In an April 2016 article in Business Law Today, we provided a primer on foreign investment regulation in Canada, an important issue in Canadian cross-border M&A transactions. Foreign investment primarily is regulated 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). In the ensuing year, a number of significant changes have occurred or have been announced by the Canadian federal government and are addressed below. 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. All currency conversions in this article are made as of March 28, 2017.
As explained in the April 2016 article, under the ICA, the acquisition of control of a Canadian business by a non‐Canadian triggers either a (usually pre-closing) review or a (usually post-closing) notification process. The review process generally is triggered if the value of the Canadian business exceeds an applicable threshold, which can vary on a number of factors.
As part of its 2016 Fall Economic Statement, other than for investments by foreign state-owned (or influenced) enterprises (SOEs), the Canadian government committed to increasing the threshold applicable to a direct acquisition of a Canadian business by nationals of World Trade Organization (WTO) member states, which would include a U.S. company ultimately controlled by U.S. nationals. This threshold for review has changed significantly over the last few years, shifting even more transactions into the notification process and thereby reducing ICA compliance costs. In March 2015, this threshold was changed, from one based on the book value of assets of the Canadian business, to a threshold based on the “enterprise value” of the Canadian business, and a planned increase schedule was set out. In its 2016 Fall Economic Statement and again in its 2017 budget, the Canadian government committed to increasing this threshold even more quickly than originally planned, as shown in the table below.
March 2015 Amendments
2016 Fall Economic Statement and 2017 Federal Budget Proposal
April 24, 2015 to April 23, 2017
Enterprise Value of C$600million (approximately US$448 million)
April 24, 2017 to April 23, 2019
Enterprise Value of C$800 million (approximately US$597 million)
Enterprise Value of C$1 billion1 (approximately US$747 million)
April 24, 2019 to December 31, 2020
Enterprise Value of C$1 billion (approximately US$747 million)
Indexed annually to GDP growth2
January 1, 2021
Indexed annually to GDP growth
- Upon enactment of budget implementation legislation, anticipated in the spring or fall of 2017.
- On a date to be determined (likely January 1, 2019).
The Canadian government also is in the process of implementing the recently negotiated Canada and European Union (EU) Comprehensive Economic and Trade Agreement (CETA), which will increase the threshold for nationals of EU member states. Once in force, CETA will increase the enterprise threshold for nationals of EU member states to C$1.5 billion (approximately US$1.12 billion). A number of countries, including the United States and Mexico, have trade agreements with Canada that contain most-favored-nation protection, with the result that nationals of these countries will also benefit from this substantially increased enterprise value threshold. The legislation in Canada to implement the CETA currently is expected to be in force as early as late June 2017.
An indirect acquisition of a Canadian business (i.e., through the acquisition of its foreign corporate parent) by nationals of WTO-member states, including the United States, with limited exceptions, are exempt from review.
An important exception to these rules on direct and indirect acquisitions remains where the Canadian business is engaged, even if only partially, in the activities of a “cultural business.” A direct acquisition of a cultural business continues to be subject to review where the book value of the Canadian business’ assets exceeds C$5 million (approximately US$3.7 million), and an indirect acquisition of a cultural business continues to be subject to review where the book value of such assets exceeds C$50 million (approximately US$37 million), although in the case of the latter, the review may be done post-transaction and therefore is not an impediment to closing.
Some Clarity on National Security Review
As explained in the April 2016 article, 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.” 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. or other investor; (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. This process is, to a certain extent, the Canadian equivalent to the Committee on Foreign Investment in the United States (CFIUS) regulations.
The concept of “could be injurious to national security” is not defined in the ICA or its regulations and, until recently, the Canadian government did not provide any guidance on what it considered “could be injurious to national security” (other than certain statistics on the frequency and outcomes of national security reviews). On December 19, 2016, the Canadian government delivered on a promise, made in the previously noted 2016 Fall Economic Statement, to make the national security review process more transparent by publishing Guidelines on the National Security Review of Investments (the Guidelines), which identify the following nine, nonexhaustive factors that will be taken into account in determining whether foreign investments could be injurious to national security: (i) the potential effects of the investment on Canada’s defense capabilities and interests; (ii) the potential effects of the investment on the transfer of sensitive technology or know-how outside of Canada; (iii) the involvement in the research, manufacture, or sale of goods/technology relating to certain controlled goods noted in the Defence Production Act, including firearms, military training equipment, certain types of aircraft, weaponry and defense systems, etc.; (iv) the potential impact of the investment on the security of Canada’s critical infrastructure, meaning the processes, systems, facilities, technologies, networks, assets, and services essential to the health, safety, security, or economic well-being of Canadians and the effective functioning of government; (v) the potential impact of the investment on the supply of critical goods and services to Canadians, or the supply of goods and services to the Canadian government; (vi) the potential of the investment to enable foreign surveillance or espionage; (vii) the potential of the investment to hinder current or future intelligence or law enforcement operations; (viii) the potential impact of the investment on Canada’s international interests, including foreign relationships; and (ix) the potential of the investment to involve or facilitate the activities of illicit actors, such as terrorists, terrorist organizations, or organized crime.
The Canadian government’s 2017 budget also announced an intention to require the publication of an annual report on the administration of the ICA’s national security.
The Guidelines also provide recommendations for dealing with national security. For example, the ICA contains no formal preclearance mechanism, which is a significant distinction between the Canadian national security regime and the CFIUS regime. To address this issue, the Guidelines recommend that foreign investors file their ICA notifications “early” and prior to the deadlines set out by statute, even though this is not required by law, particularly in cases where the assessment factors described above may be present. By doing such a filing on a preclosing basis and waiting for 45 days to elapse following the filing of such notification, if no action is taken, the investor can proceed with closing knowing that the period within which a national security review could be ordered has expired. Note, however, that this “early filing option” is not available unless an investment triggers a notification (or economic review) requirement. Where no notification (or review) is required (for example, the acquisition of minority interest in a Canadian business where there is no acquisition of control by the non-Canadian investor within the meaning of the ICA), the 45-day period for triggering the national review process runs from implementation of the investment, which precludes the early filing option for obtaining comfort. Nevertheless, early engagement with the government may still be beneficial in securing meaningful comfort from the government. Such engagement allows the government an opportunity to examine the investment and to ask questions of the investor, which, even absent explicit pronouncement from the government, may allow the investor to make meaningful inferences about the government’s assessment of whether the investment would be injurious to national security.
The proposed change to the ICA’s enterprise value thresholds will result in fewer transactions subject to review, and the Guidelines provide additional clarity on national security review. Understanding the ICA’s regulation of foreign investment is important because sanctions can include fines and even a reversal of the transaction (although the authors 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, given that many other federal and provincial laws can affect the implementation of an M&A transaction.