The rise of national security reviews

In May 2020, TMAC Resources Inc. announced that it had agreed to be sold to Shandong Gold Mining Co., a Chinese state-owned concern, for $ 230 million. In the following months, the deal received approval from TMAC shareholders, an Ontario court and federal competition authorities.

But by December of 2020, the deal was dead. The Canadian government blocked the transaction following a "national security" review. No specific reasons were given, but the logic was obvious. TMAC's main asset was the Hope Bay gold mine in Nuvavut, a sensitive region of the Arctic where Canada is intent on asserting its territorial sovereignty.

All of this unfolded during a period of heightened trade tensions with China and the chill that followed the arbitrary detention of Michael Kovrig and Michael Spavor in retaliation for Canada's arrest of telecoms executive Meng Wanzhou at the request of the U.S., where she was wanted on fraud charges.

The TMAC case was proof that Canada's national security regime has real teeth when it comes to mergers and acquisitions. And it's increasingly an area of practice that's uppermost in the minds of practitioners in competition law. So much so that the issue will be highlighted at the CBA's Fall Competition Law conference in Ottawa from October 20 to 21 in a session on merger clearance and national security reviews.

Canada has long screened large foreign acquisitions of businesses under the "net benefit" rule. But over time, the threshold for relevant transactions has grown, to the point where a deal involving a foreign buyer from a close trading ally like the U.S. or the U.K. has to have an enterprise value of at least $1.7 billion before attracting scrutiny.

National security reviews were formally created in 2009 when the Canadian government changed the Investment Canada Act to allow it to review any investment that "could be injurious to national security." Unlike the "net benefit" regime, no minimum dollar threshold was established.

The initial regime allowed a lot of government leeway to determine what constituted national security. "It was a complete black box," recalls Ian MacDonald, a partner at Gowlings WLG in Toronto specializing in competition and foreign investment law, who is moderating the conference panel. "They very deliberately took a 'we'll know it when we see it approach,' so foreign investors and their advisers didn't have any guidance."

Only after considerable pressure from the bar did the government issue detailed national security guidelines in 2016, establishing a list of nine factors to be considered, including Canada's defence capabilities, critical infrastructure and supply of critical goods and services.

"They focussed almost exclusively on the characteristics of the target business. If you only read those guidelines, you'd think that a U.S. public company trying to buy a sensitive Canadian business would be at the same risk as a Chinese state-owned enterprise. But people who practiced in the area knew that's not the case," according to MacDonald.

Once Ottawa began publishing statistics on the reviews, a clear pattern started to emerge, MacDonald said. A majority of formal reviews covered investors from China or other non-democratic countries like Russia. State-owned enterprises are also a focus.

"My own personal view is that the characteristics of the buyer are much more important than the characteristics of the target in terms of determining risk," MacDonald said. He cites the attempted 2013 takeover of Allstream, a fiber optic network owned by Manitoba Telecom Services Inc (MTS). The proposed buyer was a firm controlled by an Egyptian telecom billionaire. 

The government blocked the sale. Two years later, a U.S. company was allowed to buy Allstream "with no concerns."

Adam Kalbfleisch, a partner with Bennett Jones in Toronto and another panelist, agrees that the characteristic of the buyer is important, but so is the kind of business that's the target. One of the areas considered sensitive is "critical minerals," which include not just lithium or uranium but also commodities like copper, nickel and aluminum.

The result is that if a U.S. buyer is looking to acquire a nickel mine in Sudbury, Ontario, it would likely not be an issue, but if it were a Chinese buyer of the same asset, "there are no guarantees." Kalbfleisch noted. While there have only been a few dozen full national security reviews since 2009, about half were blocked, 30% unwound, and only a few cases allowed to proceed with no conditions. 

"Imagine you're an investor and looking at these statistics. This is like facing Nolan Ryan at his peak. It's not a great situation to be in. Avoiding them is the key if you can."

"A tiny percentage of the deals, well less than one percent, are notified, even get reviewed," says MacDonald, adding: "If you have a problem, it's likely a massive problem. When they do a full review, it most often ends choppily for the transaction. Either the transaction does not close, or divestiture is required."  

Although not mandatory, the guidelines encourage investors, especially state-owned enterprises or involved in sensitive fields, to file their notification forms at least 45 days before planned closing. This allows the buyer to complete the transaction with more certainty because the government has 45 days to initiate a formal review.

"These days, investors will sometimes negotiate to file prior to closing even though that is technically not required, but they want to surface the issue before they spend $30 million or $300 million," Kalbfleisch said.

Canada is not alone in its increased focus on national security reviews. The U.S., the U.K. and Australia all have their regimes, as do the vast majority of OECD countries, says Antonia Sherman, head of Linklaters' U.S. anti-trust and foreign investment group, based in Washington, another Conference panelist.

"In the last 10 years, foreign investment, which is not just national security, has become globally a lot more important," says Sherman, who notes that every country is different. Some emphasize national security, while others focus on critical segments of the economy like pharma or are worried about investments from sovereign wealth funds.

"Foreign investment regimes are spreading all over the world," Sherman says. "You need to be aware of this every time you do a transaction that involves a foreign buyer in addition to merger control." 

And while there's a general approach to how merger control systems work in most jurisdictions, focused on statistical measurements, the same can't be said for foreign investment and national security regimes. "It's all over the map, and it varies from country to country," she said.

This fast-changing environment means that for specialists like Sherman, "there's a fair amount of internal education to do, particularly with M&A lawyers. Antitrust lawyers are a bit more aware. If you're doing anything multinational, you absolutely need to keep your eye on it."