Canada’s law governing foreign investment, the Investment Canada Act (ICA), has come under increased scrutiny since the government’s review of BHP Billiton’s proposed acquisition of Potash Corporation of Saskatchewan in late 2010. For the second time in two years, the Canadian government blocked an acquisition by a foreign investor, using a law that had never before in its 25-year history been used for that purpose. The concern is that Canada has become protectionist and will review transactions through a political lens with a sharp domestic-preference focus, rather than an international business and investment focus. In this article, we outline the legal framework for foreign investment review in Canada, describe recent political events in Canada as they relate to the Act and conclude with lessons drawn both from recent transactions and recent political events.
To begin, here are some key points:
- A non-Canadian investor acquiring a Canadian business with assets of more than $312 million must satisfy the minister of industry that the proposed transaction is likely to be of net benefit to Canada.
- Investors provide undertakings to the minister detailing how they will operate the business in order to demonstrate that net benefit.
- The net benefit criteria include a mix of objective and subjective criteria.
- The federal government consults with affected provincial counterparts; provinces are now seeking a greater role in the process.
- The breadth of the net benefit criteria, combined with the fact that the decision ultimately rests with an elected politician, means that potential investors must be mindful of both the legal and political considerations that will influence a clearance decision.
- Investors must remember that all politics are local and they should target all levels of government with strategic messaging.
- Acquisitions of a regional or national champion will receive heightened media and political scrutiny. Hostile takeover bids will generally also attract media scrutiny.
- High-profile transactions require a mix of legal, political and public relations strategy.
Bearing those points in mind, let’s consider the legal framework of the ICA.
Non-Canadian investors establishing or acquiring direct or indirect control of a “Canadian business” must consider their obligations under the ICA. The ICA establishes standards that determine whether a transaction must be reviewed and approved by the responsible federal minister (a reviewable transaction) before it can close or whether the minister must merely be notified (a notifiable transaction). In particular, the structure of the transaction and the value and nature of the assets of the Canadian business being acquired will determine its status.
If the transaction is merely a notifiable transaction, the investing party need only complete a two-page standard form notification that is designed to provide some basic information about the party or parties and the transaction. That form must be sent to Industry Canada (or the Department of Canadian Heritage if applicable) no later than 30 days after closing. A reviewable transaction, on the other hand, requires the filing of a lengthy application for review prior to closing. The transaction may not be completed until the minister of industry (and/or the minister of Canadian heritage in certain circumstances) has determined that the transaction is “likely to be of net benefit” to Canada.
A non-Canadian can acquire control of a Canadian business either by buying substantially all of its assets or by purchasing the voting interests (i.e., shares) of the business. Such an acquisition will be reviewable if the book value of the assets of the Canadian business is equal to or greater than a prescribed threshold, which is currently $312 million. Asset values are generally determined by reference to the audited financial statements of the Canadian business for its most recently completed fiscal year.
If voting interests are acquired, an acquisition of control is deemed to occur when the non-Canadian directly acquires a more than 50-percent voting interest in a Canadian company and is presumed to occur where there is an acquisition of between 33 percent and 50 percent of the voting shares. The acquisition of control of other Canadian entities such as a partnership, trust or joint venture with assets greater than $312 million will be reviewable if a nonCanadian acquires more than a 50 percent interest.
A lower threshold ($5 million) applies if the investor is from a country that is not a member of the World Trade Organization (WTO) or if the Canadian business is engaged in a cultural business (described further below).
Any transaction that is not reviewable is a notifiable transaction.
The ICA was amended in 2009 to progressively increase the review threshold for the acquisition of control of a Canadian business to $1 billion over a five-year period (starting with a threshold of $600 million for the first year); this period has not yet commenced. Further, the measurement standard for the new threshold will be changed from the book value of assets to the enterprise value of the acquired business. These changes have not yet taken effect because new regulations to define “enterprise value” must first be adopted.
If the Canadian business that is being acquired is a cultural business, a direct acquisition of that Canadian business will be reviewable if the entity carrying on the Canadian business has assets with a book value in excess of $5 million or, in the context of an indirect acquisition, the entity carrying on the Canadian business has assets with a book value of more than $50 million.
An indirect acquisition of control of a Canadian business occurs when there is an acquisition of a company incorporated outside Canada that controls an entity in Canada carrying on a Canadian business (e.g., the acquisition of a foreign company that has a Canadian subsidiary). Pursuant to Canada’s international commitments, indirect acquisitions by or from WTO investors are not reviewable, unless the Canadian business carries on a cultural business. If it is a cultural business in Canada, there will be a post-closing review of the investment.
For non-WTO investors, the threshold is $5 million for a direct acquisition and $50 million for an indirect acquisition. The $5-million threshold will apply to an indirect acquisition if the asset value of the Canadian business being acquired exceeds 50 percent of the asset value of the global transaction.
For the ICA to apply, there must be an acquisition of control of a “Canadian business.” The Act defines that term as a business carried on in Canada that has a place of business in Canada, an individual or individuals employed or self-employed in connection with the business and assets in Canada used in carrying on the business. It is not uncommon for natural resource companies listed on a Canadian stock exchange to maintain a registered office in Canada but not have any operational assets located in Canada (e.g., the mines or oil fields are elsewhere). Although this may appear to meet the broad definition of a “Canadian business,” the Investment Review Division of Industry Canada also examines the extent of the connection of the business to Canada in deciding whether a business is a “Canadian business.” To the extent that there are no operational assets in Canada and the directing minds of the business (i.e., senior management) are located outside Canada, it is possible that the Act will not apply. For example, Sinopec’s $8.2-billion acquisition of Addax Petroleum in 2009 was not subject to review under the Act. Addax had a registered office in Calgary and its shares were listed on the Toronto and London stock exchanges. However, its assets were located in Nigeria, Gabon and Kurdistan and management was based in Switzerland. Likewise, the 2005 acquisition of Calgary-based PetroKazakhstan by China’s CNPC International was not subject to review because its management and operations were outside Canada.
If the Canadian business that is being acquired is a cultural business, a direct acquisition of that Canadian business will be reviewable if the entity carrying on the Canadian business has assets with a book value in excess of $5 million or, in the context of an indirect acquisition, the entity carrying on the Canadian business has assets with a book value of more than $50 million.
“Cultural businesses” includes those involved in the publication, distribution or sale of books, magazines, periodicals, newspapers or music in print or machine-readable form. Also covered are those involved in the production, distribution, sale or exhibition of film or video products or audio or video music recordings. Reviewable acquisitions of cultural businesses are the responsibility of the minister of Canadian heritage. Businesses that carry on both cultural and non-cultural activities that are subject to review are reviewed by both the minister of industry and the minister of Canadian heritage. Note that non-
Canadians are precluded from acquiring control of certain types of cultural businesses due to foreign ownership policies, although exceptions have been made.
Although he is a trained economist and inclined to support more open trade and investment policies, Stephen Harper is, above all, a political tactician. As head of a minority government in Parliament for five years, his decisions on foreign investments were, as is the case in most things, influenced strongly by his overriding desire to remain in power.
If a transaction is reviewable, the investor must submit an application to the minister of industry and/or the minister of Canadian heritage. Within 45 days of a completed application being received, the minister must either (i) indicate whether he or she approves the transaction (on the basis that it is likely to be of “net benefit” to Canada) or (ii) extend the review period for a further 30 days, following which the minister must advise the purchaser of his or her assessment (unless the purchaser consents to a further extension). If the minister makes an adverse determination, the transaction cannot proceed. However, the purchaser has the right to make representations and submit undertakings for a further period of 30 days (or such longer period as may be negotiated with the minister) in an attempt to convince the minister otherwise. In the BHP Billiton case, after then minister Tony Clement advised BHP Billiton that, at that time, he was not satisfied the proposed acquisition of Potash Corporation was likely to be of net benefit to Canada, the company withdrew its offer rather than make additional representations to the minister. In this respect, officials at the Investment Review Division consider that the transaction was not rejected by the minister but rather withdrawn by BHP Billiton. The minister is required to provide reasons for an adverse determination, but because the offer was withdrawn, no reasons had to be provided.
The Act contains statutory criteria for making a determination as to whether an acquisition is likely to be of “net benefit” to Canada. As may be expected, the factors to be considered include the effect of the investment on the Canadian economy; participation by Canadians in the investment; the contribution of the investment to Canada’s technological, productive and competitive profiles; and whether the investment is consistent with the industrial, economic and cultural policies of Canada and the affected provinces. Certain of these criteria (e.g., compatibility with industrial, economic and cultural policies) have been criticized as being vague, and following the withdrawal of the BHP Billiton bid, Clement committed to clarifying the scope of the “net benefit” criteria and the prime minister agreed that the ICA should be reviewed. However, no such guidance was ever provided by the minister, and although a review of the Act was undertaken by the House of Commons Standing Committee on Industry, Science and Technology (Industry Committee), its mandate did not include the scope of the net benefit criteria, and in any event its work was cut short by the dissolution of Parliament when a federal election was called in March 2011.
The review process concludes after the investor negotiates and agrees to provide written commitments to the responsible minister that will govern the conduct of the Canadian business. The term is typically three years following closing but may be longer. These “undertakings” typically relate to maintaining specified levels of employment, capital expenditures, research and development, production and Canadian participation in management at the Canadian business.
We now come to reviews for state-owned enterprise (SOEs).
In 2007, the minister of industry published guidelines that apply to investments by SOEs, which they define as “an enterprise that is owned or controlled directly or indirectly by a foreign government.” The guidelines establish additional criteria that will be considered when making the net benefit determination, including the SOEs:
- corporate governance policies (such as “whether the non-Canadian adheres to Canadian standards of corporate governance”);
- reporting structure;
- compliance with “Canadian laws and practices”;
- ownership structure, including the extent to which it is controlled by a state; and
- intentions to permit the acquired Canadian business to operate on a commercial basis.
The key concern with respect to governance is whether the Canadian business will abide by Canadian standards of corporate governance, which may include commitments to transparency, disclosure and independent directors and audit committee functions.
The SOE guidelines have not proven to be a bar to significant investments in Canada, as there have been no rejections of any SOE-led investments.
Major investments that have been approved recently include the acquisition of Nova Chemicals by International Petroleum Investment Company (owned by the Abu Dhabi government); Korea National Oil Corporation acquisition of Harvest Energy; PetroChina’s acquisition of
interests in two oil sands projects owned by Alberta Oil Sands Corporation; and Sinopec’s acquisition of a company holding a 9 percent interest in oil sands producer Syncrude Canada Ltd.
Finally, with regard to process and timing, there’s the national security review.
Amendments to the ICA enacted in 2009 authorize the industry minister to review any investment by a non-Canadian, regardless of the size of the interest acquired or the value of the assets, where the minister has reasonable grounds to believe that such an investment could be injurious to national security. There are, therefore, no monetary or other quantitative thresholds to provide guidance to investors on the issue of whether their investment will be reviewed. No guidelines or other explanatory statements have been issued to provide guidance on the scope of the “national security” review power, and the government explicitly rejected calls for such guidance.
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If the minister of industry has reasonable grounds to believe that a transaction may be injurious to national security, he must notify the investor within 45 days of receipt of an application or notification. The parties will be barred from completing their transaction until the issue is resolved. The minister will then consult with the minister of public safety and emergency preparedness and may refer the matter to cabinet, which could order a review of the investment. Following that review, cabinet may block the transaction, or allow it to proceed subject to certain terms and conditions. The entire review process can take up to 130 days.
To date, it is believed that the national security provisions have been used only once, involving the proposed acquisition by a Belgian firm of a Canadian company that owned uranium mines located in Africa. There were apparent concerns about links between the proposed buyer and Iran.
We now come to political considerations, which, while especially important in a minority House, remain now that there is a majority government.
Although he is a trained economist and inclined to support more open trade and investment policies, Stephen Harper is, above all, a political tactician. As head of a minority government in Parliament for five years, his decisions on foreign investments were, as is the case in most things, influenced strongly by his overriding desire to remain in power. This, more than anything else, likely explains his government’s decision that BHP Billiton’s attempted acquisition of Potash Corp. was “not likely to be of net benefit to Canada.” Now that Harper has a majority government, some of the dynamics may change, but political interests will likely remain a key driver in regard to foreign investment review decisions.
The politics of the BHP Billiton/Potash transaction were that Potash Corp. is based in Saskatchewan. Thirteen of Saskatchewan’s fourteen members of Parliament at that time were members of the governing Conservative Party of Canada. (All were re-elected in the election held in May 2011.) The provincial government, led by Premier Brad Wall, represents the Saskatchewan Party — a unique blend of two conservative factions — and is heavily favoured to win reelection in November. Premier Wall led the charge against BHP with a staunch nationalist, populist pitch supported in turn by several other provincial premiers and key business leaders. He argued that potash is a “strategic asset,” the control of which should not rest entirely outside of Canada. This notion of a “strategic asset” quickly became a mantra for those opposed to the transaction, despite this language not appearing in the Act.
The 13 Conservative MPs from Saskatchewan, and the Harper government as a whole, quickly fell in line. There is little doubt that the decision, while couched in the vague generalities of the “net benefit for Canada” criterion stipulated in the ICA, was motivated purely by political considerations. Keep in mind, too, that the Conservatives have strong prairie populist inclinations, stemming primarily from the “Reform” roots of the party.
The only other foreign acquisition denied under the ICA was also by the current Conservative government: the 2008 attempt by Alliant Techsystems Inc. (ATK) to purchase MacDonald, Dettwiler and Associates Ltd. (MDA). Although this bid was rejected ostensibly because it failed the “net benefit” test, it triggered concerns that led to a “national security” screen being added to the ICA in 2009. It is worth noting that MDA had received substantial government support to develop its satellite imaging capability, notably for the Canadian Arctic. In both the BHP and ATK transactions, the prospective investors focused almost exclusively on economic analyses and were less effective in countering the resulting political fallout.
As noted above, in 2007, the government added guidelines pertaining specifically to SOEs, targeted presumably at China and others as well, that enable the government of Canada to assess “the governance and commercial orientation of SOEs” as part of the net benefit calculation. This had been prompted by successive acquisitions of major Canadian mining assets — Alcan, Inco and Falconbridge — and concerns that the country was being “hollowed out” by foreign takeovers. China Minmetals’ interest in acquiring Noranda also played a role in the development of both the national security amendments and the SOE guidelines. What is certain is that the combination of “net benefit” and “national security” give ample scope for political considerations to outweigh statistical analyses.
Premier Wall led the charge against BHP with a staunch nationalist, populist pitch supported in turn by several other provincial premiers and key business leaders. He argued that potash is a “strategic asset,” the control of which should not rest entirely outside of Canada.
There was virtually no opposition in Canada to either investment decision. In fact, in the wake of the BHP rejection, the Saskatchewan government ran TV ads featuring representatives of several foreign companies celebrating Saskatchewan as an excellent place in which to do business. Even more profound was the more recent decision by BHP to move its head office for diamonds and specialty products in Canada to Saskatoon! In addition, BHP has continued with its plans to develop the potash mine it already owned in Saskatchewan.
Another common criticism of the Act is the lack of an effective enforcement mechanism if an investor fails to abide by its undertakings. When, in 2009, US Steel failed to meet the obligations it had offered to support its acquisition of Stelco, the government filed an application under section 40 of the Act seeking an order forcing compliance with employment and production obligations, along with a penalty of $10,000 per day, per breach of each undertaking. This action was also arguably essentially political. US Steel had shut down operations in Canada in part because customer demand collapsed but also because “Buy America” restrictions adopted by the US government obliged them to manufacture more in US plants. Company efforts to pressure workers to agree to radical pension plan changes only aggravated matters further. Politically, the Canadian government had little choice other than to sue US Steel for failing to meet its employment obligations. Clearly, actions by both governments were politically driven and overrode the logic of market forces.
In the wake of his decision on BHP, Clement stated that he intended to “clarify” the Investment Canada criteria but details of what changes, if any, may be contemplated to existing legislation have not yet surfaced. Primarily because of commercial confidentiality concerns, the industry minister is precluded from elaborating on the conditions proposed for prospective acquisitions and on the reasons for his decision.
In 2008, the government’s own Competition Policy Review Panel, along with several prominent economists, urged greater liberalization of Canada’s restrictions on foreign investment, which are, reportedly, at the higher end of all OECD countries and are the second highest of all G7 countries. While there have been hints of some receptivity to this in government statements of future intent, the actions taken suggest otherwise. The Prime Minister is known to have been openly scornful of the “Boy Scout” mutterings of officials cautioning about the negative fallout from its investment decisions. Rightly or wrongly, the government believes that others, notably the US, France,
China and Japan, do even more to protect against unwanted foreign acquisitions. For politicians, anecdotal examples can be more compelling than theoretical analyses. It is also relevant to note that this is a government that avoided approving a free trade agreement with Korea because of political opposition from unions and car manufacturers in Ontario. It operated in a Parliament that consistently frustrated broader trade negotiations by Canada with unanimous, all-party support of supply management programs protecting the operations of roughly 16,000 dairy and poultry farmers in Quebec and Ontario.
Statistics show that, since the 1980s, Canada’s inward foreign direct investment (FDI) has grown much more slowly than that of developed and developing economies. Yet, on a per capita basis, since 2000 Canada has ranked fifth among the top 15 destinations for global FDI, placing below the UK and the Netherlands but ahead of Australia, France, Germany and the US. However, more than 60 percent of the FDI flows since 2005 occurred in the natural resources sector. Excluding FDI in natural resources, Canada’s relative performance falls below that of Australia, Germany and the US.
In sectors where there are explicit restrictions, such as telecommunications, the message from the government has been decidedly mixed. (At present, foreign firms can own no more than 46.7 percent of telecom companies.) In the interest of stimulating greater competition and benefits for consumers, the government in 2009 overrode a Canadian Radio-television and Telecommunications Commission decision that would have precluded an Egyptian-backed company (Wind Mobile) from entering the cellphone market. However, in 2011 the Federal Court ruled in favour of the existing service providers (and the regulator) and set aside the government’s decision, saying that the government overstepped its authority under the Telecommunications Act. That decision was subsequently overturned by the Federal Court of Appeal. Meanwhile, the government says it will “review carefully the current restrictions.” It is clearly torn between providing benefits for consumers and preserving restraints on foreign investment or control.
In 2008, the government’s own Competition Policy Review Panel, along with several prominent economists, urged greater liberalization of Canada’s restrictions on foreign investment, which are, reportedly, at the higher end of all OECD countries and are the second highest of all G7 countries.
It had been expected that the proposed merger of the London and Toronto Stock Exchanges would be the next interesting test case of the government’s foreign investment policy, but the parties terminated their transaction when it became clear it lacked sufficient shareholder support. Because it did not involve sensitive resources in the ground, it seemed harmless to some. As discussed further below, there were mutters of concern, notably but not exclusively from Ontario’s provincial government, but not the visceral opposition as was seen with the BHP/Potash transaction.
We now come to lessons learned from recent events.
Although much has been made about investments by SOEs, particularly those from China, to date no SOE-led investments have been rejected. Despite drawing some attention when announced, these transactions largely proceeded to gain approval relatively quietly, on terms and conditions not out of the ordinary for transactions of that size. This suggests that those investors were able to convince the Minister that they had sufficient governance safeguards in place and had a sufficient commercial orientation.
Other lessons can be drawn from the fierce opposition to the BHP/Potash bid by the Premier of Saskatchewan. An important question is the extent to which provincial considerations are taken into account by the minister. One of the net benefit criteria is “the compatibility of the investment with national industrial, economic and cultural policies, taking into consideration industrial, economic and cultural policy objectives enunciated by the government or legislature of any province likely to be significantly affected by the investment [emphasis added].” It is standard practice for the federal Investment Canada officials to consult with provincial officials where the Canadian business is located. Traditionally, the minister pays close attention to provincial views, though he is not bound by them. In this case, in addition to Premier Wall, four other provincial premiers expressed their opposition to the transaction. This underscores the need for investors to be mindful not just of the potential federal reaction but also that at local and provincial levels. Premier Wall and several other premiers pushed for reforms to the ICA at the 2011 meeting of provincial premiers held in July and received the commitment of the federal government to review the Act.
In addition, prior to the BHP Billiton transaction, the effect of a transaction on tax and royalty revenues was paid little — if any — consideration by investors and the Investment Review Division staff that administer the statute. There were published reports that BHP Billiton was willing to structure its acquisition in a way that would save Saskatchewan approximately $300 million in tax revenues that would otherwise have been lost. If true, this represents a new high-water mark in potential undertakings that the minister may seek before approving a transaction. Documents subsequently obtained by the Canadian Press indicate that federal officials were concerned about the potential loss of “important” tax revenues but it was not clear if they referred to lost federal or provincial revenues. Saskatchewan’s energy and resources minister did meet with the then federal natural resources minister to discuss the impact of lost royalty revenues in the province. Thus, it is important to think broadly about the impact of the transaction on all levels of government and develop appropriate responses to those concerns.
Finally, parties must convince all stakeholders of the benefits of the transaction
As noted above, the now abandoned “merger of equals” between TMX Group Inc. (TMX), which operates — among other things — the Toronto Stock Exchange and the Montreal Exchange, and London Stock Exchange Group PLC (LSE Group) drew considerable attention to the vagaries of the net benefit test and the openness of governments and Canadian business to foreign investment. Ontario’s provincial government — which had to face an election in early October 2011 — expressed some initial concerns about the transaction and struck a special committee to review the matter. Despite announcing the transaction on February 9, 2011, LSE Group submitted its ICA application only on April 29, 2011. As a result, the new industry minister, Christian Paradis, had not completed his review at the time the parties terminated the transaction on June 29, 2011. The delay in filing was rather unorthodox, as parties typically submit the application upon the announcement of the transaction or shortly thereafter. A review of the merger agreement makes it clear that the parties paid considerable attention to the Act, as it contained very detailed proposed undertakings, including agreeing that the term of the undertakings would be four years instead of the typical three and that the merged entity would disclose on an annual basis in its public securities filings its compliance with the undertakings. The public disclosure of undertakings and public accountability in respect of complying with them are expected to become more common in the future.
The net benefit standard could have been used to justify either a positive or a negative decision by Paradis, but in the end the efforts by major Canadian banks and pension funds to scuttle the deal by launching their own competing bid for the Toronto exchange proved to be more decisive than political concerns.
For a government now re-elected with a solid majority, and with significant strength in Ontario and the West, future decisions on investment will be influenced largely by attitudes and concerns in those two regions. Reduced corporate tax rates (scheduled to decline to 15 percent next year) will be expected to override much of the concern about individual decisions rejecting foreign investment. Despite the objections of both opposition parties, the government is expected to stay the course on corporate tax reductions and will emphasize that its general “lower tax” approach is the most appropriate means to sustain employment and economic recovery.
In the government’s June Speech from the Throne, no mention was made of changes to the ICA or other foreign ownership laws. Indeed, all that was said was that the government will continue to welcome foreign investment that “benefits Canada.” Thus the prospect for legislative change to, or policy guidance for, the ICA appears to be dimming. Attitudes on foreign investment are likely to be secondary to other government priorities, meaning that in certain high-profile cases, ICA decisions will continue to be difficult to prejudge. While this uncertainty may accord the government great flexibility in applying the Act, the lack of predictability does not serve the interests of foreign investors or Canadian businesses. Canada’s stable, resource-rich economy will continue to attract significant foreign investment, but investors must carefully consider their legal and government/public relations strategies for navigating the increasingly murky waters of the Investment Canada Act.
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