Despite a dramatic downturn resulting from a worldwide recession, China’s economy continues to grow at a rate that is the envy of any G8 country. After a hiatus that lasted several months in the fall of 2008 and early in 2009, the Chinese government’s stimulus package now appears to be causing a significant up-tick in world commodity demand. Whether that increase can be sustained in light of continued economic weakness in the rest of the world remains to be seen.
Chinese investment in Canadian companies has assumed various forms depending on political sensitivities and the state of the Canadian (and world) economy. Prior to the recent commodity crash, direct Chinese investment in Canada was primarily focused on taking over Canadian-listed resource companies with active business assets solely outside of Canada (whether that be Syria, Mexico or Peru). Such transactions typically did not undergo Investment Canada Act (ICA) review as all of the targets’ active business assets were overseas and/or the transactions were under the applicable monetary thresholds for review.
With the onset of the recession and the disappearance of credit, many Canadian mining resources companies – particularly development stage resources companies – have found themselves in tremendous financial difficulty. They have either major project development costs or maturing debt (or both) that they are unable to finance or refinance. In some instances, they have sought such financing in the form of equity.
Private Placement Investment and Product Off-Take
A number of investors in these Canadian mining resources companies have been resource-hungry Chinese and other Asian-based companies. Rather than acquiring 100% control, these foreign companies have undertaken private placement equity investments, together with concurrent product off-take arrangements, in Canadian resource companies with Canadian-based resource assets. Under such arrangements, an investor typically both invests in shares and also has the long-term right to purchase (on market terms) a percentage of resource production equal to the percentage of its initial investment. (While Asian investors are not alone in making large private placements into cash-strapped mining companies, the combination of investment and off-take has not been as common in private placements by non-Asian-based investors.)
Shareholder Approval Under TSX Rules
These private placements have typically been structured as an investment in just less than 25% of the outstanding securities of financially stressed companies so that, for arms length investors, shareholder approval is not generally required under current TSX rules. It is also possible for a TSX-listed company to issue greater than 25% of its outstanding shares on a private placement basis without shareholder approval if the issuer can avail itself of the “financial hardship” exemption. First introduced in 2005, this exemption permits private placements in excess of 25% of the outstanding shares without shareholder approval if the issuer’s board concludes that the company was in financial distress and that the transaction was in the best interests of the company.
In April 2009, after frequent use of this exemption, the TSX released further requirements. The new rules require increased disclosure of:
(1) the circumstances contributing to the financial distress;
(2) the alternatives considered;
(3) how the transaction should solve such distress;
(4) the role (if any) of insiders participating in the issue; and
(5) the board process.
The new rules also require five business days’ notice of the closing by press release.
Review Under the Competition Act and Investment Canada Act
On a diluted basis, these private placement investments typically are equal to 19.9% of the cash-strapped Canadian company’s outstanding voting shares after the transaction. This level of investment falls below the trigger level threshold for review of acquisitions of voting shares under both the Competition Act (CA) and ICA pre-merger approval rules (assuming the investor does not already hold any other shares). Regardless of the availability of shareholder approval exemptions under current TSX rules, if the private placement transaction is above applicable monetary thresholds and results in an investor holding greater than 20% of the voting shares of a publicly-listed Canadian business, it will be subject to pre-merger review under the CA. If it is above the applicable monetary threshold and results in a non-Canadian investor holding greater than one-third of the voting shares of a Canadian business, the transaction will be subject to review under the ICA. If there is no significant competitive overlap, a review under the CA typically takes less than 2 weeks, since the assessment is based purely on competition grounds. In contrast, a review under the ICA typically takes up to 45 days, even in the simplest cases, because it involves a critical assessment of commitments by the buyer to invest in the acquired business.
Acquisitions by Chinese SOEs
With the partial recovery of equity markets and the re-awakening of at least parts of the corporate bond market in the spring of 2009, there have been selective opportunities for precious metals, uranium and copper companies to access the public markets through overnight, marketed and bought deals (albeit at a steeper discount to trading prices than historical norms). These opportunities may result in fewer large private placements going forward, at least in some mineral sectors.
Further market and economic recovery may well lead to another form of Chinese direct investment in Canadian companies – that of Chinese state-owned enterprises (SOEs) undertaking acquisitions of Canadian companies with active Canadian business assets. The feasibility of such investments in larger Canadian businesses will depend (in part) on how the Canadian Minister of Industry applies the (as yet untested) guidelines issued in December 2007 on the “net benefit to Canada” requirement under the ICA for reviewable transactions by SOEs. Another element that may affect such investments, depending on the industry, will be the interplay between these guidelines and the application of the new review criteria involving “national security.” A review premised on national security may be required by the federal government regardless of the extent or amount of the investment. Therefore, acquisitions which do not cross the monetary threshold for review and involve an acquisition of less than one-third of the voting shares of a Canadian business potentially are reviewable on national security grounds.
In April 2008, the Minister rejected the planned CDN$1.3 billion sale of MacDonald, Dettwiler and Associates Ltd.’s Information Systems and Geospatial Service Operations division to U.S-based Alliant Techsystems Inc. That decision represented the first time in the 23-year history of the ICA that a transaction outside of the cultural sphere has been blocked as a result of a failure to meet the “net benefit” test. While that decision may signal a more rigorous enforcement approach to proposed acquisitions (or at least ones involving “national security”), the review process was confidential and the Minister did not release reasons for his decision.
However, the pending acquisition of all of NOVA Chemicals by International Petroleum Investment Company (an Abu Dhabi-based SOE) is being reviewed and the results of that review could provide some guidance, at least as to the application of the SOE guidelines.