To file or not to file: Hamlet meets Canada’s national security regime

December 2024 | SPOTLIGHT | MERGERS & AQUISITIONS

Financier Worldwide Magazine

December 2024 Issue

The last several years have seen the Canadian government toughen its enforcement of Canada’s national security investment review regime, as contained in the Investment Canada Act (ICA). These developments have raised the profile of national security concerns in Canada and present a variety of challenges for non-Canadians seeking to invest in Canada.

One such challenge is little discussed but arises frequently, i.e., when, and sometimes if, to commence the national security review process. The root of the problem lies in the fact that the ICA does not currently contain a comprehensive and mandatory filing regime for national security reviews.

As a result, non-Canadian investors may face uncertainty about the best filing strategy for dealing with the ICA’s national security review process.

It is important for non-Canadian investors to be aware of these issues from the outset because they can have important deal implications and can lead to disputes between investors and vendors, whose interests may differ.

ICA review

There are two streams of review under the ICA: net benefit review and national security review. The net benefit review process requires a non-Canadian investor to file an application (application for review) to obtain government approval for any acquisition of control of a Canadian business that exceeds prescribed thresholds.

In most cases, the application for review must be filed pre-closing and approval must be obtained before the investment can be completed. To obtain approval, the reviewing federal minister must be satisfied that the proposed investment is likely to be of net benefit to Canada.

If the review thresholds are not exceeded, the investor is only obliged to file a notice advising the government of the transaction (notification), either before or within 30 days of closing, which does not carry with it any net benefit approval requirement. Notifications constitute the vast majority of filings made under the ICA given that very few transactions are large enough to exceed the net benefit review thresholds.

The ICA’s national security review (NSR) process applies more broadly. Pursuant to this regime, the Canadian government can review all investments by non-Canadians in Canadian entities – regardless of value or degree of control – to determine if they could be ‘injurious’ to Canadian national security.

If the government identifies national security issues, it may prohibit the investment from proceeding, order the Canadian business to be divested (if closing has already occurred) or condition approval of the investment on the investor’s agreement to prescribed commitments. National security reviews may be as short as 45 days, but could last seven months or more if a full review is required.

There is no comprehensive filing regime for the ICA’s NSR process. If the investment falls within the net benefit review process, the commencement of the NSR process will be triggered by the filing of either the application for review or the notification.

If the investment is not caught by the net benefit review process, e.g., because it is a minority investment and there is no acquisition of control, the ICA now permits investors to make a voluntary filing, which will trigger NSR review, but there is no mandatory requirement to do so.

That said, investors that do not make a voluntary filing open themselves to the risk of potential review for up to five years following closing.

To file or not to file – that is the question

There are several scenarios in which investors may encounter uncertainty about what filing strategy to adopt for the ICA’s NSR process.

One example relates to the voluntary pre-closing notification process, which is still relatively new. This process was ostensibly designed to give minority investors a way to obtain pre-closing comfort that their investments would not be challenged.

But even where investors might advocate for this approach, there is an understandable reluctance on the part of sellers to create regulatory risk pre-closing when none is required, even though the government in theory could review and challenge such investments for up to five years following closing.

The same divergence of interests can become an issue in the most common scenario where uncertainty is created about the appropriate filing strategy, i.e., when the investment involves an acquisition of control of a Canadian business that is not subject to pre-closing net benefit review. In those circumstances, the non-Canadian investor is obliged to file a notification advising the government of the investment, which may be filed either before or within 30 days of closing.

Although there was always the option of filing the notification before closing, typical practice prior to the enactment of the ICA’s national security regime in 2009 had been to only file after an investment was completed. The introduction of the national security regime brought that strategy into question. With the growing importance of national security reviews, investors must now consider the strategic merits of filing the notification pre-closing, in order to allow the NSR process to run before the target business has been acquired and therefore to avoid the risk of sanctions being ordered post-closing.

Typically, the investor will also want the transaction agreement to make it a condition of closing that either no national security review will have been commenced pre-closing or if a review was commenced, it will have been resolved to the investor’s satisfaction.

Not surprisingly, vendors are not always amenable to this approach, given that there is no statutory obligation to file pre-closing and thus no requirement to share in any regulatory risk relating to the NSR process. The fact that a review could entail seven to eight months of delay in a worst-case scenario acts as another disincentive in this regard.

Indeed, we have seen cases where vendors insisted on a provision in the transaction agreement that expressly prohibited the investor from filing the ICA notification pre-closing.

Factors to consider

Whether in the context of deciding when to file the notification, or if to make a voluntary filing for a minority investment, the transaction parties will have to assess their respective best interests in light of their views of the potential costs and benefits of a particular filing strategy. Relevant factors are likely to include those outlined below.

The country of origin of the investor. The jurisdiction of origin of the non-Canadian investor is a key factor in assessing national security risk under the ICA, and thus whether it may be advisable to file pre-closing. The Canadian government has made it clear that it will closely scrutinise investments from ‘non-like minded’ jurisdictions that are considered hostile to Canada’s interests. In the 2022-23 period, for example, Chinese investors accounted for 16 of the 22 investments subjected to formal national security review.

Is the investor associated with a foreign state? The Canadian government will also pay close attention to investments by entities associated with foreign state governments, such as foreign government agencies, state-owned enterprises, or individuals who may be under the direction or influence of a foreign government. Although this is meant to apply generally, in practice the government’s concerns are largely focused on entities or individuals associated with China, Russia or other foreign governments falling into the aforementioned ‘hostile’ category.

Which industry sector is involved? Although the ICA does not define what constitutes a ‘national security interest’, government guidelines and practical experience make it possible to identify sectors that are more likely to attract government scrutiny. These include areas such as defence, critical infrastructure, sensitive technology, computer software and, more recently, healthcare supply chains (following the pandemic), personal data and critical minerals.

However, other investments that have been reviewed involved less obvious industries, e.g., grocery stores, taxi and limousine services and ‘schools and instruction’. This diverse range of sectors underscores the discretionary, constantly evolving and at times unpredictable nature of the ICA national security review process, which can complicate filing strategies.

Will there be pre-closing filings in other jurisdictions. If regulatory filings are anticipated in other jurisdictions, including foreign direct investment filings, there may be no downside to proactively filing in Canada as well, especially if the Canadian process is unlikely to be the ‘long pole’ in terms of timing.

The relative importance of the Canadian business to the transaction. We have seen cases where, even though other indicators pointed toward making a pre-closing filing, the investor opted not to do so because the Canadian business represented only a small part of the target business overall. In those circumstances, the investor preferred to deal with any possible issues in Canada post-closing, even the prospect of divestiture, rather than risk delaying the closing of the overall transaction.

Implications

The uncertainty of when to file a notification has to be addressed in the vast majority of investments for which filings are made under the ICA. The introduction of the voluntary filing process for minority investments has only expanded the ICA’s web of uncertainty.

In each case, the issue essentially boils down to an assessment of the risk that a full NSR will be commenced (pre-closing or post-closing) and who should bear that risk. In some cases, the answer can appear straightforward – in many it does not.

But given the recent sharp increase in the number of investments subject to some form of extended national security review in Canada, this is an important question of risk allocation that must be addressed between the non-Canadian investor and the vendor.

The Canadian government has recently enacted amendments to the ICA to provide for mandatory pre-closing filings for certain investments in prescribed sensitive sectors that may raise national security concerns.

However, the details of this new regime still remain to be worked out, including which sectors will be subject to mandatory notification. As such, even if the ‘file or not to file’ dilemma may be resolved for certain categories of investments, investors and sellers will still be left to puzzle their way through the NSR process in the others.

Mark Katz is a partner and Teraleigh Stevenson is an associate at Davies Ward Phillips & Vineberg LLP. Mr Katz can be contacted on +1 (416) 863 5578 or by email: mkatz@dwpv.com. Ms Stevenson can be contacted on +1 (416) 367 7627 or by email: tstevenson@dwpv.com.

Mark Katz and Teraleigh Stevenson

Davies Ward Phillips & Vineberg LLP