Two months ago, Jim Prentice, Canada's Minister of Industry, announced that the Government of Canada would develop new guidelines for acquisitions in Canada by state-owned enterprises (SOEs) such as sovereign wealth funds and national oil companies.
On December 7, 2007 the Minister issued new guidelines on how the "net benefit to Canada" requirement set out in the Investment Canada Act (the Act) will be applied by the Canadian government when SOEs acquire major investments in Canada. The issue of screening investments on the basis of national security, which may also affect investments by SOEs, has been deferred until sometime in 2008.
In summary, under the new guidelines:
- SOE investments will not automatically be disallowed or prohibited;
- Investments from certain countries and in certain industry sectors are not identified as raising particular concerns;
- SOE investors will be subject to additional scrutiny of their governance structure and commercial orientation in determining whether their investments meet the "net benefit to Canada" test in the Act;
- more extensive undertakings could be sought as a condition of obtaining approval of SOE investments; and
- the existing financial and acquisition of control thresholds which trigger review under the Act will apply to SOE investments.
The Current Review Process
Under the Act, the government has the authority to review and approve direct acquisitions by non-Canadians of control of Canadian businesses if the target of the investment meets the financial threshold for review, which is currently $281 million in book value of worldwide assets, in the case of an investor from a WTO member-state. Investments by non-WTO investors and investments by all investors in certain sensitive sectors – such as cultural industries, financial services, transportation services and the production of uranium and the ownership of uranium-producing property – are subject to lower review thresholds which vary depending on whether the acquisition of the Canadian business is direct or indirect.
In applying the "net benefit to Canada" test to an investment by a non-Canadian, the government considers factors such as:
- the impact on the level and nature of economic activity in Canada;
- participation by Canadians in the newly acquired business and in the industry in which the business operates;
- the impact on productivity, efficiency, technological development and innovation;
- the impact on domestic competition;
- compatibility with Canadian industrial, economic and cultural policies; and
- the impact on Canada's ability to compete globally.
The New Criteria For SOE Investors
The government's new guidelines state that in applying the existing statutory criteria for determining "net benefit to Canada," the government will also consider: the nature and extent of control of the SOE by a foreign government; whether the corporate governance of the SOE is compatible with Canadian standards of corporate governance (such as a commitment to transparency and disclosure, independent members of board of directors, independent audit committees and equitable treatment of shareholders); as well as adherence to Canadian laws and practices. Interestingly, this statement presumably allows scope for consideration of issues such as the SOE's compliance with Canadian environmental, labour, and human rights standards.
Under the new guidelines, if a SOE is likely to interfere in the ability of the Canadian business to operate according to commercial principles, the SOE may encounter a difficult approval process. Such principles include: where to export; where to process goods; participation of Canadians in the operations of the acquired Canadian business; reduction in spending in Canada in support of on-going innovation and research and development; and appropriate levels of capital expenditures to maintain the ability of the acquired Canadian business to compete globally. For example, a SOE which plans to acquire a Canadian business to use it as a captive source of supply for home industries may experience a more critical review process.
The government's new guidelines point out that the current policy of encouraging undertakings by non-Canadians that demonstrate "net benefit to Canada" will also apply to SOEs. The new guidelines state that examples of such undertakings include: the appointment of Canadians as independent board members; the employment of Canadians in senior management positions; the incorporation of the business in Canada; and the listing of shares of the acquiring entity or the Canadian-acquired business on a Canadian stock exchange.
The new guidelines apply to an enterprise that is owned or controlled directly or indirectly by a foreign government. Whether a foreign government "controls" an enterprise (directly or indirectly) will likely be assessed, by analogy, using the rules in the Act for determining whether an entity is Canadian-controlled or WTO-investor-controlled. In addition, the government will likely consider whether the foreign government has the ability to exercise decisive control over the investor. In this connection, the government will likely examine: the equity participation of the foreign government; its voting rights; its representation on the board of directors of the investor; its veto and approval rights over business plans and budgets; and its right to appoint and remove senior management. Therefore, notwithstanding a minority equity interest position, if a foreign government can decisively influence management and decision-making of the enterprise making the acquisition in Canada, it could be considered a SOE. The determination of control is likely to centre on control in fact and not merely legal control.
The new guidelines contain no transitional rules. Accordingly, transactions which are in progress appear to be subject to the new guidelines as of December 7, 2007.
The normal acquisition review period under the Act is 45 to 75 days. This period can be extended with the consent of the government and the investor. An SOE investor who is new to Canada can expect to encounter a relatively long review period; such a period of review may put the SOE investor at a timing disadvantage, compared to a non-SOE investor, in a competitive bidding process for a Canadian business.
International Trade Implications
The new guidelines allow the government to clarify, without legislative amendments, its administration of the "net benefit to Canada" test in the case of acquisitions by SOEs. As a result, the government may immediately tackle mounting concerns within Canada that Canadian businesses could be taken over to serve the economic and political interests of foreign governments without regard to Canadian interests.
Furthermore, by using the existing mechanisms set out in the Act, the new guidelines are more likely to be consistent with Canada's obligations under its many recent bilateral investment treaties and the investment provisions of NAFTA. The new guidelines also reflect Canada's overall policy of promoting transparent and rules-based systems in the trade and investment laws of other countries, and in advancing recent international initiatives of the G7 countries, the IMF, the World Bank, and the OECD that seek to develop a set of "best practices" for SOEs.
SOEs in the Middle East, China, India and Russia are becoming increasingly active in Canada and around the world. It is not in Canada's interest to alienate these potentially significant sources of foreign investment by reviewing their investments more rigorously without a principled basis for doing so. With the new guidelines, the government is walking a fine line between being seen to be open to foreign investment and addressing concerns that SOEs may damage Canadian interests by investing in Canada for their own strategic national interests. It is hoped that through an assessment of the positive factors of SOE investments in Canada, based on a principled interpretation of what "net benefit to Canada" means, the Canadian government will maintain positive bilateral trade and diplomatic relationships with foreign governments and their SOEs who are anxious to invest in Canada.
Riyaz Dattu leads the firm's International Trade and Investment Law practice, and is a partner in the Toronto office. Peter Franklyn is a partner in the Toronto office and Chair of the firm's Competition/Antitrust Law Group. Peter Glossop a partner in the Competition & Antitrust Law Practice Group in the firm's Toronto office.
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