The Canadian Government has now passed amendments to the Investment Canada Act (ICA) implementing its new approach towards state-owned enterprises (SOEs) and lengthening the maximum amount of time required for a national security review.
As previously reported in our May 10th mailing "New Bill Heightens Potential for More Investment Canada Reviews of SOE Acquisitions", when the Canadian Government approved two acquisitions of Canadian energy companies by SOEs (CNOOC’s takeover of Nexen and Petronas’ acquisition of Progress Energy) in December 2012, it announced that in the future it would prohibit SOEs from acquiring control of Canadian oil sands businesses, except on an exceptional basis1. In addition, the Government would closely monitor SOE investments in other sectors of the economy.
The decision to intensify scrutiny of SOE investments in Canada has now been reinforced with amendments to the ICA that will almost certainly result in more SOE investments being subject to pre-closing review and Ministerial approval on the basis of “net benefit to Canada”, for the following reasons:
- The ICA review requirement only applies to acquisitions of control of Canadian businesses. The rules for determining whether an acquisition of control has occurred are set out in the act. What the amendments do is empower the Minister to make SOE investments subject to review if he finds “control in fact” even if the application of the ICA's general rules would lead to the conclusion that no acquisition of control has occurred. An ICA review is a time-consuming process and may cause delays to closing (and in rare cases, rejection). Significant commitments to the Canadian Government on a range of issues from employment to head office location to capital expenditures are almost always required.
- The uncertainty generated by this Ministerial discretion is exacerbated by the potentially very broad scope of the term "SOE" which has been expanded beyond entities that are controlled by foreign governments to include those that are influenced by such governments.
- SOEs will not benefit from the increase in the generally applicable review threshold which is set to rise dramatically over the next few years – from $344 million in book value of the target’s assets to $600 million in enterprise value (and to $1 billion within 4 years). The likely result is that SOE investments will be subject to more reviews than would otherwise be the case.
Broader Ministerial Discretion to Subject SOE Transactions to Review
The amendments may significantly increase the number of SOE investments requiring Ministerial approval by permitting the responsible Minister (the Minister of Industry except where the target industry is cultural) to avoid the general ICA rules and presumptions:
- Defining when an acquisition of control occurs. The ICA general rules establish presumptions regarding when control is acquired. For example, they state that the acquisition of less than one-third of the voting shares of a corporation or of less than a majority of the economic interests of a partnership is deemed not to be an acquisition of control. If there is no acquisition of control, there is no requirement for a "net benefit" review under the ICA. For an SOE, these rules need not be applied if the Minister concludes based on "any information and evidence" made available to him that the SOE will acquire control in fact.
- Determining whether one entity is controlled by another. The ICA sets out general rules and presumptions regarding when control exists. However, the amendment would permit the Minister to go beyond those rules in assessing whether an SOE controls another entity in fact, thus creating some uncertainty about whether such an entity would be considered an SOE when it made an acquisition.
- Determining whether an investor is Canadian or not. The ICA establishes rules to determine the Canadian status of an investor. As a result of the amendment, an entity that would otherwise be considered Canadian-controlled may be judged to be an SOE if the Minister concludes that it is controlled in fact by an SOE. The consequence is that if such an entity pursued an acquisition of a Canadian business, it would be subject to the SOE review threshold and Ministerial discretion on whether it was acquiring control in fact.
All of the above decisions may be retroactive to April 29, 2013.
As noted above, the repercussions of bypassing the normal presumptions and rules on these points could be significant for an SOE investor. As an assessment of "control in fact" can be relatively subjective and depend on a detailed analysis of the terms of the investment, it may be unclear, especially early on the deal process, whether the SOE investment is an acquisition of control in fact under the ICA and therefore potentially reviewable. Moreover, the Government has no plans to issue guidance on how it will apply a “control in fact” test, although this phrase has been interpreted in other legislation including transportation, telecommunications and tax laws. To address this uncertainty, an investor may, in the appropriate circumstances, wish to consult early on with the Government.
Unclear Scope of an SOE
The definition of an SOE now includes not only the government of a foreign state or agency of such government and an entity that is controlled, directly or indirectly, by such a government, but also an entity that is influenced, directly or indirectly, by a foreign government. The definition of an SOE has also been expanded to capture individuals acting under the direction of a foreign government or under the direct or indirect influence of a foreign government. The Government has indicated there is no plan for guidance on the term "influence". It is possible that the Government will feel constrained not to interpret this phrase too broadly as there may be a risk of a backlash against Canadian pensions funds and other quasi-public Canadian entities in foreign countries. Nevertheless, it is unclear in any given situation where the Government will choose to draw the line with respect to, for example, the degree of foreign government representation on boards or senior management links to government officials required to find "influence".
SOE Review Threshold
SOEs will not benefit from the planned increase to the current review threshold. At present, the review threshold for direct acquisitions of Canadian businesses by foreign investors controlled by nationals of World Trade Organization (WTO) countries is $344 million in the book value of the target Canadian business2. Non-SOEs will in the future3 face a review threshold based on the target’s enterprise value; the threshold will be $600 million when implemented, rising to $800,000 in two years and then to $1 billion four years later. The meaning of “enterprise value” (EV) will be defined by regulation; draft regulations to date have defined EV for public companies as market capitalization plus liabilities minus cash, while EV for private companies relates to purchase price plus liabilities minus cash.
The likely outcome of differentiating between SOEs and non-SOEs in the review threshold is that more SOE transactions will be subject to review relative to non-SOE transactions, although this is not necessarily the case. For example, Canadian businesses that are engaged in industries where book values may be lower relative to EV such as information technology companies, it is possible that an SOE investment might be below the book value review threshold while a non-SOE investment would exceed the enterprise value threshold. This would advantage the SOE investor relative to the non-SOE in a bidding process for the Canadian target business – a curious result that is at odds with the Government’s objective to require more scrutiny of SOE investments.
Longer Timelines for National Security
The amendments extend the maximum timelines for transactions subject to national security screening and "net benefit to Canada" review by an additional 25 days or as agreed between the foreign investor and the Government. In the four years since national security has been introduced, there have been very few reviews with the result that the implications of this extension are unlikely to be serious. Moreover, investors can take steps to manage timelines by consulting early on with the Government.
With the amendments to the ICA, the Government has underscored its determination to review SOE investments that may undermine the free market orientation of Canadian businesses or result in overrepresentation of SOEs in a given sector of the Canadian economy. The broadened discretion of the Minister to determine the reviewability of an investment and to define an SOE more expansively will no doubt generate some uncertainty and anxiety for SOEs looking to invest in Canada. Nevertheless, such concerns may be addressed by seeking clarity on the applicability of the ICA (for example, to a minority investment) at an early stage from the Government. Moreover, it should be emphasized that the Canadian Government has in no way closed the door to SOE investment even if more SOE transactions are reviewed and it is anticipated that SOEs will continue to invest in Canada when market opportunities are ripe.