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Since COVID-19, deals involving foreign state-owned enterprises or enterprises related to public health or the supply of critical goods and services are increasingly subject to review

Investments by foreign state-owned enterprises or by private investors “assessed as being closely tied to or subject to direction from foreign governments” will be subject to enhanced scrutiny.

 

Oliver Borgers1 authored this publication.

The Investment Review Division (IRD), which is part of the Ministry of Innovation, Science and Economic Development Canada (ISED), is the government department responsible for the administration of the Investment Canada Act (ICA), the statute that regulates investments in Canadian businesses by non-Canadians.

The IRD interfaces with investors and other parties as part of a preliminary (informal) review of an investment to determine whether there are potential national security concerns. Where concerns arise, the IRD will work with the Minister of ISED, in consultation with the Minister of Public Safety and Emergency Preparedness, who will refer investments to the Cabinet (the Canadian Prime Minister and his appointed ministers, formally known as the Governor in Council), who may order a formal review if the investment could be injurious to Canada's national security.

The national security review process is supported by Public Safety Canada, Canada's security and intelligence agencies and other investigative bodies described in the National Security Review of Investments Regulations.

Since the pandemic, the Canadian government announced a new policy that would subject certain investments by non-Canadians to enhanced national security review. This policy applies to investments "related to public health or involved in the supply of critical goods and services to Canadians or to the government." The policy does not define what businesses are subject to this policy, as it is intentionally meant to apply broadly. The policy also sets out enhanced measures applicable to investments made by state-owned enterprises or investors working under the influence or direction of a foreign (non-Canadian) government.

 

WHO FILES 

The ICA is a statute of general application that applies to any acquisition of control2 of a Canadian business by a foreign investor. If the relevant financial threshold under the ICA is exceeded, the statute provides for a process of pre-merger review and approval of foreign investments to determine if they are of "net benefit" to Canada.

If the financial threshold is exceeded, the investor must file an application for review and the transaction must be approved by the relevant minister. A key element in the application for review is the requirement to set out the investor's plans for the Canadian business, including plans related to employment, participation of Canadians in the business and capital investment. An application for review is a much more detailed document than a notification. 

If the financial threshold is not exceeded, the investor has an obligation only to file a simple administrative notification form, which can be filed up to 30 days after closing. In either case (filing of an application for review or just a notification), the Canadian government has the jurisdiction for 45 days after receipt of such a filing to order a national security review if there are concerns. 

The entry point for national security review screening will usually be the obligatory filing under the ICA (either an application for review if the financial threshold is exceeded, or a simple administrative notification form if the threshold is not exceeded). The government also has the power to subject non-controlling minority investments to a national security review, although we are not aware of any instances of such a review to date. 

 

TYPES OF DEALS REVIEWED 

It is important to keep in mind that the Canadian government has the power to review any transaction (including minority investments) in which there are "reasonable grounds to believe that an investment by a non-Canadian could be injurious to national security." Unlike the "net benefit" review process under the ICA, there is no financial threshold for investments under the ICA's national security review regime. 

Further widening the potential scope of the national security review regime is the fact that there is no statutory definition of "injurious to national security." This lack of definition creates wide discretion for the minister and some uncertainty for foreign investors. 

The types of transactions that have been the subject of formal review under the national security lens include those relating to satellite technology, telecommunications, fiber-laser technology and critical infrastructure, as well as where a non-Canadian investor proposed to build a factory located in close proximity to Canadian Space Agency facilities. Investors subject to Canadian national security reviews have included American companies, as well as investors from emerging markets, but particular scrutiny can be expected for state-owned investors, especially since the announcement of the COVID-19 policy.

 

SCOPE OF THE REVIEW 

A national security review will generally focus on the nature of the business to be acquired and the parties involved in the transaction (including the potential for third-party influence). In assessing whether an investment poses a national security risk, the Canadian government has indicated that it will consider factors that focus on the potential effects of the investment on defense, technology and critical infrastructure and supply. The Canadian government will also focus on transactions related to public health or involved in the supply of critical goods and services to Canadians or to the Government of Canada. 

Review can occur before or after closing. Transactions that run the risk of raising national security concerns can seek clearance by making any ICA filings well before the proposed time of closing (at least 45 days, although because of the pandemic, government review times are taking longer and 90 days would be more prudent). The Canadian government may deny the investment, ask for undertakings and/or provide terms or conditions for the investment (similar to mitigation requirements in the US), or, where the investment has already been made, require divestment.

 

TRENDS IN THE REVIEW PROCESS 

The Canadian government has steadily increased its focus on national security, including rejecting mergers due to national security concerns. Since COVID-19, the government is being particularly careful to scrutinize the transactions it becomes aware of. In light of the decline in value of many Canadian businesses since March 2020, fewer transactions will be subject to mandatory approval. 

Given this decline in value, along with the newly recognized importance of certain businesses to Canada's ability to combat the pandemic and to ensure a continued supply of products and services essential to Canadians and the government, the enhanced review measures described above were announced to guard against potentially harmful or opportunistic foreign investments. 

In additions, under the enhanced policy, investments by foreign state-owned enterprises (SOEs) or by private investors "assessed as being closely tied to or subject to direction from foreign governments" will be subject to enhanced scrutiny to determine whether they may be motivated by "non-commercial imperatives" that could harm Canada's economic or national security interests.

 

HOW FOREIGN INVESTORS CAN PROTECT THEMSELVES 

Where a transaction gives rise to national security risks, non-Canadian investors should consider filing notice of the transaction with the minister at least 45 days prior to closing to obtain pre-clearance (assuming the minister does not seek further time under the national security review regulations). For an investment that does not require notification (i.e., a minority investment), the Canadian government encourages non-Canadian investors to contact the Investment Review Division at the earliest stage of the development of their investment projects to discuss their investment. 

As in other jurisdictions, it is therefore critical for foreign investors to consider Canadian national security review issues in planning and negotiating transactions. In particular, an investor should ensure that it secures a closing condition predicated on obtaining national security clearance in Canada, where appropriate. It may also be appropriate for merging parties to allocate the national security risk.

 

REVIEW PROCESS TIMELINE 

The process can take up to 200 days (or longer with the consent of the investor) from the date the initial notice of the transaction is sent to the Minister of ISED. The minister has 45 days (which can be extended by up to an additional 45 days) after an application or notification under the ICA has been certified, or after the implementation of a minority investment that does not require notification, to refer an investment to the Governor in Council for an order for national security review. If an order is made, it can take 110 more days (or longer with the consent of the investor) for the review to be completed.

 

UPDATE HIGHLIGHTS 

The 2020 Investment Canada Act Annual Report is overdue, no doubt because of the unprecedented challenges posed by the pandemic.

In 2019, for the first time, the Canadian government released details regarding transactions that were scrutinized on national security grounds reflecting the new mandatory reporting requirements on national security.

 

OUTCOMES 

In its Investment Canada Act Annual Report (March 1, 2019), the Canadian government reported that 15 national security reviews were ordered from April 2012 to March 2018 and, in all cases, the proposed investment was either blocked, abandoned or subject to conditions. These 15 investments involved the following industries: pharmaceutical and medical manufacturing; civil engineering construction; telecommunications, including telecom equipment manufacturing; ship and boat building; electrical equipment and manufacturing; rail transportation; computer and related services; and crude oil and natural gas. 

The majority of the 15 national security reviews involved investors from China and Russia. Also for these transactions, examples of mitigation measures that were considered or imposed on investments were disclosed by the government for the first time. 

  • Formal national security reviews have been ordered by the Cabinet 15 times since the national security review process was introduced from March 2009 to March 2018 (the date on which IRD has released statistics) 
  • Many more transactions have been the subject of informal national security review by the IRD, most often resulting in successful pre-clearance. Only a small fraction of the thousands of notifications and applications for review filed with the IRD have attracted national security scrutiny 
  • The outcomes of the 15 instances where formal national security reviews were ordered include: the investment was authorized with conditions that mitigated the identified national security risks (four cases); the investor was ordered to divest control of the Canadian business (five cases); the investor was directed to not implement the proposed investment (four cases); and the investor withdrew its application prior to a final order being made (two cases)

 

1 Oliver Borgers is a partner in the Toronto office of McCarthy Tétrault LLP (T +1 416 601 7654, E [email protected]). White & Case LLP has no affiliation with McCarthy Tétrault LLP.
2 Generally, an acquisition of greater than 50 percent of the equity or voting interests of an entity, though in certain cases an acquisition of greater than one-third of the equity or voting interests of a corporation, will be considered an acquisition of control. 

 

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