Foreign Investment Review in Canada: The New Rules

Transcription

1 2010 LEXPERT / AMERICAN LAWYER Foreign Investment Review in Canada: The New Rules By Chris Margison and John Bodrug Davies Ward Phillips & Vineberg LLP Foreign investment in Canada is subject to the Investment Canada Act (the ICA ). 1 Pursuant to the ICA, an acquisition by a non-canadian of control of a business carried on in Canada is either notifiable or reviewable under the ICA. Whether such an acquisition is notifiable or reviewable will depend on the value of the assets of the Canadian business being acquired. Notification, when required, may be made within 30 days after closing and involves the filing of information concerning the investor and the acquired business. Notification does not represent an impediment to an acquisition. However, if an acquisition is subject to review under the ICA, the acquiror potentially may be required to divest, or be prohibited from acquiring, the Canadian business if the Minister of Industry (the Minister ) is not satisfied that the acquisition is likely to be of net benefit to Canada. 2 This article discusses a number of recent developments relating to foreign investment in Canada: Recent amendments to the ICA, which, among other things, increased the review thresholds applicable to direct acquisitions of Canadian businesses and introduced a new national security review process. 3 The Attorney General s decision to commence proceedings against United States Steel Corporation ( US Steel ) in respect of its alleged failure to comply with certain undertakings provided to the Canadian government in connection with its acquisition of Stelco Inc. ( Stelco ). The Canadian government s decision to prohibit George Forrest International Afrique S.P.R.L. ( GFI ) from acquiring Forsys Metals Corp. ( Forsys ), presumably on the basis of national security concerns. General Net Benefit Review Thresholds (a) Existing Thresholds At the date of writing, a direct acquisition of control of a Canadian business with assets having a book value in excess of C$312 million is subject to a net benefit review under the ICA. 4 For share acquisitions, control for the purposes of the ICA can be acquired at voting share levels of as low as one-third. (b) New Thresholds Amendments to the ICA passed in March 2009 and expected to come into effect later in 2009 will significantly change the review threshold. A direct acquisition of a Canadian business will be reviewable only if it has an enterprise value of at least C$600 million. This threshold will rise to C$1 billion over the next six years and will thereafter be adjusted on an annual basis. In addition, the C$5 million threshold previously applicable to the transportation, financial services and uranium sectors has been repealed so that the general threshold now applies to direct acquisitions of Canadian businesses in these sectors. These changes will likely reduce the scope of transactions subject to review under the ICA. 72

2 GUIDE TO THE LEADING 500 LAWYERS IN CANADA (c) Enterprise Value In July 2009, the Canadian government published proposed regulations that define the concept of enterprise value. 5 Pursuant to these regulations, the enterprise value of a Canadian business will be determined differently depending on whether the Canadian business is publicly traded. Specifically: In the case of an acquisition of control of a Canadian business which is publicly traded, the enterprise value will be the market capitalization of the entity plus its liabilities minus its cash and cash equivalents. In the case of an acquisition of control of a Canadian business which is not publicly traded or where the transaction involves an acquisition of all or substantially all of the assets of a Canadian business, the enterprise value will be the book value of the assets of the Canadian business as at the end of its last fiscal year, as reflected in its most recent annual financial statements. Determining the enterprise value of a Canadian business that is not publicly traded is straightforward and is unchanged from the methodology for determining book value under the current regulations. However, the proposed methodology for determining the enterprise value of a publicly-traded company raises a number of significant issues that could result in some surprising and arbitrary enterprise value calculations. For example, the proposed regulations equate the value of a class of unlisted equity securities to the value of the primary class of listed securities, even though there may be significant differences in market value between such securities. 6 The Review Criterion Net Benefit to Canada If a proposed acquisition is subject to general review, the Minister must be satisfied that the acquisition is likely to be of net benefit to Canada. The ICA requires the Minister to take into account certain factors in the net benefit analysis, including the effect of the acquisition on the level and nature of economic activity in Canada, the degree and significance of participation by Canadians in the Canadian business, the effect of the acquisition on competition within an industry in Canada, the compatibility of the acquisition with national industrial, economic and cultural policies, and the contribution of the acquisition to Canada s ability to compete in world markets. 7 The Minister normally requires an investor to provide written undertakings as a condition to obtaining approval. Such undertakings, which typically have a term of three to five years, often involve commitments to maintain or grow levels of employment, capital investment, and research and development in Canada, as well as commitments to certain levels of Canadian participation in the management of the acquired business. The actual undertakings are rarely disclosed to the public, but foreign investors sometimes issue press releases describing the undertakings in general terms. In the case of acquisitions of Canadian businesses by foreign state-owned enterprises, the Minister also considers the enterprise s corporate governance and commercial orientation as part of the ICA review process, and may seek additional undertakings directed at these issues. 8 (a) Failure to Comply with Undertakings In the past, when foreign investors failed to meet certain targets or thresholds contemplated in undertakings given to secure ICA approval (e.g., because of unanticipated adverse economic conditions), the foreign investor and the Investment Review Division of Industry Canada ( IRD ) typically addressed the situation in a pragmatic, ad hoc fashion, sometimes with the foreign investor providing replacement undertakings. In fact, the ICA was recently amended to expressly allow the Minster to accept new undertakings if he believes that a foreign investor has failed to comply with its existing undertakings. 9 The ICA also provides that, where an investor fails to comply with an undertaking, the Minister may send a demand to the investor requiring the investor to justify any non-compliance. 10 If an investor fails to comply with the demand, the Attorney General may apply to a superior court, on behalf of the Minister, for an order directing the investor to, among other things, comply with the undertaking or divest control of the Canadian business to which the undertaking relates. 11 The court can also impose a penalty not exceeding C$10,000 for each day that the investor has failed to comply with the undertaking. 12 Until recently, no proceedings had been brought against an investor for failing to comply with an undertaking. However, this changed in July 2009 when the Attorney General filed a Notice of Application with the Federal Court of Canada alleging that US Steel had failed to comply with certain undertakings provided to the Canadian government in connection with its 2007 acquisition of Stelco. 13 Only time will tell if these proceedings represent a more aggressive approach to general enforcement of the ICA by the Canadian government. (b) US Steel Transaction In August 2007, US Steel announced that it had agreed to acquire Stelco, a large Canadian steel manufacturer. The transaction exceeded the ICA review thresholds and, according to the Minister s subsequent court filings, the Minister approved the transaction in October 2007 based on undertakings provided by US Steel, including the following undertakings, which were to 73

3 2010 LEXPERT / AMERICAN LAWYER remain in effect for three years following the completion of the transaction (the Term ): Production Undertaking: US Steel would increase the annual level of steel production of Stelco by at least 10 per cent over the Term relative to the average of the three completed calendar years before the transaction. Stelco s average level of steel production during the previous three years was million tons, meaning that this undertaking contemplated an increase in annual steel production to the equivalent of at least million tons per year. Employment Undertaking: US Steel would maintain an average employment level at Stelco of not less than 3,105 employees on a full-time equivalent basis. US Steel completed its acquisition of Stelco shortly thereafter. i. Post-Transaction Developments In February 2009, IRD requested that US Steel provide it with a progress report in respect of the undertakings. IRD requested further information from US Steel in April 2009 following media reports that US Steel was moving raw materials from Stelco to its mills in the United States. According to the Minister s court filings, US Steel advised IRD that Stelco s total steel production in 2008 was approximately 3.9 million tons. US Steel explained that it had been on pace to increase production significantly above million tons, but declines in global demand for steel led to reduced production in the fourth quarter of US Steel also advised IRD that Stelco had produced a small amount of steel to that point in On an annualized basis, that amount apparently represented less than half the amount contemplated by the Production Undertaking. In addition, US Steel advised IRD that, between November 2008 and February 2009, Stelco had laid off approximately 600 workers and that a further 1,500 workers would be laid off. ii. ICA Demand In May 2009, the Minister issued a demand to US Steel pursuant to section 39 of the ICA (the Demand ). The Demand referenced the Production Undertaking and the Employment Undertaking and required US Steel to, among other things, forthwith remedy its default, show cause why there was no contravention or justify any non-compliance with the undertakings. The Demand indicated that an application might be made to a superior court pursuant to section 40 of the ICA in the event that US Steel failed to comply with it. In its response to the Demand, US Steel asserted that it was not in breach of either the Production Undertaking or the Employment Undertaking for the following reasons. First, both of these undertakings provide for a performance metric which contemplates performance over the Term of the undertakings, with the result that no breach could be found to exist at the time of the Demand. Second, guidelines issued by Industry Canada provide that an investor will not be held accountable where the inability to fulfill a commitment is clearly the result of factors beyond the investor s control. 14 US Steel subsequently advised IRD that it intended to restart operations at Stelco s Hamilton facilities and that it would shortly initiate the process of recalling more than 700 workers that had been laid off from these facilities. After reviewing US Steel s response, the Minister advised US Steel that it had failed to remedy its default, show cause why there was no contravention, or justify any non-compliance with the undertakings. The Attorney General subsequently applied to the Federal Court for an order directing US Steel to comply with the relevant undertakings and imposing a penalty of C$10,000 per day for breach of the relevant undertakings. Shortly after this application was filed, US Steel brought a motion challenging the constitutional validity of sections 39 and 40 of the ICA. As at the time of writing, the US Steel proceedings are ongoing. (c) Vale Undertakings In contrast to the US Steel proceedings, the Minister elected not to bring proceedings against Vale SA ( Vale ) for cutting jobs in Canada, even though Vale had reportedly undertaken not to lay off employees in Canada for three years following its acquisition of Inco Ltd. in The Minister s decision was based, at least in part, on the fact that Vale reduced employment and output in Canada in proportion to its reductions in other countries and did not target Canada. 16 This was apparently not the case for US Steel. New National Security Review While the higher net benefit review thresholds will likely reduce the scope of transactions that will require pre-closing ICA approval, a new review process for investments that could be injurious to national security adds significant uncertainty for foreign investment in Canada. This new process permits the Canadian government to take a broad range of measures to protect Canada s national security, including prohibiting a transaction or ordering the divestiture of assets. A very wide range of transactions can be reviewed for national security concerns, including transactions that are (a) below the threshold for net benefit review or (b) not otherwise subject to the ICA because they do not, for example, result in an acquisition of control of a Canadian business. The term national security has been deliberately left 74

4 GUIDE TO THE LEADING 500 LAWYERS IN CANADA undefined to allow the Canadian government wide discretion in the application of this review power. In addition, the applicable standard, could be injurious to national security, is ambiguous and potentially open to expansive interpretation. For acquisitions of control, the foreign investor can eliminate the risk of a postclosing national security review and challenge by filing a notice or application for review well before closing. However, a risk of a post-closing national security review will remain for investments constituting less than an acquisition of control. (a) Process If the Minister has reasonable grounds to believe that an investment could be injurious to national security, he may send a notice to the investor indicating that the investment may be subject to a national security review (Such a letter has the effect of prohibiting closing, if it has not already occurred, until either the Minister or the federal cabinet completes a review or decides not to pursue one.). The federal cabinet will subsequently determine, on the recommendation of the Minister, whether to order a national security review. If the cabinet orders a review, the Minister is required to send a notice to the investor that the investment will be reviewed, and the proposed transaction cannot be completed while the review is pending. If the transaction has already been completed, a review can still be ordered (and remedies, including divestiture of the Canadian business, can still be required) following implementation of the transaction. (b) Timing of Review On September 17, 2009, the Canadian government implemented regulations that specify the time periods for national security reviews. 17 Pursuant to the regulations, the time period within which the Minister must give the investor the first notification of a review, or possible review, runs from the time the Minister becomes aware of the investment up to 45 days after the relevant starting point: For investments subject to a general net benefit review, the 45- day period starts on the date of filing of the application for review. 18 For investments subject to notification, the 45-day period starts on the date of filing of the notification. 19 For all other investments, the 45-day period starts on the date of implementation of the investment. Where the Minister gives notice of a possible review, the cabinet, on the recommendation of the Minister, has a further 25 days to determine whether to order a review of the transaction. If the cabinet orders a review, the Minister will consult with other government officials and departments, such as the Canadian Security Intelligence Service, the Department of National Defence, the Department of Foreign Affairs and International Trade, and the Department of Public Safety and Emergency Preparedness. Following these consultations, if the Minister is satisfied that, or is unable to determine whether, the investment would be injurious to national security, the Minister must submit a report, with recommendations, to the cabinet. Alternatively, if the Minister is satisfied that the investment will not be injurious to national security, notice to that effect must be sent to the investor. Under the regulations, the deadline for the Minister to submit a report and recommendations to the cabinet, or give notice stating that no action will be taken, is 45 days from the date on which the cabinet orders a review of the investment. If the Minister submits a report and recommendations, the cabinet may then order any measure it considers advisable to protect national security. The regulations require that such an order be made within 15 days from the date on which the Minister reported on the investment to the cabinet. The Minister is then required to notify the investor of the cabinet order without delay. (c) Pre-Closing Clearance As noted above, the regulations provide that the Minister must give the first notification under the national security review provisions within 45 days after an application for review or notification is filed. This requirement effectively allows investors to obtain national security pre-closing clearance for any direct or indirect acquisition of control of a Canadian business by a foreign controlled entity. In the case of acquisitions of control subject only to the general notification provisions, the usual practice has been to file notifications after closing. However, in light of the above, investors may want to consider submitting their notifications more than 45 days before closing to provide pre-closing certainty that no national security review will be initiated, particularly if there is any risk that the transaction could raise national security issues. The regulations do not provide a mechanism for national security pre-closing clearance for transactions that do not constitute an acquisition of control and therefore are not subject to the general review or notification provisions of the ICA. (As noted above, minority investments to acquire less than a controlling interest can be subject to a national security review under the ICA.) In the case of these transactions, the Minister can order a national security review up until at least 45 days after closing. Depending on the nature of the transaction, the absence of a pre-closing clearance mechanism could create significant 75

5 2010 LEXPERT / AMERICAN LAWYER uncertainty for the parties, and is an issue that may need to be addressed in transaction documents. (d) Forsys Metals Corp. While the public disclosure is incomplete, it appears that an intervention by the Minister under the new national security review provisions played a role in the termination of a proposed acquisition of Forsys by GFI. Whatever the precise details, this development illustrates the potentially very broad scope of the ICA national security review process and the need to take its potential application into consideration for transactions with even relatively limited links to Canada. i. The Proposed Transaction Forsys is a publicly-traded mineral exploration company incorporated and listed in Canada. Its projects, including a uranium deposit which Forsys described as being close to production, are located in Namibia, Africa. Forsys does not appear to have any mineral properties or projects in Canada. GFI s proposed acquisition of Forsys was announced in November Forsys financial statements indicated that the book value of its assets was well below the C$312 million threshold for general net benefit reviews applicable to most acquisitions of Canadian businesses under the ICA. Forsys management information circular also stated that the proposed transaction was not subject to any approval requirement under the ICA and that only a post-closing notice would be filed. While the parties initial press release stated that the proposed transaction was expected to close in February 2009, closing was delayed several times to provide GFI with more time to obtain funding. In August 2009, some media coverage reported rumors that GFI might be obtaining funding from a variety of sources, including possibly the Government of Iran. 20 ii. ICA Notice On August 19, 2009, Forsys issued a cryptic press release indicating that it had been provided with a copy of an unsolicited letter GFI received last night from Industry Canada [stating] that GFI is prohibited from implementing the investment pending further notice from Industry Canada. 21 Six days later, Forsys announced the termination of the proposed transaction and stated that we remain unclear as to the specific concerns Industry Canada has about GFI s proposed investment. 22 If the proposed transaction was below the general ICA net benefit review threshold, as Forsys previously indicated, the only explanation is that the Minister invoked the ICA national security review process and issued a letter advising GFI that an order for a national security review of the proposed transaction may be made. As noted above, a transaction may be subject to a national security review even if it is not subject to a general net benefit review under the ICA. Neither the parties nor Industry Canada confirmed that the national security review process was invoked, or publicly commented on the basis for Industry Canada s concerns. It is possible that the Minister may have intervened to seek assurances that uranium from Forsys projects is not sold to persons or entities that might pose a threat to Canada s national security. In the event of a national security review, the ICA permits the Minister to require extensive information about the investor s shareholders, officers and directors, and sources of financing, as well as other persons who might be in a position to influence the investor. The proposed GFI/Forsys transaction was ultimately abandoned. Conclusion The developments discussed above have, or reinforce, a number of important implications for foreign investment review in Canada, including the following: The increased review thresholds will likely reduce the scope of transactions subject to review under the ICA. That being said, the proposed regulations could result in some surprising and arbitrary enterprise value calculations, and therefore some surprising review obligations. Investors should be confident that they will be able to satisfy any undertakings that they provide to the Minister in order to obtain approval for a proposed transaction, at least having regard to reasonably foreseeable market developments. While only time will tell, the Attorney General s decision to bring proceedings against US Steel may indicate a more aggressive approach to general enforcement of the ICA by the Canadian government. Undertakings provided by investors are typically made expressly subject to Industry Canada s Administrative Procedures Guidelines, which provide that an investor will not be held accountable where the inability to fulfill a commitment is clearly the result of factors beyond the control of the investor. The US Steel proceedings may clarify the scope for reliance on these guidelines. The Forsys case confirms that the term national security may be interpreted very broadly by the Canadian government. It is now important to consider potential direct and indirect national security implications for any acquisition of a significant interest in an entity with some presence in Canada, even if all of the entity s operating assets are located outside Canada. In the case of some transactions subject to the general notification provisions of the ICA, it may be advisable for investors to submit their notifications more than 45 days before 76

6 GUIDE TO THE LEADING 500 LAWYERS IN CANADA closing to eliminate the possibility of a post-closing national security review and challenge. For investments by non- Canadian controlled entities in Canadian businesses which do not constitute an acquisition of control, it may sometimes be advisable to proactively address possible issues to reduce the risk of a notice from the Minister late in the process that delays or blocks closing. In light of the above, any acquisition of control of, or a significant interest in, a Canadian business that may be subject to either a net benefit review or a national security review under the ICA requires a careful and well-planned strategy. As the ICA and its related regulations are very complex and can sometimes yield arbitrary or unexpected results, early consultation with experienced legal counsel can help to ensure that a particular acquisition structure does not unnecessarily trigger an ICA net benefit review. 1. R.S.C. 1985, c. 28 (1st Supp.). 2. In the case of an acquisition of a cultural business, the relevant minister is the Minister of Canadian Heritage. 3. Budget Implementation Act, 2009, S.C. 2009, c. 2, Part This assumes that the buyer or a non-canadian seller is controlled by citizens of a WTO-member country. Otherwise, the review threshold is much lower. 5. Proposed Regulations Amending the Investment Canada Regulations, C. Gaz I These proposed regulations could be amended before they are implemented. 6. For a discussion of the issues associated with the proposed regulations, see The Canadian Bar Association, Investment Canada Regulation Amendments and National Security Review of Investments Regulations (August 2009), available online at 7. Supra note 1 at s Industry Canada, Guidelines, Investment by State-Owned Enterprises Net Benefit Assessment, available online at 9. Supra note 1 at s Id. at s. 39(1)(e). 11. Id. at s Id. 13. The Attorney General of Canada v. United States Steel Corporation and U.S. Steel Canada Inc., T , Notice of Application (F.C.T.D.). The discussion of the U.S. Steel proceedings in this paper is based principally on the Notice of Application. 14. Industry Canada, Guidelines, Administrative Procedures, available online at See, for example, A. Hoffman and J. McNish, Clement s Takeover Hangover The Globe and Mail (22 July 2009) B See, for example, Reuters, Canada won t take action over Vale s Sudbury cuts (9 June 2009). 17. National Security Review of Investments Regulations, SOR/ Investments subject to a general net benefit normally cannot be completed until the Minister is satisfied that the investment is likely to be of net benefit to Canada. 19. All acquisitions of control of Canadian businesses that are not subject to a general net benefit review are subject to notification. A notification can be filed at any time before closing or up until 30 days after closing. 20. See, for example, Forsys cancels C$579 mln George Forrest takeover (25 August 2009), available online at Forsys Metals Corp., News Release, GFI Investment Update (19 August 2009), available online at Forsys Metals Corp., News Release, Forsys Terminates Arrangement Agreement with GFI (25 August 2009), available online at Chris Margison, Davies Ward Phillips & Vineberg LLP Tel: (416) Fax: (416) cmargison@dwpv.com Chris is a partner in the Competition and Foreign Investment Review practice. He has represented and advised clients on many aspects of competition law and foreign investment review, including mergers, price fixing, strategic alliances, distribution and pricing practices, and misleading advertising matters. Chris has expertise in a wide variety of industries, including the entertainment, telecommunications, information technology, agricultural, manufacturing, plastics and consumer products sectors. In the last few years, Chris has acted in connection with a number of significant mergers and acquisitions. John Bodrug, Davies Ward Phillips & Vineberg LLP Tel: (416) Fax: (416) jbodrug@dwpv.com John is a partner in the Competition and Foreign Investment Review practice. He has extensive experience in all aspects of competition law and foreign investment review, including mergers, price fixing investigations and other pricing, distribution and advertising matters. John has represented and advised Canadian, US-based and international corporations across a range of industries, including the energy and resources, transportation, agricultural, manufacturing, financial services, retailing and consumer products sectors, and has obtained Competition Act and Investment Canada Act clearances for numerous merger transactions. John is the past Chair of the National Competition Law Section of the Canadian Bar Association. 77