The high level of activity of foreign acquirors and investors in the natural resources area, particularly in the mining sector, has resulted in heightened interest in the requirements of the Investment Canada Act and recent developments relating to the legislation.
Under the Investment Canada Act, a direct acquisition of control of a Canadian business is generally subject to review if the acquiror is not Canadian and the asset value of the Canadian business exceeds C$312 million. Under amendments expected to come into force later this year, the review threshold will increase to an enterprise value of C$600 million or more, and the threshold will further increase to C$1 billion over the next four years.
The Act now also provides for review of any foreign investment, regardless of its size, that could be “injurious to national security.” There is some uncertainty about the scope of the new provision because “national security” is not defined. Although we expect that reviews will be infrequent and unlikely to be generally targeted at the natural resources sector, investments in certain resources, such as productive uranium assets, could be an exception.
Reviews of transactions that meet the applicable size threshold normally last 45-75 days and require that the transaction be of “net benefit” to Canada. The test for net benefit is assessed by reference to a number of factors such as employment, capital expenditures, technological development and level of resource processing in Canada. If the investors are state-owned enterprises, additional net benefit criteria to be considered are whether the investor operates under standards similar to other commercial enterprises and whether the investor adheres to Canadian standards of corporate governance and transparency. The Industry Minister’s approval is usually conditional upon investors entering into binding three- to five-year undertakings with the government in which investors commit to maintaining Canadian operations, production levels, employment levels, R&D expenditures and capital expenditures.
Given the effects of the global economic crisis, attention has been focused on situations in which foreign acquirors are having difficulty fulfilling the undertakings. According to guidelines issued by the Investment Review Division (IRD) of Industry Canada, an acquiror will not be held accountable for breaching a commitment “where inability to fulfill an undertaking is clearly the result of factors beyond the control of the investor.” In practice, it is also often possible to negotiate new or revised undertakings when an original commitment cannot be fulfilled. It is widely believed that a number of investors in the mining sector, including Vale and Xstrata, have been released from commitments or have negotiated revised undertakings because current market conditions have made it difficult to comply with undertakings entered into two or three years ago.
Recently, there has been significant media focus on the Canadian government’s court proceedings seeking to force United States Steel Corporation to fulfill regulatory undertakings that the company made to the Canadian government on acquiring Canadian steelmaker Stelco Inc. in 2007. The U.S. Steel case marks the first time since the Investment Canada Act became law in 1985 that the Canadian government has sued a foreign acquiror for failing to honour its commitments. It is also an extreme and unusual case. When U.S. Steel acquired Stelco in 2007, it undertook to increase steel production in Canada by at least 10% and maintain Canadian employment levels. Instead, it closed most of Stelco’s Canadian operations and laid off over 1,500 employees. Apparently, no attempt was made to negotiate new or revised undertakings.
Although this case is an important reminder that the government views undertakings seriously and will endeavour to enforce them in extreme cases, there is no indication that it signals a change in the government’s basic approach to welcoming foreign investment. If investors adopt a cooperative and proactive approach with the IRD to deal with changed circumstances, the IRD would also normally allow variances when aspects of undertakings cannot be carried out. But investors should expect the IRD to be more concerned about its ability to enforce undertakings in the future. More stringent drafting of undertakings (especially with respect to performance measurements) and more frequent compliance reporting (to increase the detection of possible violations) are likely to be the norm. However, absent similarly extreme circumstances, investors should not expect the government to bring more enforcement actions similar to the U.S. Steel case.