On July 11, 2009, Industry Canada released draft regulations (the Draft Regulations) that will implement certain amendments to the Investment Canada Act (ICA) introduced with the passage of Bill C-10 in March of this year. The Draft Regulations provide prescribed information necessary to implement amendments to the ICA raising the monetary threshold for the review of investments and establishing a process for national security reviews under the ICA, in addition to setting out new information requirements for ICA filings. As there is a 30-day comment period, the Draft Regulations could come into effect as early as mid-August.
New investment review threshold
Under the ICA, the Industry Minister is required to approve transactions that meet certain monetary thresholds on the basis that they are of "net benefit to Canada". Pursuant to the recent Bill C-10 amendments, the new WTO review threshold for direct acquisitions1 of Canadian businesses (not engaged in cultural activities) under the ICA is increased from CDN$312 million in book value of the assets of the target Canadian business to CDN$600 million in "enterprise value" (EV). (This will increase to CDN$800 million by 2011 and to CDN$1 billion by 2013 and indexed thereafter.) Although it was passed as part of Bill C-10, the new EV threshold will not be in force until the regulations defining EV are finalized.
The Draft Regulations define EV as follows:
- for acquisitions of control of a Canadian business involving the acquisition of a publicly traded Canadian corporation or other publicly traded entity (a Canadian or non-Canadian trust, partnership or joint venture), the EV is the market capitalization of the entity, plus its total liabilities minus its cash and cash equivalents.
- for other transactions, i.e. transactions involving asset acquisitions or if control of a Canadian business is acquired without acquiring a publicly traded entity, the EV is the book value of the assets as shown on the audited financial statements. This is the current method of calculating the review threshold for all transactions.
For investors directly acquiring a publicly traded entity (except a non-Canadian corporation that owns a Canadian entity, which is considered an "indirect" acquisition for the purposes of the ICA), the Draft Regulations introduce a level of complexity not faced by purchasers of assets of a Canadian business or of private entities. "Market capitalization" is calculated by adding: (i) for each of class of equity security listed on a stock exchange, the average daily number of securities that are outstanding during the "trading period" multiplied by the average daily closing price on the stock exchange where there is the greatest volume of trading (the "primary market") during the trading period and (ii) for each class of unlisted equity securities, the average daily closing price of equity securities on the primary market belonging to the "primary class" (the class with the largest number of outstanding securities) during the trading period multiplied by the average daily number of the class of unlisted equity securities outstanding during the trading period. The "trading period" is defined as the most recent 20 days of trading before the end of the entity's quarterly fiscal period immediately preceding the closing of the acquisition. By contrast, liabilities and cash are equal to the amounts listed on the audited financial statements for the year preceding closing of the transaction.
While using EV for publicly traded entities might represent a more accurate means of assessing the relative importance and size of a target Canadian business than book value (e.g., where the business has high revenues but low asset values), the Draft Regulations would cause unpredictability for certain transactions. For example, for a proposed purchase of a publicly traded Canadian corporation with a calendar-based fiscal year, the foreign purchaser that signs an agreement in January but is not able to complete the transaction until July would not have definitive knowledge of the market capitalization value required for the purposes of the EV calculation until the end of June. In a volatile market, a deal which was not reviewable on the basis of its market capitalization in January might well be reviewable in June, if the target's stock was increasing in value on the market, with the converse being possible in a declining stock value situation.
Unfortunately, the distinction the Draft Regulations make between EV for public versus private companies emphasizes the significance of the form of a transaction over its substance (i.e., the relative importance of the Canadian business to the Canadian economy). That is, a transaction that is structured as an asset acquisition would be subject to the book value determination as opposed to a market capitalization test.
National security review
Bill C-10 introduced a new national security review process, in addition to the existing investment review process noted above. The amendments provided that the timeline for national security review and its impact on the existing investment review process regulations would be prescribed by regulation. The Draft Regulations set out the timelines for each step of the national security review process. As each individual step may involve a number of possible outcomes, however, it is difficult to provide a concise summary of the length of time a national security review would take according to the Draft Regulations. Variables include: (i) whether a transaction is notifiable or reviewable under the ICA, or indeed neither; (ii) how serious potential national security concerns are and accordingly, whether a notice of possible review is given; (iii) the length of time required for a review; and, in the near term, (iv) whether timing of a transaction would be such as to trigger application of the transitional provisions respecting national security reviews.
What is clear is that the national security review process has the potential to add significant delays to the process of obtaining required regulatory approvals for transactions if the maximum prescribed periods are fully utilized. In such a scenario, a national security review could take 130 days (assuming a notice of possible review is issued), with the potential for the Industry Minister to request an extension of the period available to him to complete his review which would take the review period beyond 130 days. Moreover, it should be underscored that the national security review process applies not only to the establishment or acquisition of control of a Canadian business, but also to minority investments in Canadian businesses.
Draft information requirements for the forms
The Draft Regulations also provide that revised notification and application forms would require additional information for net benefit and national security review purposes. For example, investors would be required to give the names, mailing address, telephone numbers, fax numbers and email addresses for each member of the investor's board of directors, the five highest paid officers of the investor and any individual or entity that owns 10% or more of the equity or voting rights of the investor. They would also be asked to disclose any ownership interest by a foreign government, as well as the sources of funding for the investment.
It is clear that the Government's objective is to uncover the ultimate ownership and control behind foreign investors. Currently, applicable regulations do not generally require disclosure of a passive investor without a controlling interest. The proposed draft Regulations would therefore result in greater transparency to the Government of, for example, foreign state involvement or of known criminals or terrorists. Such disclosure accords with the Government's interest in national security and state-owned enterprises and sovereign wealth funds as evidenced by its guidelines on Investments by state-owned enterprises (released in December 2007).