With the Federal Court of Canada's June decision in The Attorney General of Canada v. United States Steel Corporation and U.S. Steel Canada Inc., the Canadian government has won the first round in its battle to hold foreign acquirers to promises they make while getting approval to take over a domestic company.
The suit against U.S. Steel marked the first time the Canadian government had taken a company to court under the Investment Canada Act (ICA), enacted in 1984. The government alleged that U.S. Steel had contravened promises to maintain employment and productivity levels at its Ontario plants. U.S. Steel responded by arguing that the enforcement proceedings were unconstitutional as they violated the company's rights under the Canadian Charter of Rights and Freedoms, the Canadian equivalent of the U.S. Bill of Rights.
But the Federal Court rejected the company's arguments, clearing the way for the case to proceed to a trial on the merits if the decision is upheld on appeal.
"The ruling is a reminder not only that the government considers Canada's foreign investment review regime to be important, but that it is both willing and able to enforce undertakings in cases involving material noncompliance despite the fact that it has never resorted to court proceedings in the past," says Omar Wakil, a partner at Torys.
The ICA prohibits, with limited exceptions, a non-Canadian company from acquiring control of a Canadian business of a designated size (see "On The Books," p. 34) unless it has filed an application for review and convinced the minister of industry that the investment is "likely to be of net benefit to Canada." In making his decision, the minister can take into account any promises offered by the investor to enhance the benefit to Canada.
Such promises, or undertakings, are binding commitments. But the government's Administrative Guidelines state that investors will not be held accountable where the inability to fulfill a commitment "is clearly the result of factors beyond the control of the investor."
Where an investor does not live up to its commitments, the ICA authorizes the minister to demand the investor comply with the undertaking, "show cause" that he has not contravened its undertaking or justify any noncompliance. If the investor does not satisfy the demand, the minister can either agree to a new undertaking or apply to the court under section 40 of the ICA for a variety of remedies, including divestiture, a compliance order or an "administrative monetary penalty" (AMP) to a maximum of C$10,000 per day for each breach of an undertaking.
It was against this statutory background that U.S. Steel announced in August 2007 that it had reached an agreement with Stelco Inc., the last of Canada's major steelmakers, to acquire all of the Hamilton, Ontario-based company's shares. Because the transaction was subject to the ICA, it could not close until the minister decided that it was likely to be of net benefit to Canada.
U.S. Steel supported its application with 31 undertakings promising, among other things, to maintain certain employment and production levels. The minister approved the takeover in October 2007, partly because of the undertakings.
But as the global economic crisis shook the North American economy, over the next 18 months U.S. Steel laid off or retired 2,400 workers and cut back production at its two plants in Ontario. In May 2009, the Minister sent a demand advising U.S. Steel that it had contravened the undertakings regarding employment and production levels. The minister required the company to either cease the contravention, remedy the default, show cause why there were no contraventions or justify its noncompliance.
"Tony Clement, the industry minister, went after U.S. Steel because he perceived that the company's Canadian cutbacks were disproportionate to its cutbacks elsewhere," says Neil Campbell, a partner at McMillan.
U.S. Steel defended the cutbacks, but the minister found the company's explanation unsatisfactory. In July 2009, he asked the Federal Court to force compliance and impose a penalty of C$10,000 per day for each breach of the undertaking, calculated from November 1, 2008 until U.S. Steel had complied.
U.S. Steel responded to the suit by applying to the court for an order that section 40 of the ICA was unconstitutional because it violated section 11(d) of the charter, which provides that anyone charged with an offense is presumed innocent until proven guilty in accordance with due process. For its part, s. 40 puts the burden on the investor to show why no contravention had occurred.
"U.S. Steel based its arguments on the premise that an order under s. 40 is either by its nature a criminal proceeding or involves the imposition of true penal consequences," says Neill May, a partner at Goodmans.
Justice Dolores Hansen, however, concluded that 40 proceedings were not criminal.
"In a section 40 proceeding, the investor is not being called to account to the public," she stated. "The investor is being called to account to the government for a failure to honour commitments made to the government."
Hansen also ruled that AMPs were not a "true penal consequence" but rather "a way to promote and ensure the attainment of the legislative objectives." The mere size of the AMPS did not necessarily make them penal consequences so long as the statutory scheme as a whole did not fall afoul of the charter.
The proceedings against U.S. Steel, then, were more a civil enforcement mechanism than a criminal proceeding and did not offend the charter.
Some commentators have suggested the federal government's aggressive pursuit of U.S. Steel may demonstrate that Canada is getting tough on foreign investment.
They point to the government's 2008 refusal to approve the sale of a Canadian satellite firm, MacDonald Dettwiler and Associates Ltd., to U.S.-based Alliant Techsystems Inc., apparently on grounds of national security, although the minister did not give reasons for the refusal. At the time, "national security" was not a specific ground for refusal under the ICA, although subsequent amendments have made it so.
But Wakil says that it's too early to treat the government's actions against U.S. Steel as the beginning of a trend.
"There's always the temptation to look at a case like this and draw broader conclusions," he says. "But right now it's too early to go in that direction."
Still, the decision will have practical implications in the M&A market.
"Some investors may have been too lax in their assumptions about what it would take to satisfy their undertakings," May says. "But the fact that the regulators have become active is a sure sign that they will be dealing with commitments more seriously than they have in the past."
From a bottomline perspective, of course, the upshot is that the prospect of undertakings is now more likely to affect the pricing of transactions that require ICA approval.