Canadian Sanctions Alert: Your Counterparty May Be Subject To Sanctions Even If It Is Not Designated

Global Affairs Canada clarifies when sanctions restrictions can extend to companies that are not themselves designated but are owned or controlled by designated persons.

Global Affairs Canada (GAC) has issued long-awaited Guidance on Canada’s “deemed ownership” rules, providing important clarification on when a company that itself is not designated under Canadian sanctions laws may nevertheless be treated as controlled by a designated person. The Guidance is important because Canadian sanctions can apply not only to designated individuals and entities, but also to non-designated companies that are owned or controlled by them. As a result, a company that does not appear on any sanctions list may still present significant sanctions risks.

When Canada introduced the deemed ownership provisions into the Special Economic Measures Act (SEMA) and the Justice for Victims of Corrupt Foreign Officials Act (the Magnitsky Act), it significantly expanded the reach of Canadian sanctions. Under these provisions, if a designated person controls an entity, property owned, held, or controlled by that entity is deemed to be property of the designated person. Consequently, dealings involving an otherwise non-designated entity may be prohibited under Canadian sanctions law.

The provisions attracted considerable attention because of the breadth of Canada’s control test. Unlike sanctions regimes in many allied jurisdictions, the Canadian framework extends beyond majority ownership and includes broad concepts of board influence and de facto control.

Under section 2.1 of SEMA and section 2.01 of the Magnitsky Act, a person controls an entity – directly or indirectly – if any one of the following criteria is met:

1. the person holds, directly or indirectly, 50% or more of the shares, ownership interests, or voting rights in the entity;
2. the person is able, directly or indirectly, to change the composition or powers of the entity’s board of directors; or
3. it is reasonable to conclude, having regard to all the circumstances, that the person is able, directly or indirectly and through any means, to direct the entity’s activities.

Particular uncertainty surrounded the board control and de facto control tests. The statutory language provided little guidance regarding when a person would be considered capable of changing the composition or powers of a board, or when it would be reasonable to conclude that a person could direct an entity’s activities.

GAC’s new Guidance provides important insight into how the Canadian government interprets these provisions and confirms that they may apply in a broad range of circumstances.

The Three Control Tests

A designated person is deemed to control an entity, directly or indirectly, if any one of the following tests is satisfied.

1. The 50% Ownership or Voting Rights Test

Control exists where a designated person holds, directly or indirectly:

• 50% or more of the shares or ownership interests in the entity; or
• 50% or more of the voting rights.

The GAC Guidance highlights two important aspects of this test.

Aggregation of interests. Holdings of multiple designated persons are aggregated. Accordingly, the threshold may be met where several sanctioned persons collectively own or control 50% or more of an entity, even if none individually reaches the 50% threshold. GAC describes this approach as an anti-circumvention measure and notes that it generally aligns with approaches taken in the United States and the European Union.

Minority interests still matter. A designated person’s stake below 50% does not necessarily eliminate sanctions risk. Once the interests of other designated persons are considered and aggregated, the threshold may be met. Significant minority holdings by designated persons therefore warrant careful review.

2. The Board Control Test

Control also exists where a designated person can, directly or indirectly, change the composition or powers of an entity’s board of directors. According to the Guidance, this may arise where a designated person:

• has the right to appoint or remove a majority of directors;
• controls a voting majority through a shareholders’ agreement; or
• has other rights that effectively allow it to control board composition, even while holding less than 50% of the ownership interests.

3. The De Facto Control Test

The broadest test applies where, considering all the circumstances, it is reasonable to conclude that a designated person is able, directly or indirectly and through any means, to direct the entity’s activities. The Guidance identifies several factors that may indicate de facto control, including:

• influence arising from being the entity’s largest shareholder;
• rights under shareholders’ agreements or constating documents that confer dominant influence;
• buyback arrangements favouring a designated person;
• transfers of shares shortly before or after a sanctions designation where there is no evidence of an arm’s-length transaction at fair market value;
• the use of family members, business associates, former employees, or other proxies to hold interests on behalf of a designated person; and
• the use of trusts, shell companies, or other structures intended to obscure connections to a designated person.

This test is highly fact-specific and is intended to capture arrangements that conceal continuing influence or effective control.

Deemed Ownership Is Not the Same as Beneficial Ownership

The deemed ownership rules should not be confused with beneficial ownership requirements under Canada’s anti-money laundering and anti-terrorist financing regime. The sanctions legislation applies a 50% control threshold, whereas beneficial ownership obligations under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act published by FINTRAC Beneficial Ownership Guidance generally use a 25% ownership threshold. The two regimes serve different purposes and operate independently. Compliance with one framework does not necessarily satisfy the requirements of the other.

Illustrative Examples

The Guidance provides several examples of how the rules may operate in practice:

• A non-designated entity that is 50% owned by a single designated person is deemed controlled and therefore caught by the prohibition.
• A non-designated entity in which multiple designated persons collectively hold 50% of the ownership interests is caught through aggregation.
• A designated person holding only 40% of an entity may nevertheless be deemed to control it where a shareholders’ agreement allows it to appoint a majority of the board.
• An entity may be treated as controlled by a designated individual where ownership is purportedly transferred to a close associate following designation, but the surrounding circumstances suggest that the associate is acting as a proxy or nominee.

Practical Compliance Considerations

In light of the Guidance, organizations should consider the following measures:

• Look through ownership structures. Identify all persons holding ownership, voting, or governance rights in counterparties and transaction participants.
• Aggregate interests held by designated persons. Assess collective holdings rather than examining sanctioned persons individually.
• Review governance arrangements. Examine shareholders’ agreements, constating documents, veto rights, board appointment rights, and similar mechanisms that may confer control.
• Scrutinize recent ownership changes. Transfers involving family members, close associates, trusts, or intermediary entities, particularly around the time of a sanctions designation, should be treated as potential red flags.
• Maintain a robust sanctions compliance program. Screening and due diligence procedures should be designed to identify both direct sanctions exposure and risks arising from deemed ownership.

Key Takeaway

The Guidance confirms that sanctions screening cannot stop with a review of sanctions lists. Businesses should consider who owns, controls, and influences their counterparties, including through board rights, shareholder arrangements, and other indicators of de facto control. A company that is not designated may nevertheless be subject to Canadian sanctions restrictions where a designated person exercises sufficient ownership or control.