Although Canadian legislation requires that Canadians substantially own and control certain targeted industries (telecommunications operators, broadcasting licensees, domestic airlines and a number of cultural industries such as certain book publishing and retailing businesses), a few determined foreign investors have found investment opportunities by carefully navigating through these rules.
To be clear, the Canadian ownership and control rules do not forbid all foreign investment in the targeted industries. But the rules are complex, and they do make it difficult for an investor seeking to make a sizeable investment, or to consummate a trans-border merger. Still, in a number of prominent cases, non-Canadians have achieved their investment objectives. For example, despite Canadian ownership and control rules, American Airlines was able to buy a majority interest in a Canadian airline and operate much of its back-office activities; Goldman Sachs was able to buy a majority interest in the Canadian broadcasting business of Alliance Atlantis; US-based Loral was able to buy a majority interest in Telesat, Canada’s largest communications satellite operator; and non-Canadian private equity firms were able to acquire a large majority of the equity in Air Canada.
The Canadian ownership and control rules are structured in a similar manner. They establish
formal limits on measurable factors, such as the percentage of voting shares that non-Canadians can hold or the percentage of the board of directors that must be Canadian. These are usually straightforward to understand and apply. A key point is that no specific limits are imposed on non-voting shares or other forms of equity participation. A foreign investor can therefore obtain a greater equity participation in a Canadian target than the ownership tests would suggest. Indeed, this is commonly done.
The rules also include a requirement that Canadians exercise "control in fact" over the enterprise — a concept that is anything but straightforward. In making a control-in-fact determination, the regulators undertake a multi-faceted review of all points of influence by non-Canadian and Canadian investors. This is done by looking at shareholders’ agreements and other agreements or arrangements that can bear on governance, composition of the board or strategic decision-making by the company.
Although the rules do not stipulate a numeric limit on non-voting equity, when examining who exercises control in fact, regulators become concerned if the overall equity stake held by non-Canadians becomes too large. Where Canadians have too small an economic stake in an entity, and non-Canadians too large a stake, regulators simply do not believe that Canadians will be in control.
Although a non-Canadian equity participation level of up to 65 per cent does not seem to generate concerns, it is not a simple matter to predict how high foreign equity participation can go before regulatory resistance becomes significant. Much will depend on the individual facts. For example, a single non-Canadian investor is probably more troublesome than a large number of unrelated foreign investors, given the difficulty likely to be encountered by multiple investors in concentrating their individual influence into control.
The rules are enforced by several federal regulators, depending on the industry involved. Although enforcement, in theory, can occur anytime, a foreign investor is most concerned at the time of a business acquisition, when regulatory scrutiny is most intense. The anticipated regulatory reaction under the Canadian ownership and control rules thus becomes a key input on whether to make an offer, and how to properly structure it.
For a more detailed analysis of these ownership and control rules, please see our Legal Update.