For more than a year, Canada’s foreign investment review regime has been on the cusp of a dramatic expansion that will supercharge foreign investors’ obligations to obtain pre-closing national security non-objection or approval in certain cases and enable the responsible Minister to impose conditions on investments. Although many important details are not yet available and the new regime is not expected to come into force until later this year, Canada’s new FDI reality is rapidly approaching, and it is no longer premature to consider the new framework in planning transactions involving a non-Canadian purchaser and a Canadian nexus of any kind.

Overview

Parties currently contemplating a transaction in which a non-Canadian may acquire any direct or indirect interest – including a non-controlling interest – in any Canadian business need to be mindful of the following:

• Transactions closing as early as this summer may be affected. Although Canada’s new FDI regime will come into force at some point in the next several months and we expect some “lead time” while the implementing regulations are finalized, it is difficult to predict exactly when the change will occur. Parties exploring or negotiating potentially in-scope investments (see below) should be thinking today about how the new rules may affect their transactions to avoid surprises – particularly where closing is anticipated around summer 2024 or later.
• A wide range of “sensitive” business activities are likely to be in scope. Transactions involving interests in Canadian businesses whose activities fall into a prescribed list of “sensitive” sectors are particularly likely to be affected by this transition. This list has not yet been released, but based on existing guidance we expect it to include businesses involving critical minerals, key infrastructure or supply chains, advanced technologies (such as AI or quantum computing), military, defence or law enforcement products and technologies and, possibly, anything involving Canadians’ sensitive personal data. We expect that, as in other jurisdictions with similar sector-based regimes, there will often be significant ambiguity as to whether a particular transaction is captured, which will make it essential to obtain practical and experienced advice early in the transaction planning process.
• Neither a majority investment nor a material Canadian nexus is required, and even indirect transactions may be captured. Canada’s new mandatory pre-closing notification requirements appear likely to capture a broad range of investments, including transactions involving the acquisition of non-controlling minority interests in a non-Canadian entity that is engaged in a prescribed activity and has a Canadian subsidiary or a Canadian branch location – potentially even if the prescribed activity is carried on outside Canada. It is not clear from the statutory language whether indirect minority interest transactions (e., acquisitions of minority interests in entities upstream from the entity with the Canadian presence) are captured. There is no de minimis threshold, so it will be important to consider whether each transaction requires a filing, even where the Canadian nexus is marginal.
• Transactions that are likely to be captured by the new regime and that may not be completed for several months should incorporate a plan for the transition to Canada’s new FDI framework. As drafted, the amending legislation does not include a “grandfathering” or “sunset” period, meaning that a captured investment could be significantly delayed if the new regime comes into force on the eve of closing and necessitates a pre-closing filing and non-objection or approval. To avoid being caught by surprise when the new regime takes effect, where the timing and subject matter of a contemplated or in-progress transaction creates the prospect that a mandatory pre-closing filing requirement may arise when the new regime comes into force, it may be advantageous during this transitional period to consider making a voluntary pre-closing filing and / or to condition closing on the absence or satisfactory conclusion of any national security process, with or without some form of “springing” mechanism reflecting the progress or content of the implementing regulations.

Each of these considerations is discussed in greater detail below.

Investment Canada Amendments Process Update and Likely Implementation Timing

The amendments to the Investment Canada Act, which will be enacted by Bill C-34, are close to the finish line, with changes expected to take effect in the second half of 2024. The changes will, on their face, impact transactions being signed today that will not be closed by the time the new national security rules have come into effect.

Introduced in the House of Commons in December 2022, Bill C-34 has now completed its Second Reading in the Senate and has been referred to the Senate Standing Committee on Banking, Commerce and the Economy for consideration (generally including the hearing of testimony from relevant experts, stakeholders and other invited witnesses) and, if necessary, return it to the House with proposed amendments. After leaving the committee stage, the bill will complete its Third Reading and receive Royal Assent and come into force on a date to be determined by Cabinet. As the Senate’s next sitting day is February 6, we expect that C-34 will receive Royal Assent no earlier than late February. In any event, the new regime will not become effective until its implementing regulations have been developed.

These implementing regulations, which have not yet been written, will set out the practical details of the new regime – including, crucially, the first set of “sensitive sectors” that will be subject to mandatory pre-closing filing requirements. Based on public statements and the last round of significant amendments to Canada’s FDI regime, we anticipate that draft regulations will be published for consultation with several weeks’ notice of the proposed coming into force date.

On this basis, we believe Canada’s new FDI regime is likely to come into force at some point in the second half of 2024, and possibly as soon as early summer. While in-progress transactions will likely have a good deal of advance warning as the implementing regulations progress, parties to such transactions will have to live with the contractual language they are negotiating now.

Sectors Likely to Be Prescribed for Mandatory Pre-Screening

Bill C-34 does not identify the “prescribed business activities” that will cause investments to be subject to mandatory pre-closing notification and approval. Rather, the list of prescribed activities is expected to be included in subsequent implementing legislation. We expect, however, that the list will be modeled at least in part on the Guidelines on the National Security Review of Investments and include some or all of the following:

• Activities connected to Canada’s defence capabilities and interests, including the research, manufacture or sale of export-controlled goods and technologies;
• Activities involving highly sensitive technology, intellectual property or know-how, particularly in advanced / high-tech sectors such as AI, biotechnology, robotics and quantum computing;
• Activities that relate to the supply of critical goods and services to Canadians or the Government of Canada, or to critical minerals and critical mineral supply chains;
• Activities affecting the security of Canada’s critical infrastructure, including processes, systems, facilities, technologies, networks, assets and services essential to the health, safety, security or economic well-being of Canadians and the effective functioning of government; and
• Activities that could enable the investor to gain access to sensitive personal data that could be leveraged to harm Canadian national security through its exploitation, such as biometric, financial or health information.

Although parties to transactions involving these sensitive activities may choose to make voluntary pre-closing filings today, the decision to make such a filing currently depends on the nature of the activity in Canada, the identity of the purchaser and numerous other factors, with many parties choosing not to file until after closing where there is no apparent national security concern or other compelling strategic need to do so. Under the new regime, investors will need highly practical advice about whether or not to file given “borderline” facts.

Investment Structure and Canadian Nexus Requirements

As proposed, the new regime appears likely to capture a number of transactions that have only minimal connection to Canada – even where the Canadian nexus is not otherwise related to the sensitive business activity. Under the new regime, a pre-closing filing will be required in respect of any foreign investment “to acquire, in whole or in part, an entity carrying on all or any of its operations in Canada” where:

• The entity has at least one of the following: (a) a place of operations in Canada; (b) an individual or individuals in Canada who are employed or self‑employed in connection with the entity’s operations; or (c) assets in Canada used in carrying on the entity’s operations;
• The entity carries on a “prescribed business activity” (to be defined in forthcoming regulations);
• The foreign investor could, as a result of the investment, obtain access to, or direct the use of, “material non‑public technical information or material assets” (also to be defined in forthcoming regulations); and
• The foreign investor would, as a result of the investment, have the power to appoint a member of the board of directors or of senior management, or a trustee or a general partner, or would have prescribed special rights with respect to the entity.

This very broad language would likely capture a direct minority investment (through which the investor would obtain some degree of access and control rights) in a non-Canadian entity that carries on a prescribed activity and has a Canadian branch, even if the prescribed activity had no other connection to the Canadian operations. It is not yet clear whether an indirect investment (i.e., an investment in an entity upstream of the one with the Canadian operations) would be captured, but we consider it possible that the government will interpret the new statutory text to require filings for indirect, minority investments.

Furthermore, it also appears that a purely internal reorganization could be captured in certain circumstances (including those involving significant minority investments), as the relevant exemption enshrined elsewhere in the statute applies only to transactions constituting acquisitions of control that result in no change to the ultimate controller of the Canadian business.

It is unclear whether the breadth of the new filing obligations is deliberate, or simply the result of hasty drafting. Unless the proposed amendments are revised, however, parties to transactions even tangentially related to Canada should plan to consult Canadian counsel to avoid missing a mandatory filing.

Implications for Contemplated and In-Progress Transactions Involving Canadian Operations

Historically, the overwhelming majority of control transactions have been subject to a straightforward notification obligation that could be completed at any time up to 30 days after closing. Non-control transactions were not subject even to mandatory post-closing notification. Except in rare circumstances where the purchaser or the subject Canadian business is highly sensitive, investors have been best advised to make Canadian FDI filings on a post-closing basis, both to minimize distractions during the pre-signing and interim period and, equally, to avoid creating a risk that the transaction might become the subject of some national security interest prior to closing. It is very common for international transactions with a very modest Canadian nexus to sign, or even close, before Canadian counsel are engaged to provide advice on FDI issues and coordinate the post-closing notification filing.

With the new Investment Canada Act regime imminent, however, that is becoming a potentially risky approach. Transactions signing now with very long interim periods are likely to become subject to the new regime, and may require a pre-closing filing.

As Bill C-34 does not include transition provisions immunizing transactions that are already in progress, parties to in-scope transactions that have not yet closed when the new framework comes into force will find themselves subject to an unexpected filing requirement and the obligation to wait 45 days – or even longer – before their transaction can legally be completed.

In this situation, it will sometimes be advantageous to have explicitly covenanted for a voluntary filing to be made before closing and conditioned closing on the absence or satisfactory conclusion of a national security process, in order to manage the risk of a last-minute review. However, simply making a voluntary filing in anticipation of the new regime may not be the right approach in every case, especially if deal closing timing is of critical importance. Vendors and targets, in particular, may wish to resist this strategy, as it eliminates any chance that a mandatory filing might ultimately be avoided and thus shifts the purchaser’s risk of a post-closing remedial order to both parties before closing. So-called “springing” provisions, which create an obligation to file only once it becomes clear to one or both parties that it is advisable to do so, may also be considered during this period.

In most cases, this level of strategy will not be necessary, and the right approach will be the practical path of filing shortly after signing or once the draft implementing regulations have been released. But, for some transactions, it will be worthwhile to think through these issues carefully in order to avoid pitfalls down the road.

[View source.]