Canada welcomes foreign investment, but there are limits on the warmth of that welcome. The limits are found in laws that enable government vetting of foreign investments to ensure that important public policy objectives are achieved. They are also found in rules that require Canadian ownership and control of aviation, communications and cultural industries. And they are found in rules that ensure a competitive marketplace, soundness of the financial sector and adequate transportation infrastructure — these latter three limits also apply in the case of domestically-sourced investment.
In March 2009, Parliament passed important changes to several of the laws that impact foreign investors. These changes followed on from the 2008 report of the Competition Policy Review Panel.1 The Panel criticized Canada’s competitiveness as compared to its major trading partners, and laid some of the blame on obsolete or inappropriate rules restricting foreign investment. The government responded in early 2009 with new legislation. At the same time, it proposed to remedy a number of long-outstanding deficiencies in our antitrust laws, which the Panel also criticised. The new legislation was tacked onto the end of the government’s 2009 economic stimulus bill, thereby ensuring speedy passage and negligible public debate. Indeed, the entire legislative process lasted barely 5 weeks from introduction into Parliament to passage into law.
Although the basic theme of the amendments is to reduce and clarify investment restrictions, some of the changes will impose new burdens on investors. Moreover, very little change is seen to the Canadian ownership and control requirements in the aviation and communications sectors, despite the Panel’s recommendations on this score. Thus, foreign investors will likely have mixed views about the changes. Still, they are now part of the Canadian investment landscape, and foreign investors will have to take them into account as they consider acquisitions of Canadian businesses.
The purpose of this article is to describe the key changes that have now become law and to discuss how they will impact foreign investment decisions. The article begins with the changes to the Investment Canada Act, which is then followed by the Competition Act. It concludes with a brief discussion of the modest changes to sectoral Canadian ownership and control rules.
2. Investment Canada Changes
The Investment Canada Act allows the Canadian government to screen foreign investment to determine if it is likely to be of "net benefit" to Canada. Foreign direct acquisitions of Canadian businesses with assets that exceed C$312 million,3 for most industries, and C$5 million, for certain sensitive sectors of the economy, must endure a "review" by one of the two government departments that deal with such matters. Often the review will lead to the foreign investor giving undertakings relating to employment, future investment and other commitments considered beneficial to Canada. Only very rarely will an acquisition be turned down.3
Investments that are below the applicable threshold need only make a notice filing with the government. No review takes place.4
The sensitive sectors (with the lower review threshold level) included uranium mining, financial services, transportation services and cultural businesses. In the latter category are the following: the publication, distribution or sale of books, magazines or newspapers or music in print or machine readable form; and the production, distribution, sale or exhibition of films or video recordings, and audio or video music recordings.
With certain cultural industries, the government has issued policy guidelines that make it very difficult, if not impossible, for a foreign acquisition to pass scrutiny. These extra-sensitive sectors include film distribution, book publishing, distribution and sale, and magazine publishing.
Canadian-controlled buyers need not be worried about the Investment Canada Act. This begs the question of what is a "Canadian" in this context. The Act answers this question by setting forth various presumptions and tests for assessing the Canadian-ness of an acquirer. Generally, an entity will be considered Canadian if a majority of its voting interest are held by Canadians. However, in the case of cultural industries in particular, the Government can look beyond the ownership of voting interests and assess if non-Canadians control the entity in fact.
The 2009 amendments are intended to make it easier for foreign investors seeking to acquire Canadian companies as fewer acquisitions will have to endure the Investment Canada review process. The first big change is the reduction in the list of sensitive sectors to only include cultural industries. Thus, acquisitions in the uranium mining, financial services, and transportation services sectors will no longer be subject to very low review thresholds (although other investment screening could still apply — see below). Rather, they will face the same threshold as other industries.
The second big change is that the formula for calculating the review threshold will be changed and the threshold number will increase. The threshold moves from a test based on the book value of the assets of the target company to a test based on its "enterprise value". The definition of this term will be set out in regulations to be issued later in 2009, but typically enterprise value means market capitalization plus debt less cash. The new enterprise value threshold will itself increase over time in steps to C$1 billion, as follows:
- C$600 million commencing when the section becomes law (later in 2009)
- C$800 million commencing 2 years after (i),
- C$1billion commencing 4 years after (i)
- thereafter the figure grows with the size of the economy, and is recalculated each January.
Unfortunately, no change has been made to the much-criticized "net benefit" test and no significant improvement has been made to the complex wording of the Investment Canada Act itself. Accordingly, investors will have to assume that this lack of change means that the government intends to carry on with its current approach to Investment Canada reviews when the threshold is exceeded — which can be quite burdensome.
3. National Security Screening
An important addition to the Investment Canada Act is the power given to the federal government to vet investments by non-Canadians on national security grounds. Canada joins the United States, Australia and most recently, Germany, with explicit procedures to review, adjust, and if necessary, reject, foreign investments that are perceived to be injurious to national security.
The scope of the review is potentially very broad. There is no minimum investment threshold. A review can be undertaken for a takeover of an existing business or the start-up of a new business. To date, there is no list of sensitive sectors, where a review is more likely; nor is there a procedure to "voluntarily pre-clear" potentially sensitive transactions.
The criteria for evaluating a particular transaction are quite vague. The government need only be satisfied that it has "reasonable grounds to believe that an investment by a non-Canadian could be injurious to national security". The terms "injurious" and "national security" are not defined.
The remedies are very broad. The government can block a pending transaction, or allow it to proceed subject to conditions. It can also order divestitures for completed transactions.
The government will be issuing regulations later in 2009 to define the review procedures. The notice or review requirements under the Investment Canada Act will likely serve as the triggers for the waiting period in which the government will be required to signal if it intends to undertake a fulsome national security review, or pass on the opportunity.
With so much vagueness and uncertainty, what is a foreign investor to do?
Perhaps some comfort can be taken from the comments of government officials that national security screening is expected to be uncommon, and the application of remedies to be very rare. That said, the government’s 2008 rejection of Alliant Techsystems’ proposed acquisition of MacDonald Dettwiler, although couched in the traditional Investment Canada language of insufficient "net benefit to Canada", could be equally viewed as a turn-down on national security grounds.
The recent Australian experience provides some useful guidance, both positive and negative, on the likelihood that national security problems can thwart a transaction. Although very few transactions have historically generated significant opposition on grounds that they fail the (equally, if not more, vague) Australian test of "contrary to the national interest", there have been two transactions where unexpected government opposition did indeed create significant problems. In a 2001 case, the government rejected Shell Petroleum’s proposed takeover of a domestic petroleum producer, Woodside Petroleum, in which Shell already held a 34% interest due to concerns that Shell might not sufficiently invest in Australian petroleum production. In 2009, the government rejected the proposed takeover by state-run China Minmetals of gold and copper miner Oz Minerals due to the fact that its most valuable mine-site was located near a government munitions testing range.
In order to provide some greater degree of predictability to potential investors, and their targets, both the US and Australia have provided guidance on the types of transactions that are more prone to national security attention, and this guidance can likely be a useful starting point for Canadian assessments as well. What follows is a non-official amalgam of this guidance, but omitting sectors that are not likely to be a concern in Canada (for example, where Canadian ownership and control rules apply):
- Target companies involved in government contracting such as military, law enforcement, telecommunications technology, aerospace, radar, information technology and classified work generally.
- Target companies in the transportation, energy, nuclear, uranium mining or advanced technology sectors or that sell export controlled products.
- Purchasers that are state owned companies and where investment decisions are not clearly independent of government.
Although Canada does not yet have a pre-clearing procedure, it is inevitable that some sort of process will develop. The early acquisitions will likely clear a path through the federal bureaucracy that others will then follow.
4. Competition Act Changes
The 2009 amendments to the Competition Act that bear most notably on foreign investment decisions concern the pre-merger notification procedures. These have now been substantially aligned with the equivalent US procedures under the Hart-Scott-Rodino Act. No change has been made to the substantive test for prohibiting anti-competitive mergers.
Under the new procedures, parties to a merger file the requisite information, and then wait 30 days. By the end of the 30-day period, either the Competition Bureau will issue a second request for additional information or, if no such second request is made, the parties are free to close the transaction. If the parties receive a second request, it will set out the further information that must be submitted. The parties must assemble the information, submit it to the Competition Bureau, and then wait a further 30 days before closing their transaction — unless the Competition Tribunal blocks the closing upon application by the Bureau.
The impact of these 2009 changes will be to make the prenotification process more onerous, expensive and prolonged when controversial mergers are under consideration. By comparison, the 2009 amendments should not have as significant an impact in the case of non-controversial mergers, although the initial 30 day waiting period is longer than the 14 day waiting period that previously applied.5 Moreover, the information to be filed at the initial stage has been expanded to include "all studies, surveys, analyses and reports that were prepared or received by a senior officer for the purpose of evaluating or analysing the proposed transaction with respect to market shares, competition, competitors, markets, potential for sales growth or expansion into new products or geographic regions".6
Other changes have also been made to the Competition Act, notably in regards to criminal conspiracies, increased penalties, and review of potentially anti-competitive agreements. But, as important as these are to operating companies, they are of limited interest to foreign investment decisions, and hence will not be further described here.
5. Changes to Canadian Ownership and Control Rules
Canada has explicit Canadian ownership and control rules in the aviation, broadcasting and telecommunications sectors. Similar rules also apply to those cultural industries where non-Canadian ownership and control is prohibited, as discussed above. These rules are all structured in a similar manner. They establish formal limits on measurable factors, such as the percentage of voting shares that that non-Canadians can hold or the percentage of the board of directors that must be Canadian. These are usually straight-forward to understand and apply. But the rules also include a requirement that Canadians exercise "control-in-fact" of the enterprise — a concept that is anything but straight-forward.
The rules are enforced by several federal regulators. 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 rules become a key input on whether to make an offer, and how to structure it. Often, non-Canadians will be permitted to own sizeable percentages of the overall equity in a Canadian business, although Canadians must retain control-in-fact of the business.
Despite repeated calls for liberalization, including most recently by the Competition Policy Review Panel, the 2009 amendments do not change the rules in the telecommunications and broadcasting sectors. The only sector where some liberalization has occurred, and it is a quite modest change, is in the aviation sector.
The Canada Transportation Act establishes Canadian ownership and control rules for the licensing of certain categories of air transportation service provider, most notably domestic airline companies. A company will satisfy the requirements if it is "Canadian", that is: (a) at least 75% of its voting interests are held by Canadians, and (b) it is controlled-in-fact by Canadians. The Canada Transportation Agency monitors and enforces the Canadian ownership and control rules for airlines. A handful of decisions appear on the Agency website at www.cta-otc.gc.ca.
The 2009 amendments allow the government to increase the percentage of voting interests that can be held by non-Canadians from 25% to a maximum of 49%, with the actual number to be set by regulations in the future. These regulations will presumably also set out the approach to reciprocity in increased ownership limits that the government announced in December 2008 at the time when the Canada-EU open skies agreement was announced. That December announcement also contemplated that nationals of each would eventually be able to establish domestic-service-only airlines in the territory of the other, although the timing of this was not set out. To be clear, the 2009 amendments do not provide a framework for such an expanded right of establishment.7
The 2009 amendments continue the slow process of liberalization of the Canadian ownership and control rules in the airline business. Already, a great deal of flexibility for non-Canadian investors was evident when Air Canada reorganized itself out of court protection from its creditors in 2004. At that time, a large majority of the equity and debt was likely placed in non-Canadian hands, with the endorsement of the Canada Transportation Agency. In effect, the law is now catching up with the regulatory reality. A formal increase in the non-Canadian ownership limit to 49% of the voting equity, when non-Canadians could already hold more than 50% of overall equity (voting + non-voting), is not a big step.
6. Other Screening Rules That Can Apply To Foreign Investment
With the Investment Canada Act, including its new national security provisions, and the Competition Act, one might wonder if there is a need for further foreign investment screening. The answer is that a number of statutes allow for potential government or regulatory review of acquisitions, whether by domestic or foreign buyers. These other screening mechanisms apply to certain sectors (e.g. broadcasting where, of course, a non-Canadian cannot acquire control) and certain facilities (e.g. international bridges and tunnels). None of these are changed by the 2009 amendments.
Perhaps the most significant such additional screening mechanism arises under the Canada Transportation Act pursuant to amendments introduced in 2007. Because these amendments are of quite recent vintage, a brief description will follow.
Any acquisition of an interprovincial transportation undertaking that is big enough to require Competition Act prenotification will also require notification to the Ministry of Transport. The Minister can then either let the acquisition proceed, or decide to conduct a more fulsome review, if the acquisition raises issues with respect to the public interest as it relates to national transportation. The more complete review can lead to the imposition of conditions or even a prohibition of the acquisition. Conversely, the review can lead to the consummation of a merger that might otherwise raise troublesome competition issues, as any merger approval decision under the Canada Transportation Act can be made to override the merger provisions of the Competition Act.
Thus, the acquisition by a non-Canadian of a sizeable Canadian railroad, pipeline, etc., will be subject to screening under the following statutes (at a minimum):
- Competition Act — test is whether the proposed merger "prevents or lessens, or is likely to prevent or lessen, competition substantially"
- Investment Canada Act — test is whether the investment is "of net benefit to Canada"
- Investment Canada Act — test is whether the investment is "injurious to national security"
- Canada Transportation Act — test is whether the transaction is "in the public interest"
This may seems like an abundance of screening, with ample opportunity to find some reason to oppose, constrain or condition a foreign investment. However, Canada does not have a history (in recent decades) of discouraging foreign investment — quite the contrary, such investment is encouraged. So a path through the maze should usually be available.
7. To Conclude
The 2009 amendments are important to foreign investors considering acquisitions or other investments in Canada. Although some of the changes will make reduce the burden of government screening, other changes will impose new burdens. Foreign investors should be prepared.