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On 22 March 2024, Canada passed the National Security Review of Investments Modernisation Act, making significant revisions to the Investment Canada Act (ICA) and broadening its review scope.

Just before this legislation passed, SRG Mining, a Canadian listed company, announced a strategic decision to terminate its deal with China Carbon One New Energy Group (Carbon One). Although SRG did not specify the reason for ending the deal, industry speculation suggests it reflects a failed attempt to evade ICA review by redomiciling the company. This article explores the context of the SRG-Carbon One transaction and the limitations on regulatory circumvention under the ICA.

The transaction

In July 2023, SRG announced a private placement worth CAD16.9 million (USD12.3 million), intending to allocate 19.4% of the shares to Carbon One. Given that graphite is a critical mineral in Canada, the deal was expected to undergo rigorous ICA scrutiny.

In November 2023, SRG decided to redomicile abroad to circumvent regulatory restrictions. That same month, SRG and Carbon One signed a non-binding term sheet that included a closing condition of SRG¡¯s redomicile outside of Canada, sparking considerable discussion.

In December, speaking to local media, a spokesperson from Innovation, Science and Economic Development Canada (ISED) said the government ¡°consistently takes decisive action against transactions that threaten national security¡±.

Additionally, on 4 March 2024, the minister of ISED warned against companies attempting to circumvent the rules. Doing so was ¡°always unwise … [the federal government is prepared to use] all tools at our disposal [to ensure compliance with Canadian law]¡±. Following these comments, SRG announced the termination of its deal with Carbon One, raising questions about possible government intervention and whether the deal breached ICA regulations.

Canada¡¯s review authority

The ICA outlines two review processes:

1. Net benefit review; and
2. National security review. The Canadian government¡¯s authority varies between these two types of reviews.

Under the ICA, a net benefit review applies if the transaction involves:

1. A Canadian business;
2. Control of the business is acquired; and
3. The transaction exceeds a specific monetary threshold.

A ¡°Canadian business¡± under the net benefit review must meet the three criterion of having a place of business in Canada, employing Canadians, and possessing Canadian assets for business operations. From the perspective of control, acquiring more than 50% of a company¡¯s shares is considered gaining control. Acquiring between 33.3% to 50% of a company¡¯s shares is also likely to be seen as obtaining control, unless evidence suggests that control has not, in fact, been acquired.

In contrast, the national security review covers a broader range of investment activities. Specifically, the jurisdiction of the Canadian government includes establishing new Canadian businesses, acquiring all or part of a Canadian business, or any investment in an entity operating in Canada if it meets any ¡°Canadian business¡± criteria.

Therefore, under the national security review system, transactions do not need to involve the ¡°Canadian business¡± required by the net benefit review, and even minimal Canada-related activities can fall under the scrutiny of the Canadian government.

Expanded review authority

The modernisation act expands the Canadian government¡¯s review powers in two specific areas. Under the net benefit review, the scope of the government¡¯s oversight of state-owned enterprises has been broadened, allowing for the review of certain investments by state-owned enterprises regardless of whether they meet the monetary thresholds typically required for net benefit review.

Under the national security review, the Canadian government¡¯s authority encompasses acquisitions by foreign state-owned enterprises of assets from entities operating within Canada, regardless of whether these assets are located domestically or abroad.

Anti-circumvention requirements

Once subject to an ICA review, the duration and scope of the review for Chinese companies, especially state-owned enterprises, largely depend on the discretion of the Canadian government. Reviews involving sensitive sectors or assets typically face significant challenges and often do not yield the desired outcomes.

Consequently, there has been market discussion on how to circumvent ICA scrutiny. For instance, SRG employed a strategy of redomiciling operations abroad in its transactions. There have also been discussions about back-to-back transactions, where intermediaries first deal with Canadian companies before selling to Chinese companies. However, under any scenario, Chinese enterprises must be mindful of the ICA¡¯s anti-circumvention provisions.

Under section 39(1) of the ICA, if the Canadian government believes a non-Canadian entity has circumvented ICA requirements, it can investigate and demand cessation or correction of the circumvention. Therefore, any attempt by Chinese companies to avoid ICA review through transaction structures may be considered a violation, leading to accountability under Canadian law.

Notably, anti-circumvention requirements apply only to non-Canadians. In the SRG-Carbon One deal, despite SRG leading the redomiciliation, the non-binding agreement suggesting the transaction depended on SRG¡¯s redomiciliation might indicate a circumvention agreement, thus breaching ICA anti-circumvention rules.

In conclusion, Chinese enterprises should exercise caution in transactions potentially subject to ICA review, communicating early with transaction partners to avoid violating anti-circumvention requirements.

Wang Jihong is a senior counsel and Zhao Huiqi is an associate at Zhong Lun Law Firm