Commentary: Canada’s new rules for foreign investment review

Since 1985, acquisitions of operating Canadian mining businesses have been subject to review under the Investment Canada Act (ICA) if the acquired business exceeded certain financial thresholds.

New, higher review thresholds will allow more transactions to proceed without ICA review, but at the same time, recently updated national security review procedures add new uncertainty and greater risks of post-closing challenges under the ICA.

As at the date of writing, an acquisition of control of a Canadian mining business with assets having a book value of more than $312 million is subject to a “net benefit” review under the ICA. This assumes that the buyer or a non-Canadian seller is controlled by citizens of a World Trade Organization member country.

Otherwise, the review threshold is much lower.

For share acquisitions, control for the purposes of the ICA can be acquired at voting-share levels of as low as one-third.

Acquisitions of exploration properties or non-producing mines are not subject to a net-benefit review.

Amendments to the ICA passed in March 2009 and expected to come into effect later this year will significantly change the review threshold: An acquisition of a Canadian business will be reviewable only if it has an “enterprise value” of at least $600 million.

This threshold will rise to $1 billion over the next six years. (The government recently released proposed regulations defining “enterprise value” with reference to the trading price of listed securities and the book value of other assets.)

In addition, a lower — $5 million — threshold previously applicable to uranium production businesses in Canada has been repealed so that the general threshold now applies to acquisitions in this sector.

In most cases, a reviewable acquisition cannot be completed until the federal industry minister has determined that the transaction is likely to be of net benefit to Canada.

Such approval has never been withheld for any transaction in the Canadian mining sector, although the government has a policy limiting foreign ownership in producing uranium mines to 49%, unless it can be clearly established that the property is in fact Canadian-controlled or Canadian partners cannot be found.

However, the minister normally requires the foreign investor to provide undertakings as a condition of approval.

Those undertakings, which typically have a term of three to five years, often involve commitments to maintain or grow levels of employment, capital investment, research and development in Canada, and sourcing of Canadian inputs, as well as commitments to certain levels of Canadian participation in the management of the acquired business.

The actual undertakings are rarely disclosed to the public, but foreign investors sometimes issue press releases describing the undertakings in general terms.

Past foreign acquisitions in the Canadian mining sector that have attracted considerable media and political attention in Canada include: China Minmetals’ failed bid to acquire Noranda in 2004; Xstrata’s 2006 acquisition of Falconbridge; and Vale’s 2006 acquisition of Inco.

Industry Minister Tony Clement earlier this year reportedly raised concerns with Vale about promises it made in relation to its Inco acquisition.

However, Clement was later satisfied on being assured that Vale’s layoffs in Canada were proportionate to its layoffs at its other international mining operations.

In the case of acquisitions of Canadian businesses by foreign state-owned enterprises, the minister also considers the enterprise’s corporate governance and commercial orientation as part of the ICA review process, and may seek additional undertakings directed at these issues.

New national security review

While the higher net-benefit review thresholds will reduce the scope of transactions that will require pre-closing ICA approval, a new review process for investments that “could be injurious to national security” adds significant uncertainty for foreign investment in Canada.

This new process, which came into effect in March 2009, permits the federal government to take a broad range of measures to protect Canada’s national security, including prohibition of a proposed foreign investment in Canada or an order to divest assets.

The new national security review powers can apply to a wider range of transactions, including acquisitions of exploration properties or non-operating mines, and acquisitions of minority interests in Canadian businesses.

Transactions of any size can be reviewed for national security concerns — even transactions below the threshold for net-benefit reviews.

Also, the term “national security” has been deliberately left undefined to allow the Canadian government wide discretion in the application of this review power. In addition, the applicable standard, “could be injurious to national security,” is ambiguous and potentially open to expansive interpretation.

Perhaps most importantly, and unlike the equivalent foreign investment review regime in the United States, the ICA does not contemplate any voluntary notification mechanism for acquisitions potentially subject to a national security review, and the government has so far indicated that it has no plans to introduce one.

The lack of a voluntary notice provision makes it very difficult to eliminate the risk of post-closing review and challenge.

Concerns about the application of the ICA national security review process in the mining sector may be heightened by experiences in other jurisdictions.

For example, the U.S. government has reviewed acquisitions of U.S. businesses that supply natural resources under its national security review process.

Moreover, earlier this year the Australian government blocked China Minmetals’ proposed US$1.8-billion takeover of OZ Minerals on national security grounds. The Australian government did not identify any security sensitivity about OZ Minerals’ operations themselves.

Rather, it was concerned that one of its mines was located close to a sensitive weapons-testing site in Southern Australia. It is too early to know whether the Canadian government will exercise its discretion under the ICA as widely.

In any event, the potential exists for the Canadian government to apply its new national security review powers to foreign investments in the mining sector, particularly in the event of widespread public concern.

Need for an ICA Strategy

Any acquisition of control of, or a significant interest in, a Canadian business that may be subject to either a net-benefit or national-security review under the ICA requires a careful and well-planned strategy that might include not only legal counsel experienced in dealing with the ICA, but also government relations advisers.

Government relations advisers can assist in developing a communications strategy for, among other things, informing key government decision makers and other stakeholders about the proposed transaction and its benefits.

As the ICA and its related regulations are complex and can sometimes yield arbitrary or unexpected results, early consultation with experienced legal counsel can help ensure that a particular acquisition structure does not unnecessarily trigger an ICA net-benefit review.

A foreign investor should also be prepared for likely undertaking demands and should take them into account in its due-diligence process.

Finally, where applicable, foreign investors need to factor ICA reviews into their transaction timetables, particularly if they face competing bidders.

Net-benefit reviews can take 45 to 75 days, and often longer for particularly sensitive transactions. We don’t yet know how long the government will take to complete national-security reviews, but if such a review is started before closing, the subject transaction cannot be completed until ICA approval is obtained.

— John Bodrug and Christopher Margison are Partners in the Competition & Foreign Investment Review practice group at Davies Ward Phillips & Vineberg LLP, an integrated firm of more than 250 lawyers with offices in Toronto, Montréal, New York and an affiliate in Paris www.dwpv.com. The firm is focused on business law and is consistently at the heart of the largest and most complex commercial and financial matters on behalf of its clients, regardless of borders. Both authors have extensive experience in the mining industry.