When engaging in cross-border M&A, foreign investment regulation is a significant issue that must be considered during the early stages of the transaction. In Canada, foreign investment is primarily regulated by the federal government through the Investment Canada Act (ICA) and its regulations (although some sectors like banking have separate rules and other statutes regulating foreign investment may also apply). The ICA and its regulations were amended in March 2015 and may be further modified for nationals of 11 “transpacific” countries, including the United States, if such countries’ governments ratify a new free trade agreement: the Trans-Pacific Partnership (the TPP). This article provides an overview of the ICA and its regulations with a focus on acquisitions of Canadian businesses or establishments of new Canadian businesses by U.S. companies that are ultimately controlled by U.S. nationals. More particularly, this article addresses the March 2015 amendments and potential changes that may result from the TPP, and provides some practical examples of the application and enforcement of the ICA. While this article focuses on investments by U.S. companies, the same regime applies to the vast majority of other countries. It should be noted that this article discusses the ICA and its regulations generally and does not discuss a number of exceptions and nuances affecting its application, including the regime applicable to investments by foreign state owned enterprises.
Review or Notification?
Under the ICA, the acquisition of control of a Canadian business by a non‐Canadian will trigger, depending on factors including the structure of the transaction and the size of the Canadian business, either a (usually pre-closing) review or a (usually post-closing) notification process. When the acquisition of control involves the acquisition of a cultural business (discussed below), lower thresholds for review apply and, in fact, a transaction may be reviewed even if it triggers only a notification obligation. Also, it should be noted that the ICA’s national security provisions (discussed below) may apply to an investment in a Canadian business by a non-Canadian even if there is no acquisition of control. (Control, for the purposes of the ICA, is defined broadly and includes the acquisition of all or substantially all of the assets of a Canadian business, or a majority of the voting shares of a Canadian corporation or of its ultimate parent. The ICA includes provisions whereby an acquisition of less than the majority but more than one third of the voting shares of a corporation is presumed to be an acquisition of control, which presumption can be rebutted in certain circumstances.) Subject to limited exceptions, the establishment of a new Canadian business (by forming a Canadian company or establishing a Canadian branch) will trigger the notification process only.
What is Involved in the Review Process?
Most of the framework for the review process has not been modified by the March 2015 amendments and will not be modified by the TPP if it is ratified by the relevant governments. The review process begins with the investor filing an application that includes prescribed information about the investment and the foreign investor’s plans for the Canadian business with the Minister of Innovation, Science and Economic Development (until recently, referred to as the Minister of Industry), who is the minister responsible for the administration of the ICA. Subject to limited exceptions, an application for review must be filed prior to closing and the transaction cannot be completed until the minister rules that the transaction is likely to be of net benefit to Canada. The ICA sets out a number of factors for the minister to consider in making this determination, including: (i) its effect on the level of economic activity in Canada, on employment, on resource processing, on the utilization of parts and services produced in Canada and on exports from Canada; (ii) the degree and significance of participation by Canadians in the Canadian business or new Canadian business; (iii) its effect on productivity, industrial efficiency, technological development, product innovation and product variety in Canada; (iv) its effect on competition within any industry in Canada; (v) its compatibility with national industrial, economic and cultural policies; and (vi) its contribution to Canada’s ability to compete in world markets. The minister has an initial period of 45 days to complete the review but may (and frequently does) unilaterally extend the period by an additional 30 days by sending a notice to the investor within the initial 45-days period. If necessary, the investor and the minister can jointly agree to additional extensions of the review period. In our experience, it can often take 60 days or more from the date on which the application is filed before a net benefit ruling is issued by the minister.
As a condition of issuing a net benefit ruling, the minister customarily relies on undertakings from the investor (in relation to, for example, maintaining a head office in Canada, Canadian participation in management or on the board of the Canadian business, Canadian employees and Canadian investment). The negotiated undertakings will typically be for a period of three to five years after closing and will be subject to monitoring, including one or more progress reports from the investor and evaluations by the minister starting approximately 18 months after the closing of the transaction. While the ICA provides for potentially serious penalties for noncompliance, ICA guidelines provide that where an “inability to fulfill a commitment is clearly the result of factors beyond the control of the investor, the investor will not be held accountable.” In practice, deficiencies in implementation of undertakings are normally resolved on a negotiated basis. We are aware of only one case where the Canadian government sued an investor for failing to respect its undertakings, which occurred in 2009, when United States Steel Corporation and U.S. Steel Canada Inc. (U.S. Steel) failed to comply with certain undertakings they gave in connection with the acquisition of Stelco Inc. In that case, the government first learned about U.S. Steel’s refusal to comply with certain undertakings through a press release issued by the company. Years later, following an unsuccessful challenge of the constitutionality of the enforcement sections of the ICA by U.S. Steel, the case was eventually settled with U.S. Steel agreeing to new undertakings. If circumstances change and an investor believes that it can no longer comply with its undertakings, it may engage with the minister to explore potential solutions. Depending on the nature of the undertakings in question, the reasons for the investor’s inability to comply and the minister’s assessment of the situation, the minister may seek modified undertakings from the investor.
Since the enactment of the ICA in 1985, the Canadian government has to date only rejected a handful of transactions on the basis that they were not of a net benefit to Canada. The rejected transactions each involved unique circumstances and areas of concern, for example national security or control over natural resources.
What Triggers the Review Process?
Generally, the review process is triggered if the value of the Canadian business exceeds an applicable threshold, which can vary depending on (i) the nationality of the persons ultimately controlling the investor (with more favorable treatment given to nationals of WTO-member states, such as the United States) and whether such persons are owned, controlled, or influenced by a foreign state or an agency thereof; (ii) whether the acquisition is “direct” (directly acquiring the assets or shares of a business in Canada) or “indirect” (indirectly acquiring a business in Canada by acquiring the shares of its parent outside Canada); and (iii) whether the Canadian business is engaged in a “cultural business”, which is defined to include activities such as (a) the publication, distribution or sale of books, magazines, periodicals, newspapers or music in print or machine readable form, (b) the production, distribution, sale or exhibition of film or video products, or audio or video music recordings, and (c) radio, television or cable television, and satellite broadcasting. As there is no de minimis exemption for acquisitions of cultural businesses, the ICA’s provisions relating to cultural businesses may apply even if a small portion of the revenues of a Canadian business to be acquired is generated from a “cultural” activity (as may be the case, for example, for a department store, grocery store or hotel that earns a small percentage of its revenues from the sale of books, newspapers, magazines, or audio and video products).
The March 2015 amendments have, among other things, changed the threshold for review where there is a direct acquisition of a Canadian business by a non-Canadian, which would include a U.S. company ultimately controlled by U.S. nationals. Prior to those amendments, the threshold used for this type of direct transaction for WTO investors was based on the book value of the assets of the Canadian business (for 2015, this threshold was set at C$369 million, or approximately U.S.$250 million, based on exchange rates in January 2016. All currency conversions in this article are made as at January 2016 and will obviously change over time). With limited exceptions, the threshold for WTO investors is now based on the “enterprise value” of the Canadian business and is set for 2016 at C$600 million (approximately U.S.$400 million), will be increased to C$800 million in 2017 (approximately U.S.$550 million) and C$1 billion in 2019 (approximately U.S.$650 million) and then indexed based on growth in nominal GDP in accordance with the formula set out in the ICA starting January 1, 2021. The elements included in the calculation of enterprise value vary with the structure of the acquisition.
The March 2015 amendments have not affected the general rule regarding the indirect acquisitions of a Canadian business by nationals of WTO-member states, including the United States, which, with limited exceptions, continue to be exempt from review. An important exception to these rules on direct and indirect acquisitions is where the Canadian business is engaged, even if only partially, in the activities of a “cultural business.” The rules regarding a “cultural business” also remain unaffected by the March 2015 amendments: a direct acquisition is subject to review where the book value of the Canadian business’ assets exceeds C$5 million (approximately U.S.$3.5 million), and an indirect acquisition is subject to review where the book value of such assets exceeds C$50 million (approximately U.S.$35 million), although in the case of the latter the review may be done on post-transaction and therefore is not an impediment to closing. Even if the threshold applicable to cultural business is not met, the Canadian government has the ability to elect to review the acquisition of control of a cultural business that would otherwise only be subject to notification.
Though the ratification of the TPP may take some time and is not guaranteed, the TPP provides, among other things, that the threshold for review for direct acquisitions of control by nationals of the participating countries will be increased to C$1.5 billion (approximately US$1 billion), and that an indirect acquisition of control by nationals of the participating countries will not be reviewable. The TPP does, however, provide that the current thresholds relating to “cultural businesses” as well as those relating to acquisitions of control by a “state owned enterprise” will still apply to nationals of the participating countries. This means that subject to exceptions, if the TPP is ratified by the relevant countries, the direct acquisition of control of a Canadian business by nationals of a U.S. company ultimately controlled by U.S. individuals will, in the future, be subject to a higher review threshold, meaning that more such acquisitions will avoid ICA reviews in favor of the less onerous ICA notification process.
If an acquisition of control of a Canadian business is not subject to review, it nevertheless triggers the filing of a notification. As mentioned earlier, the establishment of a new Canadian business is also subject to the notification requirement. The notification process essentially involves the filing of a short form by the investor at any time up to 30 days after closing, including, at the investor’s option, prior to closing.
The framework for the notification process remains the same as prior to the March 2015 amendments and will not be modified by the TPP if it is ratified by the relevant governments. The March 2015 amendments have, however, increased the information that must be included in the notification form. The additional information that must be disclosed includes:
- the names of the members of the investor’s board of directors, its five highest-paid officers and any person or entity that owns 10 percent or more of the investor’s equity or voting interests;
- for the investor and each person named above, their business and home mailing address, telephone number, fax number, e-mail address, and, if applicable, whether they are a WTO investor or a NAFTA investor, date of birth, and whether they own any interest in the acquired Canadian business;
- in the case of an acquisition, a copy of the purchase and sale agreement or, if not available, a description of the principal terms and conditions, including the estimated total purchase price for the Canadian business and, if applicable, the estimated purchase price for all entities acquired; and
- the sources of funding for the investment.
The information submitted is confidential and privileged under the ICA, subject to limited disclosure for statistical purposes.
Don’t Forget the Possibility of a National Security Review
The national security review process allows the Canadian government to review investments where it has “reasonable grounds to believe” that the investment “could be injurious to national security.” This concept is not defined in the ICA or its regulations and provides the Canadian government with the ability to intervene if it is concerned about a potential transaction. This process is, to a certain extent, the Canadian equivalent to the CFIUS regulations. Any investment in Canada by a non-Canadian investor can trigger this process regardless of (i) whether it is reviewable or notifiable according to the rules above; (ii) whether by a U.S. investor or other; (iii) whether it is for the establishment of a new Canadian business, the acquisition of control of a Canadian business or the acquisition of a minority interest in a Canadian business; and (iv) the dollar value of the transaction. This means that a minority investment in a Canadian business, regardless of its size, could trigger a national security review.
Unlike the review and the notification rules above, there is no formal filing requirement for investors. There is also no formal preclearance mechanism, which is a significant distinction between the ICA’s national security regime and the CFIUS regime in the U.S. If a foreign investor wishes to have comfort that an investment will not raise national security concerns under the ICA, it can however file an ICA notification prior to closing. Once a notification is filed, the ICA allows the Canadian government 45 days to raise any national security concerns. Our experience since the national security review rules were implemented in 2009 is that very few transactions attract the scrutiny of the Canadian government on national security grounds.
The March 2015 amendments have only changed the timeline for such review. Prior to the March 2015 amendments, if the maximum period under the regulations were applied, a national security review could take 130 days or longer, and now it can take 200 days or longer.
When engaging in M&A in Canada, dealmakers need to be mindful of the ICA. Particularly for large, direct acquisitions of Canadian businesses that will trigger the review process, and for transactions involving a “cultural business” or matters related to national security, investors should consult Canadian counsel early on as these issues may affect the critical path of the transaction.
The good news is that, as a result of the March 2015 amendments, fewer transactions will be subject to review. Even fewer transactions will trigger the review process if the TPP is ratified by relevant countries. On the other hand, these amendments have made the ICA notification process more burdensome as a result of the more detailed information now required by the Canadian government, which will apply to even the smallest transactions involving the acquisition or the establishment of a Canadian business.
Understanding the ICA’s regulation of foreign investment is important as sanctions can include fines and even a reversal of the transaction (although we are not aware of this remedy ever having been used by the Canadian government). It is also important to consult with a Canadian legal advisor as many other federal and provincial laws can affect the implementation of an M&A transaction.