Canada: Potential New Impediments To M&A Transactions: Restrictions On Foreign State–Owned Enterprises And A New National Security Test In Canada


On October 9, 2007, Jim Prentice, Minister of Industry, announced that this fall the government of Canada will consider

  • introducing new guidelines on takeovers by foreign state–owned enterprises; and
  • amending the Investment Canada Act to permit the review of foreign investments that could compromise Canada’s national security.

The Minister’s announcement appears to preempt the work of an expert Competition Panel that the government charged with considering these and other issues, and that is due to report in June 2008.

Foreign State–Owned Enterprises

On the issue of investments by foreign state–owned enterprises, the Minister said that he did not want to block such investments; rather, he wanted to ensure that these investors operate under the same standards as other commercial enterprises, including standards of transparency, good governance and free market principles. It is unclear how the government intends to apply these standards, particularly since many state-owned enterprises meet these standards but many private companies do not.

National Security Test

On the question of national security, the Minister said that Canada’s rules should be brought in line with those of its major trading partners that allow for review of foreign investments on national security grounds. The previous federal government introduced legislation on this subject but it not survive the change in government in January 2006. At that time, stakeholders expressed particular concern that the term "national security" was undefined, potentially giving the government an open-ended authority to restrict a very wide range of investments.

United States

Canada is not the only country concerned with the national security implications of foreign investments. Later this month, the U.S. Foreign Investment and National Security Act of 2007 (FINSA) will come into effect. It expands the scope of foreign investments that will be subject to review by broadening the definition of "national security" and by presuming an effect on national security when the acquiror is a foreign government–controlled entity. National security will now include, along with traditional defence sectors, matters of "homeland security" and "critical infrastructure" – that is, systems and assets so vital that their incapacity or destruction would have a debilitating impact on U.S. national security. FINSA also expands the factors that the Committee on Foreign Investment in the United States (CFI) may take into account in assessing foreign acquisitions involving national security.

The CFI may subject any transaction to a 30-day review to determine its effect on national security. In that review, the CFI may take into account a variety of factors, including the effects on critical infrastructure, such as major energy assets and critical technologies, as well as the record of the foreign country involved in non-proliferation control, counter-terrorism and diversion of technology with military applications. When the acquiror is a "foreign government or an entity controlled by or acting on behalf of a foreign government," or involves critical infrastructure, FINSA mandates a more thorough 45-day second-stage investigation. However, that further investigation will not be required if the Secretary of the Treasury and the lead agency conducting the initial 30-day review jointly determine that the transaction will not impair U.S. national security. Following that investigation, if conducted, the President may suspend or prohibit any transaction that threatens to impair U.S. national security.

Steps Available to Investors to Protect Against Retaliation by Foreign States

Canadian and U.S. investors, when structuring their investments abroad, are increasingly making use of the protection offered by bilateral investment treaties to mitigate their political risk. Investors in the energy and resource sectors, in particular, have obtained significant arbitral remedies against foreign expropriation and arbitrary action by making their investments through a subsidiary formed in a jurisdiction that has a bilateral investment treaty with the state in which the investment is made.

The Canadian and U.S. developments described above potentially increase political risk for Canadian and U.S. investors abroad because certain foreign states may take reciprocal, retaliatory action against these investors. This is particularly so if an investor from a foreign state is blocked or otherwise hindered from making an investment in Canada or the United States.

Depending on the wording of a particular bilateral investment treaty that may apply, a Canadian or U.S. investor may be able to protect itself against the possibility of having a "national security" or "state-owned enterprise" exception used against it by a foreign state . Canadian and U.S. investors should carefully consider the language of each bilateral investment treaty that might be applicable, because some protect only against the mistreatment of existing investments, whereas others also apply to proposed new investments.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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