A Chinese company at the centre of a secretive order-in-council blocking investment on national security grounds is asking the Federal Court to review the government’s decision.
The first litigated national security case in Canada has foreign investors watching closely, says Joshua Krane, an expert on foreign investment review.
In 2015, O-Net Communications Group Ltd., a Chinese developer of optical networking components, acquired Montreal-based ITF Technologies Inc., which specializes in fibre components and modules, for $5 million. But in July, the federal cabinet issued an order-in-council requiring O-Net to divest itself of the Canadian firm within 180 days.
The order-in-council did not disclose the reasons for the government’s concerns about national security. Some experts have speculated that sales by ITF Technologies Inc. to the Canadian military may have been a factor.
O-Net’s application for judicial review, filed in August 2015, “is really the bellwether case about the disclosure requirement for the government making a decision on national security issues,” says Krane, a Toronto-based lawyer with Blake, Cassels and Graydon LLP.
In its application, O-Net claims that the government breached its right to procedural fairness by not disclosing its reason for concern over national security. The government meanwhile has defended its secrecy and refused to reveal why it ordered O-Net to divest.
O-Net did not return a request for comment for this article.
Under the Investment Canada Act, the federal government has the right to review acquisitions of control over Canadian companies by foreign-owned or foreign-controlled investors or companies.
If the investment exceeds a certain monetary threshold, the foreign investor must make an application for approval to the government. The government will review the investment to determine whether it will be of “net benefit” to Canada, considering factors such as the effects on Canadian employment, exports, innovation and compensation.
The government almost always approves the investment based on plans and undertakings given by the foreign investor, says Krane.
“Ninety nine per cent of investments in Canada are approved,” he says.
The last foreign investment to be blocked by the government on net-benefit grounds was in 2010, when BHP Billiton Ltd. was not allowed to go through with its hostile takeover of Potash Corp. of Saskatchewan Inc.
However, a 2009 amendment to the Investment Canada Act also allows the federal government to review any foreign investment – regardless of size – on the basis of national security.
Even though O-Net’s acquisition of ITF Technologies Inc. was not big enough to trigger a net-benefit review, it was still found “injurious” to national security under the Act.
“Unlike in the U.S. where their equivalent law sets out the criteria or types of investments that might give rise to a national security concern, the Investment Canada Act is vague on the point. So we don’t know,” he says.
Omar Wakil, a Toronto-based Partner at Torys LLP, agrees but says that in practice the Canadian approach to national security risk-assessment aligns with the approach taken in the U.S. One should assume, for example, that the government considers whether the investment would increase Canadian dependence on foreign suppliers for critical goods or services.
The government will also consider whether the foreign acquisition would “result in the transfer of technology or expertise contrary to Canadian interests, or create a risk of espionage or sabotage,” says Wakil.
The O-Net case could provide some answers if the Federal Court requires the government to reveal its reasoning.
“O-Net is a test case to see what the courts are willing to do,” says Krane. “There has been a lot of commentary on the lack of transparency in the Investment Canada Act and investors are often left wondering why the government made the decision that it did. This case will answer some questions about the government’s requirement to disclose the reasons for its national security decision.”
“I think that investors are closely watching,” he adds.
As well, the change in the federal government after the October 2015 election could have a significant effect on foreign investment review, says Krane.
“Based on what the Liberal leadership said during the campaign, there is a perception that Canada will try to be more open to foreign investors,” he says. “I think the expectation is that the government wants to welcome foreign investment and so I don’t expect to see the implementation of any rules that would hinder foreign investment.”
Wakil, also an expert on foreign investment review, is not optimistic that the O-Net case will result in increased disclosure about the inner workings of the national security review process. However, he agrees that the Liberals are likely to adopt a different approach to foreign investment.
The former Conservative government had a “centralized decision-making process” largely driven by concerns about China and certain other countries, says Wakil.
“Although Liberal investment policy will evolve over time, early signs suggest a different approach,” he says. “Trudeau has said he will be ‘open to global investment.’”
Although Trudeau’s statements on the subject focus on traditional “net benefit” reviews, Wakil also expects that the new government may have a different approach to national security.
“The number of reviews is unlikely to change under the Liberals, but there may be an increased willingness to approve investments conditionally – rather than block them – based on nuanced assessments of risk,” he says.
Overall, Krane explains, “the government has to balance its desire for investment with its need to protect national security. But ultimately Canada has an interest in encouraging foreign investment and I don’t think that’s going to change.”
Carolynne Burkholder-James is a former journalist and a lawyer at Heather Sadler Jenkins LLP in Prince George, B.C.