National security risks arising from foreign investments into Canada might, to the untutored eye, seem to be matters that are objectively assessed and not subject to widely divergent interpretation. For example, if a foreign investor from a country that is potentially hostile to Canada gains access to critical military technology through an acquisition of a Canadian business, it may not be difficult to conclude that there may be harm to Canada’s national security and such acquisition would be rejected under the Investment Canada Act’s national security review process. Recently, however, the Canadian Government’s reversal of a national security order issued by the Cabinet of the previous Government has underscored the subjective nature of a national security risk assessment. National security may be more in the eye of the beholder than previously thought.
The O-Net story
On March 27, 2017, the federal Cabinet approved the acquisition by O-Net Communications Holdings Limited (O-Net) of ITF Technologies Inc. (ITF) subject to conditions which have not been made public. O-Net, a Chinese investor and developer of optical networking components, is reported to be state-owned. ITF is a Québec company specializing in fibre components, modules, lasers and amplifier systems. However, this same transaction was subject to an order by the previous Government in July 2015 that O-Net divest its controlling interest in ITF on the ground that it would be injurious to Canada’s national security.
As previously reported in our Dentons Insight Back to the Drawing Board, after receiving the divestiture order, O-Net launched an unprecedented legal challenge on the basis that its rights to procedural fairness were breached—the order was made without providing O-Net with any basis for the national security concerns or an opportunity to respond to them—and that the federal Cabinet had failed to take into account a number of relevant considerations. In November 2016, with the consent of the Canadian Government, the Federal Court ordered the setting aside of the Cabinet order requiring the divestiture, and remitted the investment back to the Minister of Innovation, Science and Economic Development (ISED) for a “fresh” national security review. That review resulted in an approval of the investment.
Significance of the O-Net decision
Decisions relating to national security are subject to multi-departmental scrutiny which, apart from the federal government departments of ISED and Public Safety Canada, may include the Department of National Defence, and security and intelligence agencies, such as the Canadian Security Intelligence Service. Reviews can take up to 200 days (or more with the investor’s consent). As such, they are regarded as rigorous and are not taken lightly and, until the O-Net decision, were seen as unlikely to be susceptible to legal challenge.
The O-Net decision reminds us that national security risk is very much in the eye of the beholder. While the same agencies and departments that made recommendations to the federal Cabinet two years ago would have been involved in the “fresh” 2017 review, the result—an authorization versus a rejection—is diametrically opposite: national security concerns are now not regarded as serious enough to warrant a divestiture and any concerns are to be addressed through mitigation measures.
One explanation is that the previous Government was more hawkish on national security issues and therefore might have interpreted the same facts in a different manner. But there are other possible explanations for the divergent characterizations of the investment. One is that Canada has gained more experience with national security reviews and is increasingly following the US example of using mitigation agreements where possible rather than blocking transactions outright. However, mitigation agreements were also used by the previous Government. Another plausible explanation is that the passage of time between the closing of the O-Net transaction and the divestiture order by the previous Government might have rendered moot the need to require a divestiture as the ITF technology may have already been transferred during that period. If the technology horse had left the barn, then only a mitigation agreement would be necessary to address future technology transfers.
A third alternative explanation is that Canada’s foreign policy interests are highly salient to the determination of whether a national security issue exists. If the risk arising from the transaction was viewed as unclear (possibly as a result of the second explanation noted above), the current Government may have chosen to make a decision that would not detract from a closer relationship with China. Indeed, the Canadian Government’s National Security Guidelines released in December 2016 expressly recognize “the potential impact of the investment on Canada's international interests, including foreign relationships” as a factor in its review. This could make predicting the outcome of a national security decision more difficult as there could well be a clash between Canada’s diverse foreign policy interests. For example, the Government might have to decide whether to favour alignment with the US Administration with whom it is re-negotiating NAFTA, or with China with whom it is contemplating a free trade agreement.
Whatever the correct explanation (and we will never know given the lack of transparency surrounding the national security process), the O-Net decision underscores that foreign investors involved in transactions that might raise national security risks will increase their chances of getting their deal through by developing early on a government relations strategy that takes into account the range of possible factors that can influence a national security decision.