June 14, 2012
Guidance on the Government of Canada’s approach to its review of foreign investment in Canada has been anticipated since November 2010, when BHP Billiton withdrew its $40 billion hostile bid for Potash Corporation of Saskatchewan after the Minister of Industry made an initial determination that the proposal was not likely to be of net benefit to Canada, despite BHP Billiton offering unprecedented undertakings. At the time, the Minister promised to provide clearer guidance on what is required to demonstrate “net benefit” to Canada, but never did.
In May 2012, the Government announced a number of proposed changes to the Investment Canada Act (ICA) which will impact the scope of foreign investment subject to review under the legislation as well as the process for such review. The stated objectives of these changes include ensuring that only the most significant investments are subject to ICA review, strengthening the enforcement mechanisms in the legislation, and increasing transparency of the review process. However, it is not clear the proposed amendments will achieve any of their stated objectives. The amendments, at most, only modestly improve transparency in the Government’s administration of the ICA, potentially signal a somewhat more burdensome process for foreign investors seeking Ministerial approval for acquisitions of Canadian businesses and, in the short-term at least, potentially increase rather than decrease the scope of investments that require review under the ICA.
The following is a brief overview of the proposed changes to the ICA and review process:
Increase in the Thresholds for ICA Review
On May 25, 2012, the Minister of Industry announced that the threshold for ‘net benefit’ review under the ICA will soon be changed from $330 million in book value of assets of the Canadian business being acquired to $1 billion in enterprise value. Three years have passed since Parliament initially enacted the change from a book value-based review threshold to a higher enterprise value-based review threshold, but this change in the law has not yet been implemented because regulations setting out the rules for calculating “enterprise value” have not been finalized. Shortly after the Minister’s announcement, revised regulations were released for a 30-day public comment period. Once the regulations are finalized, the review threshold will:
- immediately increase from $330 million based on the book value of Canadian business’ assets to $600 million in enterprise value of the Canadian business for two years;
- increase to $800 million in enterprise value for a further two years; and finally,
- increase to a threshold of $1 billion.
As was the case with the 2009 draft regulations, the new proposed regulations define the enterprise value of a publicly listed entity based on its market capitalization over a specific period of time rather than based on purchase price (as had been recommended). Enterprise value for private companies and asset acquisitions will, however, be based on purchase price. Since the enterprise value of many businesses calculated as proposed will significantly exceed the book value of their assets, it remains to be seen whether the proposed change from a book value test to an enterprise value test will result in a decrease rather than an increase in the scope of investments subject to review, even if the numerical threshold is raised significantly.
Enhanced Enforcement Mechanism
The government has announced two changes geared to enhancing the enforcement mechanisms in the ICA:
- The Canadian government’s omnibus Bill C-38, which was introduced on April 26, 2012, includes a proposed amendment to authorize the Minister of Industry (or Minister of Canadian Heritage, in respect of cultural businesses) to accept a security payment from investors in respect of penalties that a court might one day order if the investor is subsequently held to be in breach of its undertakings to the government. While security for performance of undertakings may be appealing in principle, it is not well suited to the ICA enforcement process. In this regard, the ICA provides that a non-Canadian cannot be penalized for non-compliance with undertakings until a court has issued an order after a full hearing on the merits. It is uncertain how taking security that could only be realized upon after a full court hearing would serve to strengthen enforcement, as there is limited risk a non-Canadian would refuse to pay court ordered penalties at that point. In our view, further consideration of, or at least better guidance on, the particular circumstances in which security will be taken is needed. Most importantly, foreign investors should not be routinely or unnecessarily pressed to tie up capital in the form of security simply to obtain approval of a pending transaction.
- On May 25, 2012, the Minister of Industry announced that a new guideline has been issued which contemplates formal mediation as an option for resolving disputes with non-Canadian investors when the Minister believes an investor has failed to comply with an undertaking given in the course of receiving ICA approval to acquire a Canadian business. With the introduction of the new guideline, the Minister has indicated that Industry Canada views formal mediation as an alternative to the current approach, which involves either the investor and the Minister reaching a consensual resolution or the Minister pursuing a remedy in the courts. In our view, while mediation may well be preferable to litigation, it is not likely to be an appropriate means to resolve the vast majority of issues, which are currently satisfactorily resolved by negotiation. In addition, it remains to be seen whether the introduction of the new guidelines signals an intention on the part of the Minister to press foreign investors to agree in their undertakings given to secure Ministerial approval to proceed to a mediated settlement in the event of any future dispute over performance of undertakings, effectively foreclosing in advance an opportunity for consensual resolution or a court hearing on the merits if a dispute does arises.
Bill C-38 includes a proposed amendment that would expand the Minister’s right to publicly disclose certain information at various stages in the ICA review process. This proposed amendment can be expected to have a relatively modest impact on transparency, and falls well short of general guidelines on the meaning of “net benefit to Canada” that were promised after the Minister of Industry rejected the proposed investment by BHP Billiton in Potash Corporation in November 2010.
Background and Analysis of Proposed Changes
Increase in the Threshold for ICA Review
The increase in the ICA review thresholds stems from a recommendation made in 2008 by the Competition Policy Review Panel chaired by L.R. Wilson. One of the Panel’s recommendations was to phase in an increase in the review threshold under the ICA to $1 billion to capture only the most significant transactions but to change the metric for calculating the threshold from book value to enterprise value to ensure that takeovers of significant Canadian technology companies (which are not typically asset intensive) are subject to review under the ICA. Enterprise value typically is higher than book value: for example, when a target company’s balance sheet does not reflect valuable assets, such as intellectual property.
In March 2009, the ICA was amended to provide for the recommended increase in the ICA review threshold, with the amendment to take effect following promulgation of new regulations on the calculation of enterprise value. The Panel had recommended enterprise value be calculated as the purchase price plus assumed liabilities minus current cash assets. However, draft regulations issued for public comment in 2009 proposed a formula for publicly traded companies based on market capitalization plus liabilities minus cash assets, while retaining the book value test for asset acquisitions and acquisitions of private companies. Concerns were expressed at the time that the proposed market capitalization formula would result in increased uncertainty in determining whether the threshold was exceeded. Concerns were also raised about whether the new threshold would capture more transactions than anticipated, even if enterprise value is calculated based on purchase price. Following the initial public comment period no further drafts of the proposed regulations were released and it seemed as though the government’s efforts to raise the ICA thresholds had been shelved.
(b) Potential Implications of New Review Threshold
The new draft regulations regarding the determination of enterprise value were published on June 2, 2012 for a 30-day public comment period. As was the case with the 2009 draft regulations, the new proposed regulations define enterprise value for listed companies based on a measure of market capitalization (plus liabilities minus cash) rather than purchase price. The proposed regulations define enterprise value for non-listed companies and asset acquisitions based on purchase price (plus liabilities minus cash). While the new regulations address some of the concerns raised in 2009 about uncertainty in calculating the market capitalization of listed companies, the calculation process is complex and potentially results in different outcomes for different bidders for the same target business, depending on the timing of their bids.
More generally, it remains to be seen what impact a higher threshold based on enterprise value will have on the scope of foreign investments that are subject to ICA review. On one hand, there will be some investments that would be reviewable under the current threshold that will no longer be subject to review under the new rules. On the other hand, there will also be some investments that would not be subject to review under the current book value based threshold that will be captured by the new enterprise value threshold, particularly during the initial two year period following implementation where the threshold will be only $600 million. While the Competition Policy Review Panel intended the change from book value to enterprise value to capture significant Canadian technology companies, it also contemplated that increasing the threshold would reduce the likelihood of capturing too many investments. It is too early to say what the result will be. However, it may be that enterprise value often exceeds book value of assets by such an extent that even with the increase in the threshold level, a greater number of foreign investments will be subject to review. If so, the proposed changes may have implications under Canada’s free trade agreements, which typically do not permit amendments to the ICA which make the legislation more restrictive (e.g., make investments reviewable which are currently exempt from review).
Security for Court-Ordered Penalties
Pursuant to the ICA, certain acquisitions of control of Canadian businesses by non-Canadians and certain other investments are subject to review and approval by the Minister under a “net benefit to Canada” test. In order to support a finding by the Minister that the proposed investment is of net benefit to Canada, investors typically provide undertakings to the government respecting aspects of the Canadian business being acquired. Where the Minister believes that a non-Canadian has failed to comply with one or more undertakings, he can initiate a formal process which eventually culminates in a court hearing on the merits. Only the court can order penalties for non-performance of undertakings.
The mechanisms provided for in the ICA for the enforcement of undertakings have been under increased scrutiny, due in part to the recently settled litigation between United States Steel Corporation and the government over the performance of undertakings. The stated purpose of the proposed amendment in Bill C-38 to enable the Minister to take security is “to promote compliance with undertakings.” It is not clear, however, how taking security for payment of penalties will achieve the desired effect, since penalties may only be imposed by a court under the ICA (and, therefore, security realized upon) after a full hearing on the merits. At that point, there should be very little concern that a foreign investor will fail to pay the financial penalties ordered. In this regard, failure to comply with a court order under the ICA carries serious consequences as a contempt of court. In addition, the foreign investor will invariably have assets in Canada (including the acquired Canadian business that was the subject of the undertakings in dispute) to backstop any penalties ordered.
The lack of clarity as to the rationale for introducing a right to take security for payment of court ordered penalties is exacerbated by the absence of any guidance on the nature and quantum of security that may be taken, the circumstances in which security may be taken, and, more significantly, if or when the Minister will proactively request payment of security as a condition for seeing ICA approval. The government has indicated that the amendments would simply authorize the Minister to "accept security, when offered by an investor." However, there is a concern that, as a practical matter, the Minister may require that investors "offer" security payments as a matter of course in their undertakings. Such a practice would considerably, and in our view, unnecessarily increase the burden on a foreign investor seeking to secure ICA approval.
There has been a long history of consensual resolution of issues arising in connection with the performance of undertakings, with the recent U. S. Steel matter being the one case in the history of the ICA having proceeded to litigation. In nearly all cases, disputes under the ICA are most productively resolved through consensual negotiations. Accordingly, while mediation may be a useful tool in certain cases, it is important that mediation not replace a potentially productive consensual process or a full hearing on the merits if that is what the investor or the Minister desires.
The new guideline requires both the Minister and the non-Canadian investor to agree to resolve an issue relating to compliance with written undertakings through mediation. This implies that the mediation should be mutually agreed upon without any compulsion on either side in relation to a particular issue. Accordingly, it would not be appropriate, in our view, for the Minister to insist as a condition of approval of a pending transaction that investors include as a matter of course in their undertakings an agreement to mediate in the event of any dispute over performance of undertakings.
While criticism has been levelled for some time at the lack of transparency and predictability in the ICA review process, the rejection of BHP Billiton’s proposed acquisition of Potash Corporation led to renewed calls for better insight into the Minister’s decision making process. While Bill C-38 stops well short of the general guidelines promised by the Minister of Industry in 2010, it is intended to address this criticism (among others) by expressly authorizing the Minister to make public disclosure:
- when the Minister sends a preliminary notice to an investor indicating that the Minister is not satisfied that the investment is likely to be of net benefit to Canada (and advising the investor of its right to make representations and submit undertakings); and
- in the case of a preliminary notice of the Minister’s reasons for the initial conclusion that the transaction is not likely to be of net benefit to Canada.
The ICA already permits the Minister to disclose final notices sent to an investor indicating whether the Minister is or is not satisfied that the investment is likely to be of net benefit to Canada, along with any reasons for the finding. Accordingly, the proposed amendments would only have the effect of enabling the Minister to make public disclosure about an interim decision. In no case, however, is the Minister required to disclose details of a financial, commercial, scientific or technical nature as the ICA permits the Minister to keep such information confidential if the Minister believes disclosure would prejudicially affect the non-Canadian. In practice, the Minister has typically been appropriately cautious about disclosing confidential information. Accordingly, guidance of a more general nature, rather than disclosure relating to particular transactions, would be most beneficial in increasing transparency and predictability in the ICA review process.