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Is it business as usual after Lochinver?

April 07, 2016


Partners James Hawes, Don Holborow, Robert McLean, Michael Pollard, Andrew Matthews
Senior Associates Victoria Anderson

Overseas investment

New Zealand Government Ministers recently declined consent for the sale of Lochinver Station to Shanghai Pengxin. The decision followed an application by Shanghai Pengxin to the Overseas Investment Office (OIO) for consent to the purchase. A copy of the decision is available here.

In their review, the Government Ministers decided that, in the context of such a large sale of land (approximately 14,000 hectares), the benefits to New Zealand of the sale were not "substantial and identifiable". The decision is an unusual one, particularly as the OIO recommended approval be given.

There has been a lot of media interest and commentary on the decision, but what does it actually mean for overseas investment in New Zealand going forward?

The consent requirement

Shanghai Pengxin was required to apply for consent for its purchase of Lochinver Station under the Overseas Investment Act 2005 (Act), because it involved "sensitive land". The Act sets out various criteria to be applied in consent applications.  One criterion applied in the case of sensitive land is that the investment must be likely to benefit New Zealand.  In the case of an acquisition of non-urban land exceeding 5 hectares, the benefit must be likely to be "substantial and identifiable".  Given the area of Lochinver Station, this enhanced "substantial and identifiable" measure needed to be met.

The decision

Lochinver Station encompasses a large area of farm land and operates as a sheep and beef farm.  The Government Ministers decided that, in the context of such a large sale of farm land, the benefits to New Zealand from the proposed sale to Shanghai Pengxin were not "substantial and identifiable".  There are specific reasons why this application for consent was declined.  These focus on the size of the farm and also the limited economic benefits in the context of a mature farm business. 

Key points from the decision:

Benefits small in context:  Shanghai Pengxin's OIO application did show some benefits to New Zealand (mainly focusing on conversion of a relatively small area of the land to pasture).  However, the benefits were small and not substantial enough for the application to be successful.  The context of such a large sale of land was highlighted (consistent with an earlier Ministerial directive letter effective from 2011 regarding the acquisition of large areas of farm land). 

Counterfactual test:  Following the Crafar farms decision in 2012, a counterfactual analysis has become the benchmark when assessing whether or not a benefit to New Zealand exists.  The Lochinver decision highlights the importance of identifying the right counterfactual to analyse benefits against.

The Government Ministers considered that the test for deciding if there was a benefit to New Zealand should be to compare the benefits associated with Shanghai Pengxin buying the land against the expected benefits from another New Zealand buyer.  The applicant and the vendor determined that the status quo was the likely counterfactual (i.e. the vendor would have retained Lochinver Station if Shanghai Pengxin did not buy it).  As a result, the application had compared the benefits to New Zealand from Shanghai Pengxin buying the land against the status quo.  The Ministers' approach makes it more difficult to show a substantial and identifiable benefit. 

For example, the Government Ministers considered employment created by the sale.  The application submitted that, against the status quo, new employment would be created resulting in a benefit to New Zealand.  However the Government Ministers considered that only a small number of jobs would be created when comparing Shanghai Pengxin's purchase to a purchase of the land by another New Zealand buyer.  Both would create new jobs, with Shanghai Pengxin creating some additional contracting jobs and a part-time role to assist in clearing land for conversion.  As a result, the specific benefit from Shanghai Pengxin as the buyer was considered small. 

This view was formed even though the vendor had indicated it would create many new jobs post-sale, applying the proceeds of the sale. 

Expert economic advice:  The Government Ministers sought expert economic advice on the application.  In his report, economist John Small carried out an analysis of the counterfactual scenario proposed by the applicant and the vendor (the status quo) and whether or not it was a suitable counterfactual.  Taking a long term, forward looking view, John Small considered that the vendor would in fact sell Lochinver Station.  The Station is not part of the vendor's core business and retaining it would not be consistent with its strategic direction going forward.  Taking a forward looking approach, a more suitable counterfactual was sale to another New Zealand buyer.   

John Small also reviewed the quantum of the benefits put forward in the application.  The fact that advice was taken by the Government Ministers demonstrates the importance of testing the possible counterfactual scenarios, to establish a robust counterfactual scenario.   

Economic factors are of high importance:  Economic benefits, such as creating employment, increased export receipts and increased productivity, are of high importance.  These factors are to be given more weight relative to other benefits, such as consequential benefits and non-economic benefits. 

Against the counterfactual of an alternative New Zealand buyer, the economic benefits brought by Shanghai Pengxin focused on conversion of a small area of the land from forest to pasture.  Overall, these benefits were considered small and therefore were given a low weighting.  For example, the increase in export receipts was considered difficult to quantify and likely to be small given that the relevant receipts would arise from farming once conversion of a small relative area of the farm to pasture had occurred.  The Government Ministers also considered that any benefit from increased export receipts would be small given the size of the converted land compared to the relevant export industries.  Comparing increased export receipts from any one farm conversion against its relevant export market looks to set an incredibly high threshold for applicants to reach. 

Reaction to the decision

The Lochinver decision has been headline news and resulted in much media discussion. 

There have been suggestions the decision was politically motivated. However, Economic Development Minister, Steven Joyce, has been quoted in the media as giving an assurance that there has been no change in New Zealand policy.

Media reports following the decision indicated that the applicant would be challenging the decision with judicial review.  That judicial review has now been withdrawn with the applicant citing in the press that the process was a distraction and they wanted to focus on management of their existing New Zealand farms, new product development and value-add exports to Asia. 

No real change

It is unusual for the Government to decline consent for an OIO application, in particular where the OIO has recommended that approval is given.  The Government did emphasise the context of a large sale of land.  We expect that farm land sales to overseas investors will continue to come under particular scrutiny – both from the regulator and the media. 

However, applications for consent are to be considered on a case by case basis.  Under the Overseas Investment Act regime, the Government has the right to refuse consent for any application where the relevant Ministers are not satisfied that the application meets the criteria set out in the Act.  This is not new.  The law is in place to ensure there are substantial and identifiable benefits to New Zealand from any overseas acquisition of farm land exceeding 5 hectares.  The Government has identified particular areas of concern, for example, vertical integration and aggregation of farm land.  This reflects the fact that the land-based primary sector is a very important part of New Zealand’s economy.  

In our view, Lochinver does not represent any real change to New Zealand’s overseas investment regime.  Rather, the regime has shown it has teeth and there were specific reasons to bite in this case.  We do not see the decision as a negative for overseas investors generally.  But investors do need to take the "benefits to New Zealand" test seriously and carefully assess the likely counterfactual scenarios and the benefits (particularly economic benefits) that will arise as a result of their transaction. 

The types of assets being acquired will affect the approach to a consent application.  Benefits to New Zealand can be more readily identified in a value-add business with incidental farm land assets - for example, a processing plant or dairy factory.  The acquisition of a stand-alone farm business like Lochinver is more difficult to "prove up" to the "substantial and identifiable" standard, particularly if it is of a large size. 

For an application involving large areas of rural land to be successful, overseas investors must clearly show that "substantial and identifiable" benefits will arise.  This can be a challenge in the case of mature, stand-alone farming assets. But it is a challenge that existed before the Lochinver decision and continues to exist.

With the withdrawal of Shanghai Pengxin's judicial review proceedings, the decision will not be tested in Court.  As such, the concepts discussed above remain unchanged. 

This article was originally published in October 2015.  It was updated in April 2016 following the decision by Shanghai Pengxin to withdraw its judicial review.