On March 25, 2015, the federal government announced the implementation of three important changes to the Investment Canada Act, each of which is summarized below.
By way of general background, the acquisition of control of a Canadian business by a non‐Canadian, or the establishment of a new Canadian business by a non‐Canadian, is subject to notification or review under the Investment Canada Act. Notification is not an impediment to closing, and is typically done within 30 days after closing.
At present, the notification form requires very basic information about the foreign investor and the acquired Canadian business, and can often be prepared in as little as an hour. Where review is required, detailed information about the foreign investor and the Canadian business and the investor’s plans for the Canadian business must be submitted before closing, and closing can only occur if the government determines the transaction to be of “net benefit” to Canada.
Different thresholds apply to the determination of whether a transaction is reviewable or merely notifiable, including whether the foreign investor is controlled by residents of a World Trade Organization member state, whether the target Canadian business is being acquired directly or indirectly (as a result of the acquisition of a foreign parent) and/or whether the target Canadian business is a defined “cultural business.” The government also has a number of discretionary powers to review transactions that would otherwise not be reviewable, including on national security grounds.
At present, the vast majority of transactions are merely notifiable. Typically, there are less than 20 reviewable transactions per year (and last year there were only 12), whereas there are several hundred notifiable transactions each year.
While the increased review threshold, which takes effect April 24, 2015, will reduce the number of transactions that are subject to review, the much more important practical implication of the recently announced changes is that for the vast majority of transactions, where only notification is required, the notification form will require substantially more information, including a substantial amount of information that most businesses consider to be highly sensitive, and, in many cases, will take substantially more time to prepare.
- The nature of the review threshold that applies to most transactions/investors will be changed and the amount of the threshold will be substantially increased. At present, the review threshold applicable to the direct acquisition of control of a Canadian business (other than a defined cultural business) by a foreign investor that is ultimately controlled by residents of a WTO member state is C$369 million, and is based on the book value of the assets of the acquired Canadian business. Effective April 24, 2015, the review threshold for this type of transaction will be C$600 million, based on the enterprise value of the acquired Canadian business. For more detail, please click here.
- For the vast majority of transactions that are merely notifiable, the new notification form will require substantially more information and, in many cases, will take substantially more time to prepare. The goal of many of the new information requirements appears to be to enable the Canadian government to better determine whether the transaction raises potential national security concerns and/or the extent to which the investor is owned, controlled or influenced by an SOE. Much of the newly required information is also of a nature that most businesses consider to be highly sensitive. In this regard, it is worth noting that, like the Competition Act, the Investment Canada Act contains a robust confidentiality provision that protects the investor’s information. The new notification form must be used for notifications submitted on or after April 24, 2015. A summary of the additional information required by the new notification form is available here.
- The timeframe for national security reviews is extended by 70 days. For more detail, please click here.
- The new enterprise value threshold will not apply to WTO investors who are state‐owned enterprises. SOEs who are WTO investors will continue to be subject to the C$369 million book value threshold when they directly acquire control of a non‐cultural Canadian business, and the C$369 million book value threshold will continue to be an adjusted annually in relation to the change in Canada’s GDP.
In some cases, it may be difficult to determine whether a foreign investor is an SOE and, by extension, which threshold applies. This is because the ICA’s definition of SOE includes an entity that is “controlled or influenced, directly or indirectly,” by the government of a foreign state, whether federal, state or local, or an agency of such a government. By way of example, several commentators have suggested that Canada’s major pension funds and banks could qualify as SOEs under this definition. As a practical matter, in most cases it will be clear whether a foreign investor is an SOE and/or whether the transaction is reviewable will not turn on that determination in any event. In addition, while the Canadian government has not provided bright line guidance as to what constitutes an SOE, we do have a pretty good sense as to where the lines are (see the examples below and sections 12‐18 of the new notification form which is available here).
- The new enterprise value threshold will remain at C$600 million for two years. In 2017 it will be increased to C$800 million for two years. In 2019 it will be increased to C$1 billion. Thereafter, it will be adjusted annually in relation to the change in Canada’s GDP.
- The formula for determining the enterprise value varies depending upon whether the foreign investor is acquiring shares of a publicly traded company, 100% of the shares of a private company, less than 100% but more than a controlling percentage of the shares of a private company, or assets. By way of high level summary:
EV of Publicly Traded Company = market capitalization + liabilities other than operating liabilities – cash and cash equivalents. Market capitalization is based on the average closing price of the target’s quoted equity securities in its principal market during the 20 trading days ending before the first day of the month immediately preceding the month in which in which the foreign investor submits its Application for Review or notification form.
EV of Private Company = acquisition value + liabilities other than operating liabilities – cash and cash equivalents.
EV of Assets = acquisition value + liabilities assumed by the investor other than operating liabilities – cash and cash equivalents.
In situations where not all of a public company’s equity securities are quoted, the acquisition value cannot be precisely determined until a future date (e.g. there is an earn out or some other form of post‐ closing adjustment), the foreign investor is acquiring less than 100% of the shares of a private company, or the parties are non‐arms length or the consideration is nominal or zero, the board of directors or other authorised body of the foreign investor are required to determine the fair market value of the applicable item for inclusion into the balance of the applicable enterprise value formula.
- While the change to the new threshold will result in fewer transactions being reviewable, it is worth noting that some transactions that would not have been reviewable under the existing C$369 million book value threshold will be reviewable under the new enterprise value threshold, particularly when the enterprise value threshold is at C$600 million. In rare instances, this could result in a scenario where the acquisition by an SOE buyer is below the review threshold but the acquisition of the same target by a private sector buyer would be above the threshold (the Canadian government would still be able to rely on its discretionary national security review powers to order a review of the SOE transaction).
- The existing thresholds that apply to other permutations of transaction remain unchanged (e.g. the indirect acquisition of control of a non‐cultural Canadian business by a WTO investor, the direct or indirect acquisition of control of a Canadian cultural business by any foreign investor, the direct acquisition of control of a Canadian business by a non‐WTO investor, the indirect acquisition of control of a Canadian business by a non‐WTO investor).
- The name, address and date of birth of:
- each member of the foreign investor’s board of directors, or similar governing body;
- the five highest-paid officers of the investor; and
- each individual who owns more than 10% of the equity or voting interests of the investor.
- The name and address of each entity that owns more than 10% of the equity or voting interests of the investor.
- A description of the business activities carried on by the investor and the ultimate controller of the investor.
- Whether the investor, a subsidiary of the investor, any member of the investor’s board of directors or similar governing body, any of the investor’s five highest‐paid officers or any person or entity that owns 10% or more of the investor’s equity or voting interest own any equity or voting interest in the Canadian business.
- Seven separate questions relating to the extent to which the investor is owned, controlled or influenced by an SOE, several of which have one or more sub‐questions. These questions essentially embed in the notification form information that the government has informally required in the context of reviewable transactions for several years.
Even for entities that could not, on any reasonable basis, be considered SOEs, it can be difficult to answer “no” to some of the questions without qualification. For example, two of the questions are: does a foreign state have any direct or indirect ownership interest in the investor, and does a foreign state own a minority of the investor’s voting interests. Private equity funds often have limited partners who are SOEs, and public companies are typically unable to prepare a definitive list of their ultimate beneficial shareholders. Set out below are two examples of how we have approached these questions in the past in the context of a reviewable transaction, and this approach has been acceptable to the Investment Review Division:
(i) Where the investor is owned by a private equity fund: No state owns a direct interest in the investor. As noted in the application for review, the investor is ultimately indirectly owned by a private equity fund [Fund]. Some of the investors in [Fund] ….. either do or could arguably fall within the “controlled or influenced, directly or indirectly, by” portion of paragraph (b) of the Investment Canada Act’s definition of “state‐owned enterprise.” In total, only approximately X% of the investors in the fund could be considered state‐owned enterprises that are not U.S. public sector pension plans or other similar entities. The largest such investor holds less than X% of the limited partnership interests in the fund, and collectively, all such investors hold less than X% of the voting interests in the fund (it is important to note that these investors are not related to each other and are not members of a voting group). Based on the low percentage interest held by each such investor in the fund, and also on the fund’s limited partnership structure, a core legal principle of which significantly restricts the extent to which limited partners (investors in the fund) are permitted to become involved in the management of the fund or its portfolio companies in order to, among other reasons, protect their limited liability status as limited partners, we can state without equivocation that no state controls or influences the investor, and we have provided an unqualified “no” in response to all other questions in this questionnaire.
(ii) Where the investor is owned by a widely held public company: No. Please note that x’s shares are publicly traded on the [stock exchange] under the symbol x and are widely held. It is not possible for X, or any other widely held public company, to prepare a definitive list of its beneficial shareholders. It is possible that a state has purchased a small number of shares on the open market, although x has no knowledge to suggest that this has happened. In addition, it is worth noting that under U.S. securities laws, if any person acquires more than 5% of the voting shares of a publicly traded company, that person is required to file a notice disclosing that they have done so. X confirms that no notice has been filed in respect of the acquisition of more than 5% of its shares by any state.
- Name of the vendor’s ultimate controller.
- A copy of the purchase agreement.
- Sources of funding for the investment, including a list of all individuals and entities that have or will provide any financial contribution to the investment and the amount of the contribution.
- Questions relating to determining the enterprise value of the Canadian business (see item above), including confirmation as to whether any component of the enterprise value calculation required a fair market value determination.
- A description of the products that are or will be manufactured, sold or exported and the services that are or will be provided by the Canadian business and the 4‐digit code(s) assigned to these products and services by the North American Industry Classification System (NAICS 2012) – Canada.
- All of the above information also needs to be provided in the revised Application for Review Form if the transaction is reviewable. However, the change to the Review Form is comparatively less significant, because a significant amount of information is already required by the Review Form and, as a practical matter, the government has informally required substantial information about potential SOE ownership, control or influence for several years as part of its review of reviewable transactions.
The government has broad discretionary powers to review and prohibit, condition or require the unwinding of, any foreign investment that could be injurious to Canada’s national security, including non‐control level investments, and investments in businesses that have tenuous links to Canada. Prior to the changes announced by the government, a national security review could take up to 130 days.
As a result of the changes, which took effect immediately, a national security review can take up to 200 days, or possibly longer with the consent of the investor (as a practical matter, an investor would have little choice but to consent to a requested extension because the likely outcome of refusing to consent would be a prohibition of the investment). The government has deliberately refrained from providing guidance on what investor or target characteristics could give rise to a potential national security concern, preferring to afford itself the flexibility of a ‘we’ll know it when we see it’ approach. In addition, full or even substantial information on the government’s use of the national security review powers, including the number of national security reviews that have occurred, is not available due to the high degree of confidentiality surrounding them.
However, based on our own experience, anecdotes from other members of the Bar (to the extent that they were permitted to share them), and a limited number of newspaper articles on the subject, national security reviews are relatively rare but when they do occur they are extremely frustrating for the transacting parties. They tend to take a long time, be conducted in a “black box”-like manner, with the investor responding to questions and information requests with little to no explanation as to why the information is being requested and ultimately conclude with a disposition that is accompanied by little to no explanation.