded entities.
Similarly, the total consideration payable in an asset transaction will be the value for the purposes of the financial threshold.
Where the foreign investor is buying less than 100 percent of the entity's voting interests, the total acquisition value will be the total amount of the consideration payable for the acquisition plus the amount that the foreign investor's governing body determines in good faith and certifies to be the fair market value of the portion of the entity that is not included in the total consideration. Liabilities, cash and cash equivalents are included in the calculation and determined in the same manner as they are to be determined in respect to publicly traded entities. The value to be considered is thus that of the entire entity, not merely the investment being made by the foreign investor.
Where some of the consideration for assets or the equities of a non-public entity is not quantified at the time of closing, that portion will either be valued in the same manner or determined and certified by the foreign investor's governing body.
The value test for transactions involving publicly traded entities uses recent historical trading data rather than the acquisition price and thus ignores any premium to be paid by foreign investors, while for transactions involving purchases of assets or companies that are not publicly traded, the value test is based on the acquisition price.
Increased Transparency under the ICA
On April 26, 2012, the Canadian government introduced, as part of the budget implementation legislation under Bill C-38, proposed amendments to the ICA that would authorize the Minister of Industry to disclose publicly certain general information previously subject to the confidentiality provisions of the ICA. These amendments would permit the Minister to disclose the preliminary notice sent to an investor where the Minister is not satisfied the investment is of net benefit to Canada (which advises investors that they may make additional representations and undertakings) and the reasons for giving the notice. This amendment, for example, would have permitted the Minister to disclose publicly the reasons for the preliminary notice to BHP Billiton that its $38-billion takeover of Potash Corporation of Saskatchewan was not of "net benefit to Canada". Although it is one of only three known decisions by the Minister to reject an investment (other than investments to buy control of cultural businesses), the BHP decision led to increased uncertainty regarding what is required to establish that an investment is of net benefit to Canada and raised questions as to the degree of political influence on the Minister's decision-making process, especially in light of the significant undertakings that BHP had purportedly offered to the Minister in order to obtain approval and the public and political opinion generated by the proposed takeover.
It should be noted that while the ICA currently permits the Minister to make a general disclosure regarding a final notice sent to an investor indicating whether the Minister is or is not satisfied that the investment is likely to be of net benefit to Canada, the undertakings provided by the investors and the reasons for such determination, it is the practice of the Minister not to disclose this information.
Accordingly, the impact of the proposed amendment is at this time unclear. However, the proposed amendment may provide increased transparency to the Minister's decision-making process and greater insight as to what is necessary to satisfy the Minister that an investment is likely of net benefit to Canada.
Increased Compliance and Resolution of Disputes under the ICA: Acceptance of Security and Introduction of Mediation Guidelines
The Minister typically requires investors to provide contractual undertakings as a condition of the Minister's approval of a reviewable investment. Undertakings are based on the plans provided by the investor and typically relate to, among other things, capital and other types of expenditures in Canada, R&D commitments, levels of employment, maintaining the location of the head office in Canada, and levels of Canadian participation in management by employees, management and directors.
Acceptance of Security
The proposed amendments to the ICA in Bill C-38 would also authorize the Minister to accept security offered by a foreign investor for payment of any future court ordered penalty against such investor resulting from its breach of the ICA, including in particular, failure to comply with its undertakings. In addition, the proposed amendment would authorize the Minister to disclose that the Minister has accepted security from an investor.
The introduction of this change is likely intended to avoid lengthy and time-consuming litigation to resolve disputes in connection with alleged breaches of undertakings by foreign investors, such as the protracted litigation between the federal government and U.S. Steel in connection with U.S. Steel's alleged failure to comply with certain significant undertakings made in respect of its 2007 acquisition of Stelco. The government has not offered any insight into the circumstances where security would be appropriate or required or the amount of security that would be acceptable to the Minister. We believe that if the government was to adopt a policy of requiring security in most cases, this would run counter to the government's stated goal of facilitating foreign investment.
As a matter of practice, especially where security may be required, investors should carefully consider all risks of non-compliance with any undertakings provided to the Minister in connection with a proposed investment.
On May 25, 2012, the Minister of Industry issued a Guideline providing that if the Minister believes that a foreign investor has failed to comply with an undertaking, the investor and the Minister may agree to a formal mediation process to assist in the resolution of the dispute. The goal of this process is to reduce the time and cost associated with formal legal proceedings to resolve disputes.