In Canada, only a "Canadian" air carrier is permitted to operate a domestic air service between points within Canada. Under the Canada Transportation Act (Act), there are three requirements in order for an air carrier to be considered "Canadian":
- it must be incorporated or formed under Canadian federal or provincial laws;
- a minimum of 75 per cent of its voting interests must be owned and controlled by Canadians; and
- the entity must be "controlled in fact" by Canadians.
In May 2011, the Canadian Transportation Agency (Agency) released two Interpretation Notes which clarify how the Agency applies the Canadian ownership requirement under the Act. These Interpretation Notes have important implications for businesses which are considering acquiring an interest in a Canadian air carrier as well as for those which currently have a financial stake in Canadian airlines.
The first requirement under the Act that the carrier must be incorporated or formed in Canada is the most straightforward and easily met. The second requirement of 75 per cent equity ownership by Canadian interests is also reasonably clear but there are important points to bear in mind. The voting interests must be both beneficially owned and controlled by Canadians. It is not sufficient for the securities to be simply registered to Canadians. The Interpretation Notes advise that publicly-traded Canadian air carrier companies should have a control system in place to prevent the transfer of securities resulting in less than 75 per cent Canadian ownership of voting interests or an alternative means to achieve the same result, such as securities with a variable voting value.
Of the three requirements, the "control in fact" test, which recognizes that legal control does not always equate to actual control, is the most complex. The Interpretation Notes emphasize that no one factor is determinative and that each case must be assessed on its own facts. The Interpretation Notes provide guidance with respect to a number of factors which may affect an air carrier's Canadian-controlled status:
- Risks and benefits: It is presumed that parties which carry a majority of risks and the entitlement to the majority of the benefits in connection with the operation of an air carrier have control in fact.
- Concentration of voting interests: Voting interest concentration may be relevant where a non-Canadian or non-Canadian group holds a block of voting interests, and where the remaining voting interests controlled by Canadians are spread amongst numerous unrelated persons. The non-Canadian minority interest-holders may have a greater ability to direct the business of the air carrier than the Canadian majority.
- Directors and officers: It is essential that Canadian shareholders have the right to appoint the majority of the board of directors, and the Agency takes the position that the majority of the board must also be Canadian. However, the officers need not be Canadian, unless there is a reason to believe that the officers are conduits for non-Canadian shareholders' exercise of control. Quorum provisions should be designed to ensure that a majority of the shareholders or directors present at a meeting are Canadian, and that a majority of the directors present are those appointed by Canadian shareholders.
- Veto rights: Veto rights over matters such as the payment of dividends are generally not considered by the Agency to affect control in fact. However, the veto rights (especially in conjunction with other factors which permit minority interest holders to affect decision-making outcomes) or the nature of the veto rights in question (for example, veto rights over the selection of officers) can affect control in fact.
- Security rights, options and warrants: While these rights are not normally significant for the control in fact analysis, they may be important where such rights are not exercisable at market prices and a non-Canadian investor holds an unequal proportion of these rights.
- Debt, guarantees, lease of assets: Financial arrangements concerning debt transactions, guarantees, the power to wind up a company and the lease of assets do not generally indicate control in fact in the creditor, guarantor or other party, unless the magnitude or nature of the transaction is unusual.
- Financial strengths and business activity: These factors can indicate those shareholders who have control in fact over the air carrier. For example, where a shareholder is a non-Canadian air carrier, and the Canadian shareholders have minimal experience in the aviation industry, this could be an indicator that the non-Canadian shareholder is exercising control in fact. Further, a non-Canadian shareholder which has significant financial resources and strength may be seen to have control in fact where the Canadian shareholders do not have such financial resources and strength.
- Management agreements: Where management services are provided by a non-Canadian, the Agency recommends that an independent contractor (as opposed to an employee of another carrier) be used. Payment should be based on services rendered and any incentive bonus should be comparatively small. The Board of Directors should retain authority over major decisions and should have the ability to terminate the management agreement.
- Operational or service agreements: Such agreements may affect control in fact if the service provider makes major operational decisions or is paid on a contingency fee basis.
In addition to the Interpretation Notes, there are also other changes pending which will impact the issue of foreign ownership. In 2009, Canada introduced a proposed change which would allow for an increase in the amount of voting interests owned and controlled by non-Canadians to a percentage not exceeding 49 per cent. This proposed change was made in response to the Comprehensive Canada-European Union Air Transport Agreement, which came into effect that year. The Agreement provides for phased market opening and increasing degrees of foreign ownership. Ultimately, the Agreement contemplates that EU and Canadian carriers will be granted full rights to operate between, within and beyond both markets, including between points in the territory of the other party (known as cabotage). These rights will be granted once both sides complete the necessary steps to allow the full ownership and control of their carriers by the other's nationals.
Until such time, and in any event for all non-EU investors, the Interpretation Notes issued by the Agency will provide important guidance to industry about how to structure foreign investment in Canadian air carriers.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.