Mergers And Acquisitions In The Defence Sector: A Strategic Lever Under High Surveillance

Mergers and acquisitions (M&A) in the defence sector carry distinct features that set them apart from transactions in other industries. The subject is particularly timely in today's geopolitical and economic environment, shaped by protectionist policies, heightened international tensions, Canada's renewed commitment to NATO and recent announcements of increased military spending and modernization of Canadian defence capabilities.

Against this backdrop, M&A transactions in the defence sector not only serve traditional commercial objectives: they now represent strategic levers to bolster industrial resilience, safeguard access to critical technologies and address national security imperatives. This article highlights key considerations for transactions involving a Canadian target, taking this dynamic into consideration.

1. Understanding the rules of the game: Regulation and national security

Foreign investors seeking to acquire control of a Canadian business must submit either a notification or an application for review under the Investment Canada Act. If the Minister has reasonable grounds to believe that a transaction could pose national security risks, the investment may be blocked or authorized only under specified conditions. Factors assessed include the potential impact on Canada's defence capabilities, the transfer of sensitive technologies or know-how, involvement in the research, manufacture or sale of defence-related goods and the potential effects on supply chains, among others. Acquisition agreements must therefore anticipate the possibility of a national security review—and the risk that the transaction could be prohibited or subject to strict conditions.

In parallel, the export of goods and technologies designed for, or capable of, military use is regulated under the Export and Import Permits Act. Depending on the circumstances, Canadian economic sanctions, the U.S. International Traffic in Arms Regulations (ITAR) and U.S. extraterritorial sanctions may also apply. Importantly, an electronic transfer, such as granting remote access to technology, may constitute an export that requires a license.

Moreover, even in the absence of an "export" from Canada, access to certain controlled goods is restricted to individuals registered under the Defence Production Act and the Controlled Goods Program.

These rules must be factored into pre-acquisition due diligence. Investors should be mindful of the constraints these laws and programs may impose, both during the acquisition process and in the post-closing integration of the target.

2. Managing sensitive data and intellectual property

Canadian defence companies often handle classified information or participate in confidential government contracts. This creates unique risks of non-compliance specific to the defence sector, limits the scope of due diligence procedures and raises particular challenges for post-acquisition integration.

Intellectual property is also a critical asset in the defence sector and requires thorough review. Contracts frequently include sector-specific provisions for IP assignment or licensing—often designed to ensure equipment maintenance and support after the contract ends. Where collaboration involves public institutions or foreign partners, ownership of rights can become even more complex.

3. Navigating a complex supply chain

The Canadian defence industry is deeply embedded in North American and global supply chains. Companies may operate as parts suppliers, integrators, or prime contractors, and they typically interact with governments, customers, suppliers and partners both domestically and abroad.

This interconnectedness creates strategic opportunities, but also exposes companies to regulatory vulnerabilities. For instance, Canadian entities must frequently comply with foreign standards such as the US ITAR, and a change of control can trigger requirements for third-party consents or regulatory notifications in multiple jurisdictions.

Accordingly, due diligence must include a careful review of liability allocation clauses, industrial and technological benefits obligations, and the status of ongoing projects—often the cornerstone of a target's success. Obtaining the necessary third-party consent should be built into the closing conditions. Finally, post-acquisition synergies must be evaluated in light of cross-border integration, which can serve as a powerful growth driver but also a significant source of contractual and regulatory complexity.

4. Financing acquisitions in a changing industry

For years, many public, institutional, and even private funds avoided the defence sector, often viewing it as incompatible with ESG (environmental, social and governance) principles due to reputational risks linked to weapons, conflict and corruption. That perception is now shifting, with defence being increasingly recognized as a strategic industry vital to national stability and sovereignty. Lenders and investors are responding by revising exclusion policies, distinguishing between defence-related and armament activities, developing sector-specific ESG frameworks, emphasizing transparency, governance, anti-corruption compliance and human rights, and introducing tailored due diligence mechanisms. As a result, while the sector remains sensitive, it is increasingly considered "investable" for companies that demonstrate strong governance, strict regulatory compliance and proactive ESG risk management. This transition period must be factored in the closing process, including with respect to financing terms, representations and warranties, and investor expectations.

5. Anticipating the impacts of geopolitical tensions

Beyond national security reviews, international tensions—whether armed conflicts, trade disputes or tariff wars—can directly affect defence-sector M&A. These developments can influence investment decisions, strategic alliances and regulatory approvals, while also disrupting supply chains, increasing costs and creating uncertainty. Acquisition agreements should therefore expressly address the potential impact of these disruptions on the transaction and its execution.

6. Integrating ESG, ethics and compliance considerations

The integration of ESG criteria is now critical to attracting capital and mitigating reputational risk. The defence sector has historically been vulnerable to corruption allegations, particularly given that governments are often the end-users and procurement processes frequently involve multiple intermediaries. Anti-corruption laws in Canada and other jurisdictions impose severe criminal and civil penalties on companies and individuals who offer or accept bribes. These risks must be carefully assessed during due diligence and reflected in acquisition agreements—particularly through representations, warranties and indemnification provisions—to ensure robust compliance and ethical safeguards.

7. Incorporating defence-sector considerations into deal documentation and negotiations

The unique features of the defence sector affect not only valuation and due diligence, but also the drafting of transactional documents and the dynamics of negotiations. Acquisition agreements typically include:

• Conditions precedent relating to governmental approvals, reviews under the Investment Canada Act, the granting of required licenses or authorizations, and counterparty consents for transfers or changes of control;
• Enhanced representations and warranties covering regulatory compliance, sensitive data management, intellectual property ownership, and the absence of corruption; and
• Broad indemnification provisions often tailored to address risks identified during due diligence, particularly around compliance with laws and regulations.

As with any M&A transaction, those in the defence sector must be carefully planned and executed. Industry-specific considerations should never be overlooked. In a context marked by rising public investment, mounting geopolitical pressures and the imperative of innovation and productivity, M&A remains a powerful growth driver—provided that the unique characteristics of the industry are fully addressed.

Our lawyers specializing in mergers and acquisitions and regulatory compliance work together to guide clients through these challenges and support their strategic growth in this highly sensitive sector.