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Interpretation Note: Control in Fact
Table of Contents
The Canadian Transportation Agency publishes guidance material to provide additional information about specific topics of interest. Should there be any discrepancy between the content of this interpretation note and the Canada Transportation Act (CTA), the latter will prevail.
This document describes the factors the Canadian Transportation Agency (the Agency) commonly considers when evaluating whether a corporation or other entity is "controlled in fact" by Canadians, as defined under subsection 55(1) of the CTA.
II. Key Terminology and Definitions
Subsection 55(1) of the CTA defines "Canadian" as:
"a Canadian citizen or a permanent resident within the meaning of subsection 2(1) of the Immigration and Refugee Protection Act, a government in Canada or an agent of such a government or a corporation or other entity that is incorporated or formed under the laws of Canada or a province, that is controlled in fact by Canadians and of which at least seventy-five per cent, or such lesser percentage as the Governor in Council may by regulation specify, of the voting interests are owned and controlled by Canadians."
While this document frequently refers to principles normally associated with a corporate ownership structure, they would also apply to other ownership structures such as partnerships, proprietorships and trusts.
In this document, reference to a non-Canadian includes a person or entity related to that non-Canadian.
Definition: Concept of Control
It is important to distinguish between two types of control: control in law (known as de jure or legal control) and control in fact (known as de facto control). Control in law is generally manifested by the ownership of such number of securities that carry the right to a majority of votes. Control in fact goes beyond control in law and includes the ability to exert control by any direct or indirect influence.
III. Applicability of Control in Fact
Domestic air service: Air carriers must be Canadian to operate or propose to operate domestic air services, as per subsection 55(1) of the CTA.
Scheduled international air service: A non-Canadian is eligible to hold a licence for a scheduled international air service if, among other items, the non-Canadian has been designated by a foreign government or its agent to operate under the terms agreed to by that government and the Government of Canada. All other air carriers operating or proposing to operate a scheduled international air service must be Canadian.
Non-scheduled international air service: A non-Canadian is eligible to hold a licence for a non-scheduled international air service when the non-Canadian holds a document issued by the government of the non-Canadian's state or an agent of that government that provides for services that are equivalent to the non-scheduled international licence for which the non-Canadian is applying. All other air carriers operating or proposing to operate a non-scheduled international air service must be Canadian.
The Canadian requirement is a market entry as well as an ongoing requirement that must be complied with at all times. Where the Agency determines that a licensee ceases to meet the requirement, it has no discretion and must suspend or cancel the appropriate licence. Only carriers exempt from the requirement by the Minister of Transportation, Infrastructure and Communities are not subject to this statutory obligation.
IV. Agency View of Control in Fact
The Agency views control in fact as the ongoing power/ability, exercised or not, to determine or decide the strategic decision-making activities of an enterprise and the ability to manage and run its day-to-day operations. Minority owners and their designated representatives normally have the ability to influence a company, as do others, such as financial institutions and employees. The influence, which can be exercised either positively (i.e., the requirement for a positive approval to be given for a decision to be made) or negatively (i.e., ability to veto a decision), needs to be dominant or determining, however, for it to be considered control in fact.
Each case is unique
Control in fact depends upon the facts of each situation and so can only be evaluated on a case-by-case basis. As each case is unique, all managerial, financial and operational air carrier relationships, or proposed relationships, must be considered before making a determination. The applicant alone has the burden of satisfying the Agency that it meets the regulatory requirement to be considered controlled in fact by Canadians.
All the facts are weighed together
Normally, no single factor dictates whether control in fact is held by Canadians. Rather, the Agency considers and weighs all facts together to make a determination. There is no single objective test that can be solely relied upon to determine where control in fact lies and judgment is required to evaluate the facts of each case.
Control does not need to be exercised
Control does not need to be exercised for a person to have control in fact. For the purposes of compliance with the requirement to be Canadian, when the individual has the ability to control, whether exercised or not, they are considered to have control in fact.
Control can reside with different individuals
Control in law and control in fact can reside in the hands of different individuals or groups of individuals. Control in fact may exist even without ownership of any voting securities.
A determination that an air carrier is not controlled in fact by non-Canadians does not mean that it is controlled in fact by Canadians. Where an air carrier is controlled jointly by Canadians and non-Canadians, it would not be considered Canadian.
In a situation involving an ownership chain (e.g. where a company is owned by one or more companies which, in turn, are owned by one or more other companies), the Agency must determine who controls the company up to the top of the ownership chain, applying the definition of "Canadian" under the CTA at each step.
In determining where control in fact resides, the Agency assesses each applicable factor to determine whether it, individually or in combination with others, provides the non-Canadian(s) with the direct (e.g. formal voting or other rights) and/or indirect means (e.g. ability to exert influence through their investment in the company or through any other means) to control the company. The Agency also considers the intent and ability of the non-Canadian(s) to exercise control over the company, particularly where control is obtained through indirect means.
The following is a list of factors considered by the Agency, which is not exhaustive.
- Risks and benefits
- Concentration of voting interests
- Board of Directors
- Shareholder and Board of Directors' meetings
- Veto rights
- Security rights, options, and warrants
- Rights of first refusal / Pre-emptive rights
- Power to wind-up the company
- Lease of assets
- Financial strength and business activity
- Management agreements
- Operational or service agreements
- Charterer / air carrier relationship
It is impossible to list all of the factors that may be relevant in determining whether a Canadian is in a position to exercise control in fact over an air carrier. As each case is unique, the facts of each case will dictate which factors are relevant in assessing control in fact. That being said, ownership structures with little or no involvement by non-Canadians do not normally necessitate extensive analysis.
a) Risks and Benefits
The Agency generally expects that the parties that assume the majority of the risks and are entitled to the majority of benefits related to the air carrier's operation are the parties with the ability to exercise control in fact. Risks are generally tied to the level of economic interest in the air carrier including:
- investment in its voting, non-voting and debt securities;
- commitments for future investment; and
- any guarantees that may have been provided.
Benefits generally accrue from an entitlement to share in the expected profit of the company. They can also accrue from revenues that result from aircraft lease, managerial services, royalty and other similar agreements. However, as this is not always the case, the evaluation of other factors specific to each case is paramount to a determination.
b) Concentration of Voting Interests
The concentration of voting interests owned and controlled by Canadians versus non-Canadians can be indicative of where control in fact lies. Situations could arise where the majority of the voting interests, while owned and controlled by Canadians, are heavily dispersed among a large number of unrelated individuals each holding a relatively small interest. In this situation, if a non-Canadian or a group of non-Canadians, individually or together, holds a concentration of the voting interests, it could be indicative of Canadians not being able to exercise control in fact.
c) Board of Directors
The Board of Directors is elected by the shareholders to govern and manage the affairs of the corporation. For control in fact to reside with Canadians, Canadian shareholders must have the right to appoint the majority of the Board of Directors. In addition, the majority of the Board members must be Canadian. Generally, the same principle applies to Board members who are sitting on individual Board committees.
Officers of a corporation serve at the pleasure of the Board of Directors and are entrusted with the day-to-day responsibility of running the corporation. Officers normally do not have the ability to exercise control in fact and do not need to be Canadian for the corporation to be considered Canadian by the Agency. However, control in fact implications could arise if officers have a relationship with non-Canadian shareholders that provides a vehicle through which the non-Canadian shareholders can exert their influence over the operations of the air carrier.
e) Shareholder and Board of Directors' Meetings
A quorum indicates the minimum number of members required to be present at a meeting for it to be considered valid. The Agency generally expects a corporation's quorum provisions to require:
- a majority of the shareholders or directors present at a shareholders or Board of Directors meeting be Canadian; and
- a majority of the members at a Board of Directors meeting have been appointed by Canadian shareholders.
Where there are tie vote provisions, the director who is allowed to cast the deciding vote should be a Canadian who has been appointed by Canadian shareholders. The same general principle should apply at shareholders' meetings.
f) Veto Rights
Veto rights allow a shareholder or director to reject or veto a resolution in spite of having majority assent and come in many different forms. For example, the affirmative vote required of a specific shareholder or director for a resolution to pass is a type of veto right, as is the requirement for unanimous shareholder or director approval.
Generally, there are no Canadian ownership implications associated with non-Canadian shareholders and their designated directors having veto rights to protect minority shareholders' investment. As a general rule, veto rights that do not pose any control in fact implications deal with matters outside the scope of the day-to-day operations of the air carrier and which cannot impact on the operational, marketing and financial decisions made on an ongoing basis. For example, matters that are not normally considered to indicate control, but rather could represent normal restrictions to protect the minority shareholders' investment, include:
- the payment of dividends;
- the sale or transfer of major assets;
- the incursion of large capital expenditures;
- entry into large and significant agreements, mergers, amalgamations and large business purchases;
- amendments to incorporation documents; and
- the issuance or redemption of capital stock.
However, the accumulation of such restrictions could raise concerns that control in fact might be exercised by non-Canadians, especially where such restrictions have been combined with other means of exercising influence.
Veto rights which are comprehensive and broad could indicate control in fact resides with non-Canadians. For example, veto rights indicative of control include:
- the selection, removal and remuneration of the company's officers and executives;
- the approval of the annual business plan; and
- changes to airline operations of the carrier.
All examples are not intended to be exhaustive, but are meant to show how the Agency has dealt with similar matters in the past.
g) Security Rights, Options, and Warrants
When evaluating where control in fact lies, the individual rights, privileges, restrictions and conditions attached to each class of security are relevant. In addition to voting rights, there are other rights such as redemption rights (right to force the corporation to buy back securities), conversion rights (right to exchange one security for another), and buy-out rights (right to acquire another person's interest in a security) that could influence where control in fact lies. The same applies to rights associated with warrants and options that provide the right of conversion or the right to purchase securities of the corporation at specified prices. This particularly applies in cases where the holder has the right to convert from a non-voting to a voting interest.
Where these rights are exercisable at market prices and are reciprocal to all the owners, they would normally not be determinative of where control in fact lies. However, when a non-Canadian investor is the sole holder of the right or a disproportionate amount of the rights, particularly when the rights can be exercised at prices below the market price, it may indicate that control in fact resides with non-Canadian(s).
h) Rights of First Refusal / Pre-emptive Rights
Rights of first refusal and pre-emptive rights are contractual rights under which a person has an opportunity to purchase securities or other assets from the owner on specified terms prior to them being offered for sale to a third party. As long as they reflect typical terms and are exercisable at market prices, the Agency generally views such rights as a legitimate means to protect shareholders from situations such as undesirable takeovers. In terms of specific securities purchases, these rights would normally be reciprocal and in direct proportion to shareholdings. If the potential consummation of such a transaction could result in the air carrier no longer being Canadian, the proposed transaction will generally be considered to cause the loss of Canadian status unless an additional provision is inserted to ensure that no transaction of this type can proceed and be consummated unless the air carrier remains Canadian.
Debt transactions executed in the normal course of business activity do not normally pose any control in fact implications. However, where the monetary magnitude of the debt is comparatively significant to the other sources of financing, there could be implications on control in fact, particularly if there is reason to believe the intent for the transaction extends beyond typical financing. In these cases, the specific terms of the agreements would be of particular significance, especially if there are provisions that provide for the debt to be converted into voting securities of the company or if there are restrictions or veto rights that go beyond what would normally be expected from a passive lender.
The nature of the debt holders and their relationship to the air carrier would be equally important as a non-Canadian financial or lending institution would normally not have an interest in managing or influencing the direction of an air carrier and thus not raise concerns regarding control in fact. On the other hand, a non-Canadian air carrier or other non-Canadian investor might have different intentions, which could magnify indicators of control in fact in such transactions.
A debt or loan guarantee is a promise by a person or an entity to assume a debt obligation in the event of non-payment by the borrower. When the guarantee is provided by a non-Canadian, the monetary magnitude, the terms, the borrower's level of dependence and the guarantor's intent would be considered for any control in fact implications. Nevertheless, unless there are mechanisms in place for the guarantor to exercise its influence over the direction of the air carrier, a debt or loan guarantee will normally not be indicative of control in fact.
k) Power to Wind Up the Company
An individual shareholder or lender may be in a position to exercise control in fact over the affairs of an air carrier if it has the power to close down the company by calling loans payable on demand. However, this ability in and of itself does not bestow control in fact over the company's affairs. For example, a bank does not normally control a company even though it might have the ability to call a demand loan and wind up the company.
l) Lease of Assets
The operation of an air carrier is a capital-intensive business that often involves the purchase or lease of aircraft, hanger space and other key assets. An agreement with arm's length parties for the use of assets at market terms would not normally be indicative of control in fact, even in cases where there is a high concentration of assets being provided by one or a small group of parties. However, where the air carrier is dependent on a specific party to provide assets which cannot be obtained practically or financially elsewhere, it may indicate control in fact. In these cases, the nature of the relationship, the terms of the agreement, the intent or ability of the lessor party to influence the affairs of the air carrier would have to be considered.
m) Financial Strength and Business Activity
The comparative financial strength, business activity and relevant expertise of individual shareholders can indicate which shareholders exercise influence and control in fact over an air carrier. This is especially true when dealing with shareholders who are non-Canadian air carriers. In these situations, the shareholders' underlying intent for the equity investment is important, along with the ability or the requirement for the individual shareholders to offer financial, managerial and operational assistance to the air carrier. Nevertheless, the greater the financial ability and airline business acumen of the individual Canadian shareholders, the less likely a large, non-Canadian investor would be viewed as raising any control in fact concerns.
n) Management Agreements
Management services can be an essential component of an air carrier's business strategy and some management agreements could result in an independent entity managing the affairs of the air carrier. To avoid any control in fact concerns where management services are provided by a non-Canadian, the manager should be an independent contractor in the airline management business rather than an employee of a carrier. Remuneration should be based on services rendered with any incentive bonus representing a relatively small percentage of the overall fee and the overall corporate profit. In addition, the Board of Directors should have the authority for all major decisions and should have the right to terminate the management agreement if they are not satisfied with the manager's performance and, in any event, on reasonable notice and terms.
In the absence of these conditions or where there is an affiliation between the manager and a minority non-Canadian investor, control in fact could reside with a non-Canadian.
o) Operational or Service Agreements
Operational or service agreements for the provision of services to the air carrier can sometimes include the provision of an aircraft with flight crew, maintenance activities, ground-handling services, along with reservations and other computer-based services. Where the service provider is responsible for operations of the air carrier, it would normally be indicative of control in fact residing with the service provider. Similarly, if the service provider fee is based directly or indirectly on the profit or loss of the air service, it can be an indication of control in fact residing with the non-Canadian service provider.
Therefore, when a non-Canadian service provider has been contracted to perform the day-to-day operational functions of the air carrier, all major decisions (such as approval of the business plan, incursion of large debt and operational expansion) should remain with the air carrier's Board of Directors in order to avoid any control in fact implications. In addition, the air carrier must be entitled to the profit and be responsible for any loss associated with the operation of the air service.
p) Charterer/Air Carrier Relationship
A charterer leases the full aircraft capacity from the air carrier which it then sells to the public, normally through a travel agent. Charterers fall under provincial jurisdiction and are not subject to the Canadian ownership and control requirement of the CTA.
By the very nature of the relationship, charterers have the ability to enter into contracts with air carriers that dictate such items as the level of service to be offered, routes and schedules. Normally, these charterer/air carrier relationships do not pose any federal control in fact implications. However, if the charterer has assumed the role and responsibility of the air carrier, as evidenced by the assumption of the risks and entitlement to the benefits relating to the air carrier's operations, it would be indicative of control. This is especially true when the air carrier intends to conduct business with only one charterer.
All questions should be directed to the Agency c/o the Manager, Financial Evaluation.