Canadian COMPETITION LAW

August 18, 2010

Recent Investment Canada Act Amendments

Significant changes were recent made to Canada’s foreign investment regime.  The recent changes coincide with sweeping amendments to the federal Competition Act, including significant changes to Canada’s merger control regime.

The recent amendments to the Investment Canada Act adopt a number of the recommendations of a Government appointed Competition Policy Review Panel in its report entitled Compete to Win: Final Report.  The Competition Policy Review Panel was established in 2007 with a mandate to review Canada’s competition and foreign investment policies and to make recommendations to the federal government to make Canada more globally competitive.  Overall, the Panel indicated that its recommendations were based on the view that Canada would benefit from increased global openness that that attracting greater foreign investment would be in Canada’s interest.

Some of the key changes to Canada’s foreign investment regime as a result of the Panel’s report, though not all of which are yet in force, include:

Calculation of Monetary Threshold.  Changing the method of calculating the general monetary threshold to determine whether a foreign investment is reviewable from “gross assets” (based on book value) of the Canadian business to be acquired to one based on the “enterprise value” of the Canadian business (not yet in force).

Increased Review Threshold.  Increasing the threshold for review for WTO members from the current Cdn. $299 million threshold (for 2010) to Cdn. $600 million based on enterprise value, which will progressively rise to Cdn. $1 billion over a four-year period (not yet in force).

Sector Specific Review Thresholds.  Eliminating certain lower review thresholds in specific industry sectors, namely financial services, uranium production and transportation services (not yet in force).

National Security Review Regime.  The introduction of a new national security review regime, under which the Minister and the federal Cabinet now have the power to review investments that may be “injurious to national security”.  Unlike a general review under the Investment Canada Act, there is deliberately no definition of what constitutes “national security” and any investment may be subject to a national security review, regardless of whether the general thresholds for review under the Investment Canada Act are met or whether control of a Canadian business is acquired.

For more information about the recent amendments to the Investment Canada Act and regulations, see: Regulations Amending the Investment Canada Regulations – Regulatory Impact Analysis Statement.

OVERVIEW OF THE INVESTMENT CANADA ACT

The Investment Canada Act is federal legislation that governs foreign investment in Canada and is primarily administered by the federal Minister of Industry and Investment Review Division (“IRD”) of Industry Canada.  The federal Minister of Canadian Heritage is responsible for investments relating to Canadian cultural businesses.

Mergers in Canada are also subject to mandatory pre-merger notification under the federal Competition Act where a transaction exceeds certain prescribed monetary thresholds (see: Canadian Merger Control and Canadian Merger Control FAQs).

The Investment Canada Act applies where a “non-Canadian” acquires “control” of a “Canadian business” (or establishes a new Canadian business), all as defined in the Investment Canada Act.  The application of the Investment Canada Act, and in particular what constitutes a “non-Canadian”, “control” and a “Canadian business” in specific circumstances, however, can be complex.

Where a foreign investment in a Canadian business is subject to review under the Investment Canada Act, an investor must show that the investment is likely to be of “net benefit to Canada” (discussed in more detail below).  Alternatively, where the applicable monetary thresholds under the Investment Canada Act are not met, investors are only required to file simple notifications with basic information within thirty days of the completion of a transaction.

“Non-Canadian”

“Non-Canadians” under the Investment Canada Act are defined as individuals, entities or governments (or agencies of governments) that are not “Canadian”.  A person will be considered to be a “Canadian” under the Investment Canada Act if they are a Canadian citizen or are a permanent resident of Canada who has been ordinarily resident in Canada for not more than one year after they first became eligible to apply for Canadian citizenship.

In the case of corporations, a corporation will be “Canadian” if the ultimate controlling shareholders of the corporation are “Canadian”.  In the case of widely held corporations, a corporation will be “Canadian” if at least two thirds of its board of directors are Canadians and the corporation is not controlled in fact through its shares (i.e., there is no de facto control).

Acquisition of “Control”

The second general test to determine whether the Investment Canada Act applies is whether there will be an acquisition of “control”.  Control for the purposes of the Investment Canada Act can be achieved as a result of: (i) the acquisition of voting interests (in the case of non-corporate entities), (ii) all (or substantially all) of the Canadian assets of a business or (iii) the acquisition of voting shares (for corporations).

The provisions regarding acquisition of “control” under the Investment Canada Act are complex.  The Investment Canada Act, however, sets out a number of presumptions regarding the acquisition of control as follows: (i), where a majority of voting shares is acquired, control is deemed to have been acquired, (ii) where 1/3 or more (but less than a majority) of the voting shares of a Canadian business has been acquired, control is presumed, unless it can be demonstrated that the shares that will be acquired will not confer control in fact (de facto control) and (iii) where less than 1/3 of the voting shares of the Canadian business will be acquired, control is deemed not to have been acquired.  In sum, control may be acquired under the Investment Canada Act with the acquisition of as little as 1/3 of the voting shares of a Canadian business.

Acquiring the shares of a non-Canadian corporation that has a Canadian division, but no Canadian subsidiaries, will not constitute control under the Investment Canada Act.

The Canadian Minister of Heritage may also determine that there has been an acquisition of control of a Canadian business, in relation to Canadian cultural businesses, even in circumstances where the general tests under the Investment Canada Act for determining control are not met.

“Canadian Business”

Under the Investment Canada Act, a “Canadian business” is defined as a business carried on in Canada that has: (i) a place of business in Canada, (ii) an individual (or individuals) employed or self-employed in connection with the business and (iii) assets in Canada used for carrying on the business.  In other words, to constitute a Canadian business, there must be at least one Canadian employee, a place of business in Canada and some Canadian assets.

A “business” under the Investment Canada Act is defined as an enterprise or undertaking that is capable of generating revenue and is carried on in anticipation of profit.  As such, in considering whether there is an investment in a “Canadian business”, it is important to determine whether the target is operational (e.g., mining properties that are not yet producing, and only at the exploration stage, are not “Canadian businesses”).

REVIEW UNDER THE INVESTMENT CANADA ACT

Investments are reviewable under the Investment Canada Act when they exceed the prescribed financial thresholds (discussed below).  Where the prescribed financial thresholds are not met, foreign investors are only required to file a simple notification with basic information within thirty days of the completion of the transaction.

Whether a particular investment will be subject to Investment Canada review depends on several factors.  These include: (i) whether the investment is direct or indirect, (ii) whether the Canadian business in which the investment is being made is a Canadian cultural business and (iii) whether the investor is a WTO or non-WTO investor.  As such, determining whether an investment is reviewable under the Investment Canada Act requires an analysis of the structure of a transaction and the nature of the acquirer and target.

Canadian Cultural Businesses

For investments in Canadian cultural businesses there are lower review thresholds.  A “cultural business” under the Investment Canada Act includes a Canadian business that: (i) publishes, distributes or sells books, magazines, periodicals or newspapers in print or machine readable form, (ii) produces, distributes, sells or exhibits film or video recordings, (iii) produces, distributes, sells or exhibits audio or video music recordings or (iv) publishes, distributes or sells music in print or machine readable form.

It is worth noting also that a Canadian business can still be a “cultural business” if the cultural activities engaged in comprise only a small portion of the total business (i.e., there is no specific financial threshold).  Moreover, the Canadian Minister of Heritage has the power to review the acquisition of Canadian cultural businesses even where the general relevant monetary thresholds are not met.

Indirect Investments

An indirect acquisition under the Investment Canada Act is where a foreign investor acquires control of a corporation that is incorporated in a jurisdiction other than Canada, which in turn controls a Canadian entity carrying on a Canadian business.  The significance of determining whether an investment is direct or indirect is that the thresholds for review are different depending on whether a transaction is direct or indirect.  As well, indirect acquisitions by WTO investors are generally not reviewable.

Investments by WTO Investors

Finally, with respect to WTO investors, generally speaking an individual will be a WTO investor where they are a national of a member of the WTO or have a right of permanent residence in a country that is a member of the WTO.  In the case of corporations, a corporation will be a WTO investor where ultimate control rests with one or more WTO investors.  In the case of widely held corporations, a corporation will be a WTO investor where the majority of the corporation’s voting shares are owned by WTO investors or, where no person or group of persons controls the corporation, where a minimum of 2/3 of the corporation’s board are comprised of Canadians and WTO members.

FINANCIAL THRESHOLDS FOR REVIEW

Acquisitions of a Canadian business where the following financial thresholds are exceeded will be subject to review.

WTO Investors

Where the investor is a WTO investor (discussed above) or, alternatively, the Canadian business being acquired is controlled by a WTO investor, the following thresholds apply:

Direct Acquisitions.  Direct acquisitions will be subject to review when the value of the assets of the Canadian business is equal to or exceeds the review thresholds for WTO investors (which is currently Cdn. $299 million and based on the gross book value of the Canadian business being acquired and ●).  However, as a result of the recent amendments that are not yet in force, the financial threshold for review in the case of direct acquisitions of Canadian businesses will be if the “enterprise value” of the assets of the Canadian business is equal to or exceeds Cdn. $600 million, which threshold will apply for the first two years after the new thresholds come into force.  This threshold will increase annually.

Indirect Acquisitions.  Indirect acquisitions by WTO members are generally not reviewable (except where the Canadian business being acquired is a cultural business and the relevant threshold of Cdn. $50 million is exceeded), but only trigger a notification requirement.

Non-WTO Investors

Where the investment is by a non-WTO member lower review thresholds apply as follows:

Direct Acquisitions.  In the case of direct acquisitions by non-WTO investors, an investment will be subject to review if the value of the assets of the Canadian business exceeds Cdn. $5 million.

Indirect Acquisitions.  In the case of indirect acquisitions by non-WTO investors, an investment will be subject to review if the value of the assets of the Canadian business exceeds Cdn. $50 million.

TEST FOR REVIEW

“Net Benefit to Canada” Test

Under the Investment Canada Act, where an acquisition is subject to review, the foreign investor must show that the acquisition is likely to be of “net benefit to Canada”.  This is the relevant test against which the Minister will evaluate a reviewable investment.

In evaluating whether an investment is likely to be of “net benefit to Canada”, a number of factors are considered including employment, exports, productivity, technology development and compatibility with Canada’s national industrial, economic and cultural policies.

It is rare for an investment to be refused under the “net benefit to Canada” test under the Investment Canada Act.  For example, the recent Competition Policy Review Panel stated in its 2008 Report Compete to Win that of the 1500 non-cultural sector reviews undertaken by the Minister of Industry under the Act since 1985, only one investment proposal had been refused.  Similarly, between 1999 and 2008, the Minister of Canadian Heritage has reviewed and approved 98 cultural investments, while only disallowing three investment proposals.

Having said that, in one relatively recent case, involving MacDonald Dettwiler’s proposed sale of its space division in 2008, the transaction was blocked on national security grounds.

Review Application, Review Periods and Undertakings

Where an investment is reviewable, an application must be filed setting out the information about both the investor and the Canadian business (and in particular, the investor’s plans for the Canadian business and why the investment will be of net benefit to Canada).

Once an application has been filed, the Minister has an initial 45 days to approve or refuse the investment.  Where a review is not completed within the initial 45 days, the Minister may extend the review period for another 30 days (and the review period may be further extended with an investor’s consent).

If the Minister concludes that an investment would not be of “net benefit to Canada”, an investor may make representations and file undertakings within thirty days of the Minister’s notice.

Where binding undertakings are required for approval of an investment, they may involve terms in relation to maintaining certain employment levels in Canada, Canadian participation in the management of the business, undertaking capital expenditures, commitments to invest in research and development and the location of the head office of the Canadian business.

PENALTIES

Where an investor fails to comply with the Investment Canada Act, for example fails to file an application for review or notification, fails to comply with undertakings or completes a reviewable investment without the requisite approval, a number of penalties may be imposed.  These include divestiture of assets, the revocation (or suspension) of voting rights and financial penalties of up to Cdn. $10,000 per day that an investor is in contravention of the Investment Canada Act.

While the imposition of penalties under the Investment Canada Act is rare, the recent U.S. Steel case, involving U.S. Steel’s undertakings in relation to its acquisition of Stelco, illustrates that the Government is increasingly intent on ensuring that foreign investors comply with their commitments.  See: Federal Court of Canada Dismisses U.S. Steel’s Motion Challenging the Constitutionality of Section 40 of the Investment Canada Act.

NATIONAL SECURITY REVIEW

Recent Investment Canada Act amendments have now also introduced a new national security test, under which the Minister and the federal Cabinet have the power to review investments that could be “injurious to national security.”  The national security review regime, which is administered separately from the net benefit review process under the Act generally, also arose as a result of recommendations made by the Competition Policy Review Panel in its report entitled Compete to Win.

In particular, the Panel recommended in its report that Canada’s national security review regime should be “aligned with that of the investment review process used by the Committee on Foreign Investment in the United States”, which would “bring Canada into line with other countries that have introduced a national security screening procedure, including the United Kingdom, China, Japan and Germany.”

Under Canada’s new national security review regime, the Government may conduct a review regardless of whether an investment meets the general thresholds for a review under the Act and regardless of whether control of a Canadian business is acquired.  Moreover, the term “national security” has intentionally been left undefined, which gives the Minister and federal Cabinet wide scope to determine which investments to review from a national security perspective (and the grounds on which to approve or block investments).

A national security review of a proposed investment could take place where there is an investment (or proposed investment) by a non-Canadian to: (i) establish a new Canadian business, (ii) acquire control of an existing Canadian business or (iii) to acquire (in whole or in part) an entity carrying on all or part of its operations in Canada (where the entity has a place of Canadian operations, employees in Canada and Canadian assets).

The relevant threshold for commencing a national security review is low and undefined.  In this regard, the Minister may commence a national security review where there are reasonable grounds to believe that an investment by a non-Canadian “could be injurious to national security”.

When a notice is issued by the Minister that an investment may be reviewed on national security grounds, the investment cannot be completed unless prescribed conditions are met as follows: (i) receipt of a notice that no further action will be taken in relation to the investment or (ii) a copy of an order authorizing the investment.

Where a proposed or completed investment is found to be “injurious to national security”, the federal Cabinet has the power to: (i) block an investment (in whole or in part), (ii) impose conditions on an investment or (iii) in the case of a completed investment, order divestitures.

For more information about Canada’s new national security review regime see: National Security Review of Investments Regulations and Investment Canada Act (Part IV.1 – Investments Injurious to National Security).

GUIDELINES – INVESTMENT BY STATE-OWNED ENTERPRISES

Industry Canada has also recently issued guidelines for its “net benefit to Canada” assessment where an investor is a state-owned enterprise (“SOE”) (See: Guidelines – Investment by state-owned enterprises – Net benefit assessment).

Investment Canada defines an SOE as an enterprise that is owned or controlled directly or indirectly by a foreign government, and states that it is the Government’s policy to consider the governance and commercial orientation of SOEs as part of the “net benefit to Canada” analysis.

Relevant factors include whether the SOE investor adheres to Canadian standards of corporate governance (e.g., commitments to transparency and disclosure, independent audit committees and independent board members) and to Canadian laws and practices.  Investment Canada also considers the extent to which a SOE investor is owned or controlled by a state and whether it will continue to have the ability to operate on a commercial basis.

Investment Canada also provides examples in its SOE Guidelines of undertakings that could be provided to ensure that Canadian investments by SOEs are of net benefit to Canada, including the appointment of Canadians as independent directors, appointing Canadians to senior management positions, incorporating the business in Canada and listing the acquirer’s shares on Canadian exchanges.

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