On 11 July 2009, the Canadian government issued proposed regulations under the Investment Canada Act (ICA). These regulations further implement the important changes to the ICA that were enacted in March 2009: a revised formula, with increased investment thresholds, to determine which foreign investments will need to be reviewed and approved by the Canadian government, and the imposition of a new national security screening mechanism. There is a 30-day comment period, after which the regulations will be finalized and then brought into effect.
Although most of the proposed regulations are not controversial, foreign investors will be dismayed at the requirement for increased disclosure of confidential information, and the heightened risk of post-closing government intervention to unwind or restrict acquisitions.
New ICA Review Thresholds
The ICA requires that direct foreign takeovers of large Canadian companies be reviewed and approved by government applying the test of "net benefit to Canada." Frequently, the acquiring foreign investor will provide the government with negotiated undertakings as to employment, head office location, future investment, and the like. Today, except for certain cultural industries (where special rules apply), an ICA review is required for any direct takeover by foreign investors from a WTO country of a Canadian company with more than C$312 million in gross assets.
The March 2009 amendments to the ICA will change the review test from one exclusively based on the target’s assets to one based on the target’s enterprise value. Initially, the threshold will be C$600 million, and will increase in stages over four years to C$1 billion. These changes will come into effect later this year at the same time as the proposed regulations are promulgated.
The proposed regulations calculate enterprise value for a publicly traded company as follows: Market Capitalization + Total Liabilities – Cash. Market capitalization will be based on actual traded value of the company’s equity securities during a defined trading period. Non-traded securities will be valued as having the same value as the largest class of traded equity securities. Rights, warrants or options will be ignored in the calculation.
Enterprise value for a non-publicly traded company, or in the case of a sale of assets, will be calculated using the same value-of-assets formula that is currently applied under the ICA. The proposed regulations therefore achieve a pragmatic compromise between the desire to move to a more market-driven valuation formula, and the practical difficulty in trying to establish market value at an early stage in the acquisition process — which is typically when the foreign investor applies for any necessary ICA review. For acquisitions of this sort, one practical consequence of the proposed regulations is that fewer acquisitions will likely be caught by the review process, given that the ICA review threshold will almost double from today’s C$312 million to C$600 million when the regulations come into effect later this year (and more in subsequent years).
New Disclosure Requirements
With the new national security screening mechanism now enacted as part of the ICA, it comes as no surprise that the government wants more information about who exactly are the foreign investors. Armed with this information, the government can determine if it needs to take further action to disallow or otherwise restrict the investment on national security grounds.
The proposed regulations follow through on this need for disclosure, not only in cases where a foreign investor makes an acquisition that is ICA-reviewable, but also in cases where a non-Canadian makes an acquisition that is below the size threshold to warrant a review (and thus where only a notice must be filed with the government) and, as well, in cases where a foreign investor makes an investment to establish a new Canadian business (which is also notifiable).
Under the proposed regulations, the foreign investor that applies for a review, or files an investment notice under the ICA, must now disclose the following:
- names of directors, the five highest paid officers and any person or entity holding more than 10% of the investor’s equity or voting rights; and
- the name of any foreign state that holds a direct or indirect ownership interest in the investor.
The requirement to disclose the name of direct and indirect foreign state investors does not contain an exception for minor or non-controlling shareholdings. Thus public companies with many shareholders and shareholder registrations through nominees will face practical difficulties in trying to satisfy this requirement.
National Security Screening Procedures
The March 2009 amendments to the ICA established a new national security screening mechanism for foreign investments. By doing so, Canada has caught up to the USA and Australia, which have had such screening procedures in place for many years. The Canadian government now has the legal authority to examine foreign investments in Canada, whether direct or indirect, to determine if they are "injurious to national security." If the government is satisfied that the investment will be injurious to national security, it can disallow, impose restrictions on, or even unwind the investment.
The proposed regulations set out time frames for the government to invoke the national security screening process. To a large extent, these time frames are triggered by the review and notice processes already in place under the ICA. The key time frames for the government to invoke national security screening are as follows:
- where an ICA review is required — up to 45 days after filing the complete review application;
- where only an ICA notice is required — up to 45 days after the later of (a) the filing of the complete notice, and (b) implementation of the investment;
- in all other cases — up to 45 days after implementation of the investment.
The good news is that once these screening time frames have expired, the government has given up the right to challenge foreign investments on national security grounds. The less-than-good-news is that for a period of 45 days after "implementation" of a non-reviewable investment (including minority investments), the government can initiate national security screening, with the risk that an investment can be unwound or restricted. Needless to say, a foreign investor that has already implemented its investment will be very dismayed to learn that the government will undertake such an after-the-fact review with the potential for mandated divestiture or other unwelcome remedial action.
If an investment is one that becomes subject to national security screening, the proposed regulations set out time frames for the various steps. Depending on the results of the government’s national security analysis, and the outcome of negotiations with the investor, the entire screening exercise could stretch to four months or more.
The proposed regulations complete the updating to the ICA that began with the March 2009 amendments. The regulations provide a necessary filling in of the various procedural steps to make the amended ICA provisions work properly. Many of the changes are benign in nature. Some, such as the increase in review thresholds, will be welcomed by foreign investors. Other changes, however, will burden foreign investors with increased disclosure requirements and a heightened, albeit still remote, risk of government action post-closing. Foreign investors will want to take note of the finalized regulations, once these come into effect later this year.