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The Canadian government continues to propose changes to Canada’s foreign investment review regime under the Investment Canada Act (“ICA”). In its most recent announcement (available here) the government proposes to significantly increase the principal threshold used to determine whether foreign investments will be subject to review under the ICA. The government also published new guidelines on the mediation of disputes with foreign investors over the performance of undertakings and issued an annual report on the administration of the ICA which contains some interesting insights into the review process under this statute.

New Proposed Review Threshold

As described previously in our Flash of May 2, 2012, the Canadian government tabled proposed amendments to the ICA on April 26, 2012 as part of omnibus budget implementation legislation. Among other things, the proposed amendments would authorize the Minister of Industry to accept security from investors and to provide greater public disclosure of reasons and notices it issues pursuant to the ICA. The bill is currently being studied by the House Standing Committee on Finance.

On May 25, 2012, Canada’s Minister of Industry Christian Paradis announced that, in addition to the proposed changes described above, the Canadian government intends to significantly increase the financial threshold used to determine whether acquisitions of Canadian businesses by (or from) investors from World Trade Organization (“WTO”) member countries will be subject to review by Industry Canada under the ICA’s “net benefit to Canada” test. Although there are other thresholds applicable in certain circumstances, in practice, this “WTO Investor threshold” is the most frequently applied under the ICA.

Pursuant to the current threshold, direct acquisitions of Canadian businesses by (or from) WTO Investors are subject to “net benefit review” if the book value of the Canadian business’s assets exceeds $330 million based on the business’s most recent audited annual financial statements. (The threshold fluctuates annually based on a prescribed formula. The $330-million threshold applies to transactions that occur in 2012.)

The Canadian government proposes to change this WTO investor threshold in two ways:

• first, by basing the threshold on a new measure – “enterprise value” – rather than the book value of the Canadian business’s assets; and
• second, by progressively raising the threshold to $1 billion over four years once the new threshold comes into force (the threshold will initially be $600 million for two years, then rise to $800 million for the following two years, after which it will finally jump to $1 billion, with subsequent increases indexed to reflect changes in Canada’s gross domestic product).

The Canadian government proposed similar changes in 2009 and issued draft regulations to that effect for comment. However, the draft regulations were never finalized, apparently because of difficulties in defining the new “enterprise value” basis for the threshold. According to the Minister, the government now intends to issue new regulations which will reflect comments received during the 2009 consultation process. No date for issuance of the revised regulations has been announced.

The Minister’s announcement of a new threshold reflects the Canadian government’s continuing objective of focusing the ICA’s net benefit review process on only the most significant transactions involving foreign investments in Canada. This policy, in turn, has its roots in the 2008 report of the Competition Policy Review Panel, which recommended increasing the thresholds for “net benefit” review and basing the thresholds on enterprise value instead of asset value. The “enterprise value” threshold is likely to be based on very different criteria than the current “book value” threshold, and the new thresholds are likely to significantly reduce the number of transactions subject to net benefit review by Industry Canada.

Mediation Guideline

For reviewable transactions, foreign investors are typically required to provide binding undertakings to the Canadian government covering various aspects of the operations of the Canadian business being acquired, in order to demonstrate a likely “net benefit” to Canada arising from the investment.

As a result of its recent experience in the U.S. Steel case the Canadian government has been seeking to improve its ability to deal with cases involving alleged non-performance of such undertakings. For example, as noted above, the government wants to amend the ICA so that investors can provide it with “security bonds” in the event of disputes over performance. In the same vein, Minister Paradis has now announced the issuance of an Industry Canada guideline that provides for the mediation of disputes where the Minister believes that a foreign investor has failed to comply with its undertakings. The objective is to establish a mechanism whereby disputes can be resolved without resorting to costly and protracted litigation (as was the experience with U.S. Steel).

According to this guideline, where both parties agree, the Minister and the foreign investor may enter into an agreement to use third-party mediation to resolve a dispute over the performance of undertakings. The terms of such an agreement would include provisions on the appointment of a mediator, confidentiality, the duration and termination of the mediation process and cost sharing. The guideline also points out that the Minister will remain free to accept new undertakings from an investor at any time, regardless of whether the mediation process is utilized. (Indeed, this is how the government’s dispute with U.S. Steel was ultimately resolved.)

ICA Fiscal 2009-2010 Annual Report

Finally, in conjunction with the Minister’s announcement, Industry Canada issued the first annual report on the administration and enforcement of the ICA since 1992-1993. As a result of amendments to the ICA in 2009, Industry Canada is now required to issue these annual reports in order to provide greater transparency into the operation of Canada’s foreign investment review process.

The just-issued report (available here) relates to the government’s 2009-2010 fiscal year and is out of date in several areas for that reason. Nonetheless, the report contains some interesting statistics and other pertinent information relating to the ICA review process.

For example, the report discloses that, in the period between June 30, 1985 and March 31, 2010, the Minister issued 12 initial notices stating that he was not satisfied that proposed investments were likely to be of net benefit to Canada. Although not a large number when viewed in context, it is interesting to see just how many times the government has taken at least this initial step towards rejecting a foreign investment. The report also discloses that, in addition to the well-known instance in which the proposed acquisition of MacDonald, Dettwiler and Associates Ltd. was rejected (the first such denial of approval outside of the cultural sphere), there have also been two cases in which foreign investors abandoned proposed acquisitions after having received initial notices from the Minister.

The report also provides more details on how the Minister applies the net benefit test in practice. According to the report, each case will be decided on its own merits and the relative importance of the different criteria and factors involved will vary from transaction to transaction. As a general matter, however, the Minister will first establish a baseline against which he can compare a proposed transaction by looking at the Canadian target and considering its likely prospects in the absence of the proposed foreign acquisition, taking into account the business’s strengths, areas for improvements and key challenges. The Minister will then consider the foreign investor’s plans for the Canadian business, any undertakings provided by the investor and “what the foreign investor brings to the investment”, such as capital or expertise that is not otherwise accessible to the Canadian business. Based on the foregoing, the Minister will weigh the positive and negative effects of the proposed investment and decide whether it is likely to be of net benefit to Canada. Finally, the report clarifies that where there are competing foreign investors bidding to acquire a Canadian business, the Minister will not compare the proposed investments against each other to determine their relative benefits to Canada. Instead, the Minister will apply the net benefit test to each application on its own merits and, in appropriate cases, will provide approval to more than one prospective acquirer provided they each meet this test. The Minister’s objective in adopting this approach is to leave the ultimate decision of who the business is sold to in the hands of the vendors rather than have the government try to weigh which offer may be preferable.