Take note, foreign investors: Canada’s net-benefit test can theoretically impale your take-over.
More than a year after the transaction flamed out, it’s still impossible to talk about foreign investment in Canada without talking about the deal that didn’t happen.
BHP Billiton’s $40-billion run at Potash Corp. in late 2010 was one of the largest hostile transactions ever attempted anywhere in the world.
No one knows why Prime Minister Stephen Harper’s government issued a surprise interim decision that the acquisition was not of "net benefit" to Canada. The global giant quickly withdrew its offer, so the government was not required to provide reasons.
The Potash ruling had many in Canada’s deal-making community crying foul, claiming the government was interfering with the free movement of global capital. The net-benefit test under the Investment Canada Act can theoretically impale any foreign take-over. That’s because it’s not rules-based; the outcome is at the government’s discretion.
In response to the outcry, Tony Clement, then industry minister, promised to spell out principles for the net-benefits test that would serve as a guide for future Canadian take-overs.
That was in late 2010. Clement has been replaced as industry minister and the Harper government appears to have dropped plans to clarify the rules for foreign take-overs, leaving investors in the dark as to how Ottawa would react if an acquirer were to bid for a major Canadian company.
"Potash created uncertainty that just hasn’t been cleared up," says Norman Steinberg, chairman of Norton Rose Canada LLP, "While the government promised to clarify the policies in the Investment Canada Act, it has not done so and everybody wonders when they approach Investment Canada with a significant acquisition whether or not it will go through.
"Wherever you go in the world, people have been asking about this because they say they always saw Canada as very open to foreign investment."
Without guidance, all Canadian lawyers advising clients on how not to become the next BHP are left with is "a black box of bureaucratic and ministerial discretion," says Alicia Quesnel, a partner at Burnet, Duckworth & Palmer LLP in Calgary. She says that raises questions.
"Are we still open for business — what was the reason for rejecting Potash? We don’t know. When you couple that with the new national security provisions and the whole concept of energy security, what is the new reality? What’s the new scope of Canada’s intervention in foreign investments?"
Good questions, but it’s not as though foreign take-overs have dried up. Brock Gibson, the chairman of Blake, Cassels & Graydon LLP, which acted for BHP, said while there may be some residual uncertainty, "deals are continuing to get done.
"It would always be better to have follow-up reasons for anything to have better guidance, but it has not stopped deal flow," Gibson says from Calgary. "We’re seeing strong interest from emerging markets into Canada and we’re getting deals done by working through the system."
As 2011 drew to a close, Sinpoec, a unit of China Petrochemical Corp., closed a deal to buy Daylight Energy Ltd., a Calgary-based conventional oil and natural-gas producer, for $2.2 billion. It was the first-ever 100 per cent take-over of a North American energy firm by a Chinese oil company. And China’s state-owned CNOOC also acquired OPTI Canada, a bankrupt Calgary-based oil sands producer, for $2.1 billion with no problem.
Gibson’s right. Foreign take-overs are getting done. So why does Potash still have so many people rattled?
For one thing, many in Canada’s deal community say they didn’t see any obvious road block when BHP’s hostile bid was announced. Government approval was viewed as a formality.
Ottawa had blocked only one foreign take-over since the Investment Canada Act was introduced 25 years ago, in 2008, when Alliant Techsystems proposed buying the information systems division of MacDonald Dettwiler, which involved the military use of some relevant technology. The rejection was accepted as being legitimate on national security grounds.
There was no similar concern with Potash and so most people thought it was all systems go provided shareholders supported the sale. In fact, the federal Competition Bureau had even provided an advance ruling certificate giving the proposed deal the green light.
But if anyone was using that as a signal they were in for a rude surprise.
It doesn’t take a rocket scientist to figure out what killed the Potash deal. Canadian politics killed the Potash deal; the Investment Canada Act was simply the weapon.
The proposed take-over would have had the largest impact in Saskatchewan and Premier Brad Wall warned it would cost his province billions in lost revenue for the benefit of a global mining giant, successfully turning the public against the deal.
Susan Hutton, a senior partner in the foreign investment and international trade practice groups at Stikeman Elliott LLP, which advised Potash, says to the extent the decision was political rather than purely business — that’s exactly the way the Investment Canada Act was designed to work.
"The Investment Canada Act is ultimately political and that’s why we have it," Hutton said from her Ottawa office. "There would be no point in having the legislation if Parliament wasn’t saying once in a while that concerns other than business are going to trump pure business considerations."
Kevin Thomson, a partner at Davies Ward Phillips & Vineberg LLP in Toronto, believes the significance of BHP-Potash "is widely misunderstood.
"We regard it as very much an outlier in the way in which government and regulatory approvals for foreign investment in Canada would typically be obtained."
He says it was a unique combination of circumstances: Potash was a crown jewel and critically important to the economy of one of Canada’s 10 provinces, and because of the size of the transaction — the target company knew it could not realistically run an auction once BHP had put it into play.
As a consequence, Potash did not have many cards in its hand. But it had public and political sentiment — which proved to be strong ones. He believes BHP also made a fundamental miscalculation that left it vulnerable to being trumped.
"The card Potash chose to play, in no small part, was precipitated by what analysts and shareholders all considered to be a very underwhelming price that was offered by BHP," says Thomson. "Because the price was generally perceived as so low relative to fair value coming out of the gate, it never got traction for that transaction amongst any constituency that mattered in Canada. So it was very easy for Potash to defend the way it did because there was no support for the transaction."
Thomson says it’s wrong to look at Potash and conclude Canada has made a fundamental shift around foreign investment.
"We believe it’s a mistake to say there’s been a sea change in the way in which foreign buyers of Canadian assets should be looking at the investment climate in Canada. We do not believe that is the case. We believe very much that BHP-Potash should be looked at as an outlier as opposed to the new standard bearer."
That may be true, but the BHP-Potash deal changed a key component of foreign take-overs — the undertakings.
Having withdrawn its bid, BHP complained publicly that Ottawa’s decision was wrong. It told Canadians it had made a series of legally binding undertakings "unparalleled in substance, scope and duration" that clearly would have been of net benefit to Canada, especially Saskatchewan.
In a highly unusual step, BHP made those undertakings public. It had offered to forgo tax benefits, spend over $820 million on exploration and infrastructure in Saskatchewan and list its shares on the Toronto Stock Exchange. It had committed to moving 200 jobs to Canada from outside the country and to increasing overall employment levels in the combined Canadian potash businesses by 15 per cent.
It’s not hard to see why the Australian mining giant was both angry and bewildered that having committed to so much, it was nonetheless rebuffed.
Many Canadian advisers are equally struck.
Clay Horner, chairman of Osler, Hoskin & Harcourt LLP, says the BHP undertakings set a new bar in controversial transactions and "the people at Investment Canada are well aware of those undertakings now.
"Entirely apart from the politics, there was a very detailed negotiation with Investment Canada and BHP went public with what they were prepared to do in terms of their undertakings," Horner says from Toronto. "What they were prepared to do was more extensive and significant than anything anyone had ever seen before.
"So when you look at a big transaction today in a sensitive area, you look and say: ‘OK, I need to go and see what Potash was prepared to do.’"
William Braithwaite, a senior partner at Stikeman Elliott LLP in Toronto, says there is worry the proposed BHP undertakings will lead to "undertaking creep.
"There is a concern that each time these deals happen, and the acquirer commits more, there’s this creep in undertakings," says Braithwaite. "One of the peculiar undertakings that it looked like BHP was prepared to make, or the government was asking for from BHP, was to post a US$250-million bond with the government to support their compliance with the undertakings — like a surety bond. No one’s ever done that before.
"I’m not aware of any foreign bidder having posted one of these bonds post-BHP but there’s a concern that we may see continued requests by the government for foreign bidders to give more and more."
That’s not the only concern, says Braithwaite.
Prime Minister Stephen Harper told Reuters earlier this year that he questions whether hostile take-overs of key domestic firms are in the country’s best interests. He was responding to stubborn speculation that a foreign buyer could take a run at Research in Motion (RIM).
Harper told the news agency that not every foreign bid is good for Canada, saying, "Take-overs of critical technology that the government’s invested in, or … hostile take-overs of key Canadian businesses, are obviously something that I think is widely understood is not in this country’s interest."
Braithwaite says the distinction drawn between hostile and friendly deals is something people should pay attention to.
"In practice, it’s always been an issue. If you do a hostile bid for a foreign client, it’s difficult negotiating undertakings with Investment Canada since you don’t have access to the target and in effect you’re doing it blind. But Ottawa still expects you to negotiate the undertakings.
"So the foreign bidders have always been at a practical disadvantage, but this is the first time we’ve ever heard anybody from a policy point of view distinguish between friendly and hostile bids. We’re all trying to figure out what it means.
"Our guess is the Prime Minister was not speaking casually, that this does represent a policy direction for Investment Canada. I don’t know what it means for us when it comes to advising our foreign clients about launching hostile bids for significant Canadian companies."
So between Postash and RIM, where do things go from here?
No can read the tea leaves with certainty but Derek Burney of Norton Rose wrote a paper saying "the concern is that Canada is becoming selectively protectionist and will review transactions through a political lens with a sharp domestic-preference focus, rather than an international business and investment focus."
While many in the deal-making community say making the guidelines for the net benefits test public would be a good start in providing reassurances, Donald Campbell of Davis LLP in Vancouver says don’t hold your breath.
If the Canadian government is dancing around the net-benefit test, it is because it’s trying not to antagonize two opposing constituencies.
On the one side is Corporate Canada, which has largely applauded the deregulation of the Canadian economy and supports higher thresholds for review as essential in a free-market globalizing world.
On the other side is Main Street, voters who have watched iconic Canadian companies such as Inco, Falconbridge, Alcan, Hudson’s Bay, CP hotels, Molson, Dofasco and Stelco fall into foreign hands in recent years in the name of globalization. Many would like to see a higher bar on foreign investment in Canada.
Opposition Members of Parliament jumped on that this past winter, calling publicly for more clarity on the Investment Canada Act. David Denison, CEO of the massive Canada Pension Plan Investment Board, also called on Ottawa to clarify the take-over rules, telling a business audience in Australia that protectionism is increasingly standing in the way of investors.
Campbell is convinced it’s not going to happen. As a former Conservative deputy foreign minister as well as deputy minister for International Trade, his read of government thinking merits special attention.
He says Prime Minister Stephen Harper’s majority government has nothing to gain by making net benefit a bright-line test.
"My view is the government is not likely to clarify or become more transparent in terms of the scope of the net-benefit criteria because they’ll want to keep as much flexibility as they can to take the decisions they want to," Campbell says.
Steinberg of Norton Rose says clarifying the terms "could open up a can of worms itself. So I think they’ll deal on an ad hoc basis and look at the various acquisitions including, unfortunately, the politics related to it."
Sandy Walker, a partner at Fraser Milner Casgrain LLP in Toronto, says the problem with that approach is it gives practitioners no guidance.
"There have been two rejections under the Act and we haven’t seen reasons for either of them. The government has taken particular positions but we don’t really know why. We need to know why they made those rejections. Foreign investors want predictability and certainty."
That said, Walker believes the Canadian government is sensitive to the optics of Potash.
"I think the government will go out of its way to show that Canada does welcome foreign investment in order to counterbalance the perception that the Investment Canada Act is increasingly being politicized," she says. "So I expect it will try to demonstrate that the Potash case was exceptional and that it won’t be held hostage to narrow political interests in future deals that raise the public temperature.
"At the same time, I expect international investors will be watching Canada to gauge the prospects for future investments in potentially sensitive areas or in Canadian icons."
Kevin Thomson of Davies Ward says if there’s one takeaway for US lawyers it’s to be sensitive to local nuances.
"What BHP has highlighted is it certainly is the case that for a transaction that is of significant size and scale, the Investment Canada process can quickly become politicized," he says. "What that means is that American buyers and their advisers have no reason to be unduly concerned with the prospect of receiving Investment Canada approval, provided that they are sensitive in the way in which they approach the government and regulatory approval process."
Sandra Rubin is a freelance legal affairs writer.