The state of foreign investment review in Canada

January 2024 | SPOTLIGHT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

January 2024 Issue

The Investment Canada Act (ICA) authorises the Canadian government to review certain investments by non-Canadians in Canadian businesses and, where considered appropriate, to either prohibit these investments from proceeding, order investments to be unwound or divestitures made, or condition approval on undertakings and commitments by the investor.

There are two key aspects to ICA review: the ‘net benefit review’ process and the ‘national security review’ process.

Pursuant to the net benefit review process, a non-Canadian proposing to acquire control of a Canadian business (including a business in Canada owned by a foreign entity), and whose acquisition exceeds certain thresholds, must satisfy the government that its investment will be of net benefit to Canada. Typically, this is accomplished by the investor providing commitments (undertakings) to the government regarding matters such as the role of Canadian management, the number of employees, and investments in the Canadian business, post-closing. It is rare for approval to be denied on net benefit grounds.

In addition to net benefit review, the ICA authorises the Canadian government to review and prohibit proposed foreign investments if they would be “injurious” to Canada’s national security interests. The national security review process applies more broadly than does the net benefit review process, i.e., there are no monetary thresholds and no requirement that control be acquired.

There is no statutory definition for what constitutes “injurious” to Canada’s national security, which gives the Canadian government considerable discretion in this regard. That said, the Canadian government has published guidelines that outline areas of potential concern, including foreign investments that involve: (i) Canada’s defence capabilities and defence-related industries; (ii) the transfer of sensitive technology or know-how outside of Canada; (iii) the supply of critical goods and services to Canadians or to the Canadian government; (iv) critical minerals and critical mineral supply chains; (v) the security of Canada’s critical infrastructure; (vi) access to sensitive personal data that could be exploited to harm Canadian national security; and (vii) threats of foreign surveillance or espionage.

Trends

The key recent trend in ICA review is the steady decline in the number of net benefit reviews versus national security reviews.

Net benefit reviews. In the most recent year for which statistics are available (2022-23), there were only five applications for net benefit review outside of the cultural sector, down from 22 applications for review in 2016-17. The falling number of net benefit reviews reflects the cumulative impact of increases in financial thresholds for net benefit reviews first introduced in 2009.

Interestingly, despite the decline in the number of net benefit reviews conducted annually, the time required by the Canadian government to complete such reviews has increased. For example, the median review period for net benefit reviews was 64 days in 2018-19, 76 days in 2019-20, 77 days in 2020-21, 88 days in 2021-22 and 93 days in 2022-23. Generally, investors are well advised to anticipate reviews of up to 105 days in the ordinary course.

National security reviews. In contrast to net benefit reviews, the number of national security reviews continues to increase. In 2022-23, a record number of 22 investments were the subject of a full national security review, up from 12 such reviews the year before. This reflects the more robust commitment of the current government to monitor foreign investments for potential national security concerns, which represents a fairly recent change from its formerly benign attitude.

Given the growing importance of national security reviews, it is interesting to note a few features of such reviews, as extrapolated from the most recent 2022-23 statistics.

Of the 22 investments that went to formal review in 2022-23, slightly more than half were blocked or withdrawn; the others were permitted to proceed following review when no further action was found warranted under the ICA.

Not only may acquisitions of control lead to the initiation of formal national security reviews, in 2022-23, both minority investments and the establishment of new businesses featured prominently in the transactions subjected to formal review, accounting collectively for half of the 22 investments that went to review.

The jurisdiction of the investor remains a key factor in determining whether a transaction may be subject to formal national security review. As a general principle, the government will apply enhanced scrutiny to investments from hostile, non-like-minded nations. In practice, this policy has meant that Chinese investors continue to bear the brunt of the ICA’s national security review process. In 2022-23, 16 of the 22 national security reviews involved Chinese investors, all three of the forced divestitures involved Chinese investors, and seven of the eight withdrawals also involved investors from China.

State-owned enterprises

State-owned enterprises (SOEs) are a particular focus of foreign investment review under the ICA, with a variety of provisions and policy statements providing for the special treatment of investments by such entities. These apply to both the net benefit and national security review processes.

For example, a special (and lower) review threshold applies when the non-Canadian investor is an SOE. In addition, SOEs will be expected to provide specific undertakings over and above the usual types of net benefit undertakings relating to employees, investments in the Canadian business, and so on; SOEs must also provide undertakings guaranteeing their commitment to transparency and commercial operations, including adherence to Canadian standards of corporate governance and free market principles.

In a policy that was first announced in connection with the coronavirus (COVID-19) pandemic, but which has since been adopted permanently, the Canadian government will subject all foreign investments by state-owned investors, or private investors assessed as being closely tied to or subject to direction from foreign governments, to “enhanced” national security scrutiny, as such investments “may be motivated by non-commercial imperatives that could harm Canada’s national security”.

In the wake of Russia’s invasion of Ukraine, the government issued a policy stating that: (i) investments by “Russia investors”, including Russian SOEs, will only receive net benefit approval on an “exceptional” basis; and (ii) investments that have “ties, direct or indirect, to an individual or entity associated with, controlled by or subject to influence by the Russian state” will support a finding that there are reasonable grounds to believe that the investment could be injurious to Canada’s national security.

In October 2022, the government announced a policy governing investments by SOEs in Canada’s critical minerals industry. Like the Russia policy, this policy states that any such SOE investments will only receive net benefit approval on an “exceptional basis” and support a finding that reasonable grounds exist to believe that the investment could be injurious to Canada’s national security. The policy applies not only to SOEs, but also to private investors who are “closely tied to, subject to influence from, or who could be compelled to comply with extrajudicial direction from” foreign governments.

Proposed amendments to the ICA

Proposed amendments to the ICA signal that the government intends to ratchet up its powers even further with respect to foreign investment.

On 7 December 2022, the federal government introduced Bill C-34, National Security Review of Investments Modernization Act (Bill C-34) to enhance its ICA review powers. The headline amendment in Bill C-34 would expand the number of transactions subject to national security review by introducing a new pre-closing filing regime for investments in yet to be prescribed sectors. Specifically, non-Canadian investors in new or existing Canadian businesses engaged in the prescribed sectors would be required to provide notice of their investments in advance of closing and prevented from implementing the investment until the statutory review period has lapsed or been terminated. Importantly, this proposed mandatory notice requirement would apply to both direct and indirect investments in the prescribed sectors and, in certain circumstances, to investments to acquire less than control of the Canadian business. Non-Canadian investors that fail to comply with the pre-closing filing obligation would be subject to a penalty of up to $500,000.

Subsequent parliamentary deliberations have added an important new power to the proposed changes in Bill C-34. This proposed new power would authorise the government to order the net benefit review of investments that fall below the relevant thresholds in cases where the investor is an SOE from a country without a trade agreement with Canada, and where the government is “of the opinion that a review of the investment is in the public interest”. This discretionary ‘call in’ power, therefore, would not apply to major investors in Canada such as the US, members of the European Union, the UK, Australia, Japan and South Korea, all of which have trade agreements with Canada. However, it could be applied to investments from China (unsurprisingly) and other countries without such trade agreements with Canada.

Conclusion

The last few years have seen unprecedented government and public attention on foreign direct investment (FDI) into Canada and whether the ICA is ‘fit for purpose’ to address the issues of concern relating to such investments. The result has been a tougher approach to FDI, with more restrictive policies introduced and possible stricter ICA provisions on the legislative agenda. As such, it is now imperative for non-Canadian investors to address the potential implications of the ICA on deal economics and certainty.

Mark Katz is a partner at Davies Ward Phillips & Vineberg LLP. He can be contacted on +1 (416) 863 5578 or by email: mkatz@dwpv.com.

Mark Katz

Davies Ward Phillips & Vineberg LLP