Canada: "Deemed Ownership" Rule Now In Force: Addressing Heightened Canadian Sanctions Risk

Major changes to the Canadian economic sanctions regime, the most significant in recent years, are now in force. On June 22, 2023, the Budget Implementation Act 2023, No. 1 (the "Act") received Royal Assent, bringing into force significant amendments to Canada's autonomous sanctions regime including a new "deemed ownership" rule in the Special Economic Measures Act ("SEMA") and the Justice for Victims of Corrupt Foreign Corrupt Officials Act (Sergei Magnitsky Law) ("Magnitsky Act").

The following provides a brief overview of the amendments and discusses some immediate actions that should be considered in order to address the increased sanctions risk Canadian companies are now facing as a result of the new deemed ownership rule.

The final Act is substantively unchanged from first reading (see our client alert, Proposed Changes to Canada's Economic Sanctions Laws Create New Challenges and Uncertainty for background and our initial review of these changes). Notably, no changes were made to the proposed deemed ownership rule to address the concerns raised by the business and legal community in Canada, including the International Law Section of the Canadian Bar Association ("CBA").

A very broad deemed ownership rule

Most significantly, the Act alters Canada's sanctions legislation by adding "deemed ownership" provisions to SEMA (as section 2.1) and the Magnitsky Act (as section 2.01) as follows:

Deemed ownership

(1) If a person controls an entity other than a foreign state, any property that is owned — or that is held or controlled, directly or indirectly — by the entity is deemed to be owned by that person.

Criteria

(2) For the purposes of subsection (1), a person controls an entity, directly or indirectly, if any of the following criteria are met:

(a) the 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 in the entity;

(b) the person is able, directly or indirectly, to change the composition or powers of the entity's board of directors; or

(c) 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.

It is important to note that control, under this new test, is deemed to exist where only any one of the three criteria is satisfied (i.e., a person is deemed to have control over an entity if any of the criteria in paragraphs (2)(a), (b) or (c) is met). If one of the criteria is met, such a person will be deemed to own any property that is owned, held, or controlled directly or indirectly by the entity for purposes of the SEMA and Magnitsky Act provisions, including for purposes of applying their sanctions prohibitions against dealings in property of designated persons as well as the new mechanism enabling the Canadian government to seize and forfeit property relating to designated persons.

Companies should be vigilant as this "control test" is very broad — in fact, broader than many similar measures in allied countries.

For example, the "50% rule" in paragraph 2(a) is not aligned with United Kingdom and European Union regulations and guidance, which apply a "more than 50%" standard, as discussed in greater detail in our May 3, 2023 client alert.

More significantly, the criterion in paragraph 2(b) is both broad and vague, and unlike any ownership or control criterion used by Canada's allies, including the United States, the United Kingdom and the European Union. It could capture situations where a person may have only a minor or nominal role in the governance of an entity, such as being able to vote on board composition, appoint a single board member, or have contractual rights to nominate or remove directors. There are concerns that this may pose practical implementation problems as information relating to board composition, rights, and changes is often not public, and accordingly could lead to the imposition of sanctions measures on the property of entities that are not effectively controlled by designated persons.

Paragraph 2(c) acts as a residual or "basket" clause to bring situations (including those that could involve minority shareholders) that do not meet the requirements of paragraph 2(a) and 2(b) within the "control test". This may also lead to imposition of sanctions measures on entities that are not effectively controlled by designated persons. For Canadian businesses to be able to practically address this the risk posed by the "basket" clause, it will be important for the Canadian government to issue guidance on what circumstances it is "reasonable to conclude" that a person is "able, directly or indirectly and through any means, to direct the entity's activities."

Global Affairs Canada ("GAC") has not yet issued any guidance regarding the interpretation or application of these new provisions, or announced any timeline for doing so.

In submissions to the Senate Standing Committee on Foreign Affairs and International Trade and the House Standing Committee on Finance, the CBA recommended a number of changes to the proposed "deemed ownership" rule, noting that it in its current form it would create significant compliance challenges and is not aligned with sanctions legislation in allied countries and important trading partners, including the United States, the United Kingdom and the European Union, thereby putting Canadian businesses at a competitive disadvantage. None of the CBA's proposed amendments were reflected in the final version of the Act.

Some practical considerations requiring immediate attention

If they haven't already, companies should be reviewing their sanctions compliance policies and procedures to ensure they are brought into conformity with these new rules.

Some key considerations include the following:

• ongoing screening of counterparties – screening protocols, especially as they apply to parties that may own or control counterparties, should be updated to reflect the new criterion, which will likely require additional information regarding the counterparty's direct and indirect ownership, its board's structure and appointment rights, and other factors to identify parties, in addition to shareholders, who may be in a position to direct the counterparty's activities;
• internal sanctions reviews and risk assessments – past sanctions reviews, legal opinions, and risk assessments which continue to be relevant to the operations of the company should be revisited in light of the new deemed ownership rule, especially in those cases involving non-listed entities having connections to sanctioned countries or parties;
• formal and informal government guidance or determinations – past guidance and determinations received from GAC, whether informal or formal (e.g., a determination in writing that an activity does not engage Canada's sanctions prohibitions), should be carefully reviewed and assessed as it may no longer be effective or reliable given that the law in force at the time of such determination has now changed;
• transactional due diligence - it is expected that sanctions due diligence in mergers and acquisitions, joint ventures, commercial lending, private equity investments, investment funds, underwriting, and other transactions relating to debt and equity investment, should also be expanded to account for increased exposure arising out of these amendments; sanctions-related representations, warranties, covenants and certifications should also be carefully drafted to reflect the expanded scope of property now deemed to be "owned" by designated persons;
• property subject to seizure and forfeiture – the impact of the new rules is not limited to the sanctions prohibitions as they also apply to Canada's new regime for the seizure, forfeiture and disposition of assets considered to be "owned" by individuals and entities that Canada has sanctioned and thereby expand the scope of property that may be targeted with these measures — further details on Canada's use of this mechanism are discussed in our client alerts Canada Announces First Use of Seizure and Forfeiture Mechanism Against Sanctioned Persons and Canada Initiates Second Forfeiture of Property of Russian Sanctioned Persons, This Time Targeting Russian Aircraft.

Secondary sanctions: "a person outside Canada who is not Canadian"

The recent amendments also lay the groundwork for the imposition of secondary sanctions, something which Canada has not been actively engaged up to now. Subsection 4(2) of SEMA sets out a list of those "activities, whether carried out in or outside Canada, in relation to a foreign state" with respect to which the Canadian government may impose restrictions or prohibitions. The Act amends each of the sanctions authorities set out in paragraphs 4(2)(a) to (c), (e), and (h) to (i) to add "a person outside Canada who is not Canadian" to the scope of the prohibition that may be imposed by the Canadian government. For example, paragraph 4(2)(a) of SEMA now allows the government to make orders or regulations that restrict or prohibit the following activity in relation to a foreign state:

(a) any dealing by any person in Canada or Canadian outside Canada in any property, wherever situated, that is owned — or that is held or controlled, directly or indirectly — by that foreign state, any person in that foreign state, a national of that foreign state who does not ordinarily reside in Canada or a person outside Canada who is not Canadian [emphasis added];

This change grants the authority to the Canadian government to impose sanctions on non-Canadians in third countries (countries other than Canada and the foreign state that is the target of sanctions) for violations — or facilitation of violations — of Canadian sanctions, such as the dealings prohibition in paragraph 4(2)(a). In other words, the Act allows Canada to effectively impose secondary sanctions.

Canada's May 30, 2023 sanctions against Moldova targeting Moldovan oligarchs, business people, parliamentarians and politicians considered to be "instruments of Russia's malign influence campaign in Moldova" are a case in point. Because SEMA paragraph 4(2)(a) permitted the imposition of prohibitions regarding dealings with only the foreign state targeted by sanctions or nationals of that foreign state, these Moldovans could not be designated under Canada's Russia sanctions and instead it was necessary to issue new Moldova sanctions regulations. With these amendments now in force, the Canadian government will be able to list or designate any non-Russian individuals and entities, other than Canadians, under its Russia sanctions regulations.

Additional key changes

The Act also implements a number of other important measures intended to strengthen Canada's sanctions regime and address evasion concerns, including:

• the permanent withdrawal of the Most-Favoured-Nation preferential tariff for goods originating in Russia and Belarus;
• amendments to SEMA and the Magnitsky Act to support the effectiveness of the seizure, forfeiture, and disposal framework introduced in 2022 for assets of sanctioned parties;
• new obligations for the financial sector to report sanctions-related information to Canada's Financial Transactions and Reports Analysis Centre ("FINTRAC"); and
• authorizing FINTRAC and any Minister designated under SEMA or the Magnitsky Act to share information with one another if beneficial for the enforcement or administration of any order or regulation under SEMA or the Magnitsky Act.

For further discussion of these issues, please see our review in Federal Budget 2023: International Trade and Investment Law Analysis.

Conclusion

The Canadian statutory sanctions regime continues to undergo significant change and development, all so far in the absence of formal substantive guidance from Canadian authorities. These changes expose Canadian businesses to new compliance challenges and increased sanctions risks, liabilities and compliance costs, including those arising from the growing differences between Canadian sanctions and those of Canada's major allies.

Businesses should be carefully reviewing their due diligence and screening protocols as well as any past sanctions determinations, risk assessments, and opinions in light of these important changes to Canadian sanctions laws.

We anticipate that these amendments will not be the last, and our team will continue to monitor sanctions legislation and developments, including the release of long-awaited guidance from the Canadian government on its interpretation of these measures.