Canada: Back To The Drawing Board: Canadian Government Divestiture Order In National Security Case Set Aside And New Review To Take Place

Last Updated: November 21 2016
Article by Sandy Walker

In a consent order dated November 9, 2016, the Federal Court ordered the setting aside of a Cabinet order requiring a Chinese investor to divest control of a Canadian business for national security reasons.

The court also remitted the investment back to the Minister of Industry (now the Minister of Innovation, Science and Economic Development) to conduct a "fresh" national security review. The case relates to the acquisition by a Chinese developer of optical networking components, O-Net Communications Holdings Limited (O-Net), of control of ITF Technologies Inc. (ITF), formerly known as Avensys Inc., and its subsidiary, ITF Laboratories Inc. ITF is a Québec company specializing in fibre components, modules, lasers and amplifier systems.

This case represents the first time that a Cabinet decision on national security under the Investment Canada Act has been litigated. As we reported in our August 23, 2016 Insight on Foreign Investment Review, there have only been eight national security reviews since the introduction of a national security review process in 2009, with seven of these resulting in Cabinet orders and one investment being withdrawn.

O-Net's application for judicial review emphasized the lack of procedural fairness in the national security review process, a criticism that has repeatedly been made by foreign investors and their representatives who say that there is often little disclosure of the Government's concerns. The highest profile example of this was the rejection on national security grounds of Accelero Capital's acquisition of Allstream's national fibre-optic network for telecommunications three years ago under the previous government.

While the Government has not publicly stated why it has agreed to set aside the Cabinet order and undertake a "fresh review" in response to O-Net's application, it is noteworthy that the Federal Court order on consent follows the Finance Minister's comment in his Fall Economic Statement (delivered on November 1) that the Government will publish guidance on the national security review process before the end of 2016.

Background

On July 9, 2015, the Cabinet required O-Net to divest its controlling interest in ITF which serves clients in a number of sectors, including defence and security.

According to O-Net's court filings, O-Net had acquired control of ITF at a bankruptcy auction after no Canadian or North American investor offered to purchase the company. The Minister of Industry initiated a national security review because of concerns that the acquisition could be injurious to national security. The Minister then referred the investment to Cabinet for review, which ultimately rejected the acquisition and ordered O-Net to divest its interest in ITF.

On August 10, 2015, O-Net filed an application for judicial review of the Cabinet order seeking to have it quashed on several grounds. First, O-Net claimed that its rights to procedural fairness were breached, as the order was made without providing O-Net with any insight or basis for the national security concerns or an opportunity to respond to them. Second, O-Net claimed that the order was unreasonable, as Cabinet failed to take into account relevant considerations, including that:

  • ITF had been under non-Canadian control since 2005;
  • O-Net was a credible investor that could provide ITF with the support it needed to compete in the global marketplace;
  • The investment would not provide O-Net with access to any technologies or products to which it did not previously have access;
  • O-Net is publicly traded on the Hong Kong Stock Exchange and is subject to regulatory oversight;
  • The investment increased ITF's revenue projections and gave ITF access to a global and diversified customer base;
  • The investment created almost 50 new engineering jobs with an approved pension plan and share grant options; and
  • The order would discourage investment foreign investment in Canada and would jeopardize ITF's future success and the employment of its staff.

In its application for judicial review, O-Net also requested a complete record of all material and information that was before Cabinet, or should have been considered by Cabinet, with respect to the order. This request was denied on the basis that the "materials are confidences of the Queen's Privy Council for Canada" and could not be disclosed.

On August 11, 2015, the Attorney General of Canada filed a Notice of Appearance demonstrating the Government's intent to oppose O-Net's application. It has taken more than a year for the Federal Court proceeding to end on consent.

Changes to foreign investment review thresholds

In its Fall Economic Statement, the Canadian Government indicated its intent not only to issue guidance on the national security review process but also to raise the review threshold for investments by foreigners in Canada to CA$1 billion in target enterprise value next year – two years ahead of schedule. The review threshold determines which foreign acquisitions of control of Canadian businesses are subject to (generally) pre-closing approval by the Minister of Innovation, Science and Economic Development or (for cultural businesses) the Minister of Canadian Heritage under the Investment Canada Act's "net benefit to Canada" test.

In addition, as a result of the Canada-European Union Comprehensive Economic and Trade Agreement, the review threshold for investors from the European Union—and from other countries, such as the US, Mexico and Korea, through most-favoured-national (MFN) requirements in trade agreements—will rise to CA$1.5 billion in target enterprise value. The precise timing for implementation of this increase in the review threshold is not clear at this point.

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