Proposed Changes to Canada’s Economic Sanctions Laws Create New Challenges and Uncertainty
Businesses should be carefully reviewing their due diligence and screening protocols in light of recently proposed amendments to Canadian economic sanctions laws regarding dealings with non-sanctioned entities that may have connections to sanctioned parties. Any past determinations from the Canadian government or legal opinions relating to these issues should also be reassessed given these latest developments.
Canada’s economic sanctions measures prohibit a number of commercial transactions or relationships known as “dealings” with sanctioned persons known as “Designated Persons”. Such prohibitions include dealings in any property that is “owned, held, or controlled by” Designated Persons. With no statutory or administrative guidance available, interpreting the concept of “ownership” in this context has historically been extremely difficult for Canadian businesses and their advisors. Canada is proposing important amendments to sanctions laws which contemplate threshold criteria, presumably to facilitate the interpretation of ownership. That said, as further outlined below, the proposed amendments may not provide the intended much-needed clarity on this issue, and in some cases, even create additional ambiguity. They may also mark a significant departure from the US approach to “ownership”, creating additional risks for Canadian businesses.
Sanctions Amendments in Budget Implementation: Deemed Ownership
On April 20, 2023 the Budget Implementation Act 2023, No. 1 (the “Act”) was introduced for first reading in the House of Commons as Bill C-47. The Act is intended to make consequential amendments to legislation to give effect to the commitments made by the Government in its 2023 Budget.
One notable element of the Act is a series of comparatively brief amendments to the Special Economic Measures Act (“SEMA”) and the Justice for Victims of Corrupt Foreign Corrupt Officials Act (Sergei Magnitsky Law) (“Magnitsky Act”). The amendments are designed to provide greater clarity to those situations where Canada will look through the corporate veil when applying its sanctions restrictions against Designated Persons.
A Brief Background on the Sanctions
Both the SEMA and the Magnitsky Act contain restrictions and prohibitions around dealing with Designated Persons. The amendments in the Act specifically address the “dealings” prohibitions.
While the precise form of the sanctions measures vary from one targeted jurisdiction to another, the Special Economic Measures (Russia) Regulations (the “Russia Regulations”) provide an illustrative example of the general structure of the prohibitions regarding activities involving Designated Persons:
- It is prohibited for any person in Canada and any Canadian outside Canada to
(a) deal in any property, wherever situated, that is owned, held or controlled by or on behalf of a designated person whose name is listed in Schedule 1;
(b) enter into or facilitate, directly or indirectly, any transaction related to a dealing referred to in paragraph (a);
(c) provide any financial or other related service in respect of a dealing referred to in paragraph (a);
(d) make available any goods, wherever situated, to a designated person listed in Schedule 1 or to a person acting on their behalf; or
(e) provide any financial or related service to or for the benefit of a designated person listed in Schedule 1. [Emphasis added.]
In the ordinary course, the application of these prohibitions may be relatively straightforward. For example, if a Canadian were to enter into a transaction to purchase a product from an entity listed on Schedule 1 to the Russia Regulations, that would generally constitute a breach of section 3 (absent the granting of a permit or the transaction falling within certain exemptions as provided for elsewhere in the Russia Regulations).
While sanctions risks in some transactions may be relatively straightforward to identify, interpreting the prohibition above in paragraph 3(a) as it relates to dealing in property “owned, held or controlled by or on behalf of a designated person” has historically been extremely challenging, as the concepts of “ownership” and “control” are nebulous without the application of certain criteria. With no statutory or practical administrative guidance or helpful case law on how to interpret ownership, holding, or control in this context, Canadians engaged in cross-border transactions have struggled in conducting sanctions due diligence and risk mitigation without the benefit of meaningful interpretive tools. This has been in marked contrast with some of Canada’s key allies, such as the United States, the United Kingdom, and the European Union, each of which has implemented laws and practices that provide further clarity on these issues.
For over a decade, the business community has been calling for the Canadian government to provide guidance as to how entities that are wholly or partially owned or controlled by Designated Persons should be treated under our economic sanctions law. The draft amendments contemplated in the Act attempt to clarify how Canada will determine whether a sanctioned person “controls” an entity and is therefore considered to own its property for the purposes of the application of sanctions rules. In doing so, the amendments codify a “deemed ownership” structure, which at first glance appears to be somewhat of hybrid of other jurisdictions’ regulatory regimes.
Canada’s Allies’ Approach
In addressing this issue, the US approach solely considers whether “blocked” persons (including those listed on the annexes to an Executive order or otherwise placed on the Office of Foreign Assets Control’s list of Specially Designated Nationals) own at least 50% of a given entity. If that entity is at least 50% owned by a blocked person, then the property and interests of that entity are blocked, and that entity becomes a blocked person itself for purposes of applying the sanctions prohibitions. In practice, this can then be used to create a “waterfall” of blocked person classification. Here, we note that a true joint venture with equal ownership between a blocked person and a non-blocked person may itself become a blocked person, because it fulfills the so-called “50% rule”.
The EU approach is similar, but with a distinct requirement. First, the EU sets the bar on ownership at more than 50% of the proprietary rights of the entity. Accordingly, if there is a 50/50 joint venture between a sanctioned person and a non-sanctioned person, there is will be no ban on directly or indirectly engaging in a transaction with the joint venture. Second, the EU also applies a separate control test so that even if an entity would not be covered by the ownership criteria, it may still be de facto controlled by a sanctioned person, and thus subject to EU sanctions prohibitions.
Similarly, the UK applies distinct ownership and control tests. UK guidance provides that an entity is considered to be controlled directly or indirectly by a designated person if the person holds more than 50% of the shares or voting rights in an entity, if the person has the right, directly or indirectly, to appoint or remove a majority of the board of directors of the entity, or if (most subjectively) it is reasonable to expect that the person would be able to ensure the affairs of the entity are conducted in accordance with the person’s wishes. For example, if Person A (an individual) is not themselves designated, but is a family member or friend of a designated Person B, and there is evidence that Person B is using Person A to enter into transactions, Person A will be subject to the same restrictions as Person B.
The Proposed Canadian Approach: Deemed Ownership
Possibly inspired by the various approaches of our allies, Canada proposes an identical change to both SEMA and the Magnitsky Act that would deem property of an entity to be owned by a person when that person is considered to “control” the entity:
(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.
(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.
Importantly, the amendments do not create a rebuttable presumption of control; instead, control is deemed to exist where only one of the three criteria is satisfied. This precludes, for example, the ability for an entity to claim that its 50%-owner is a simple passive shareholder without any practical control.
On its surface, this change appears to align Canada with a hybrid version of the US, UK and EU approaches. In reality, the new “deemed ownership” structure creates situations where Canadian sanction measures are in some cases far stricter and in others far looser than those of the US, UK and EU. This can result in inconsistent outcomes between jurisdictions when determining whether a non-sanctioned entity is owned or controlled by a sanctioned entity. Below we highlight some key observations.
Deemed Ownership, Not Deemed Designation
The Canadian approach applies a 50% or more share ownership criterion similar to that of the United States. Unlike the US regime, however, it does not contemplate the practical scenario where numerous designated individuals in a transaction could collectively meet or exceed the 50% threshold, but individually would not. Notably, the Canadian approach also imports from the EU and UK systems conditions whereby ownership or control of an entity by a designated person means that the sanctions measures will also be applicable to that entity’s property.
Because the Act would treat the property of a Designated Person’s subsidiary as the property of the Designated Person, but does not appear to make the subsidiary itself a Designated Person, could one could provide financial or related services to or for the benefit of that subsidiary so long as one avoided dealing in its property, as the prohibition in paragraph 3(e) above only applies to services being provided to a Designated Person? Alternatively, could one simply make goods available to that subsidiary while not dealing in any property it holds (as the prohibition under paragraph 3(d) only applies to providing goods to Designated Persons)? The proposed amendments do not provide a clear answer. It is also unclear whether one could create a “waterfall” of Designated Persons classifications as is done by US sanctions authorities as described above.
Further, because many exemptions from the sanctions prohibitions set out in each target country regulation apply in respect of “Designated Persons” rather than the property owned by Designated Persons (for example, payments to be made to Canadians by Designated Persons pursuant to contracts entered into before they were designated), it will be necessary to amend the sanctions regulations to ensure the exceptions continue to apply.
Ability to Make Board Changes – Too Broad?
Beyond share ownership, Canada would impose the deemed ownership rule for entities where a Designated Person, “is able, directly or indirectly, to change the composition or powers of the entity’s board of directors”.
As drafted, this provision is nearly impossibly broad, and interpretive guidance will be required to appropriately assess the concept of being “able” to change the composition of a board. Would voting on a board slate constitute this ability? Would the right(s) of a minority shareholder to appoint a board member trigger this ability? Is it reasonable that a small minority shareholder who has the ability to appoint one of 12 directors on an entity’s board should be considered to “control” that entity?
The Residual Test – Lack of Clarity Continues
While there is now increased clarity for entities that are wholly or majority-owned by Designated Persons, situations involving minority share ownership or other control remains ambiguous. For entities that are not caught by either of the tests set out in either paragraphs 2.1(2)(a) or (b), the Canadian government has essentially continued the status quo with its residual test for control. These entities are still subject to an analysis as to whether they are controlled by a Designated Person. While this is in line with the EU approach, the combination of criteria in assessing ownership will prevent Canadians from making a comprehensive and clear decision on the viability of a transaction, especially if Canada continues to refrain from issuing meaningful guidance on the interpretation of its sanctions laws.
Foreign State Exemption – What is Covered?
The deemed ownership rule excludes entities that are “foreign states”. As defined in SEMA, a “foreign state” means a country other than Canada, including:
- any political subdivision thereof;
- the government and any department, of a foreign state or of a political subdivision thereof; and
- any agency of a foreign state or of a political subdivision thereof.
As such, a person who controls a “foreign state” (including a government department or ministry) will not be deemed to own any property that is owned – or that is held or controlled, directly or indirectly – by that entity. This avoids cases where a minister or head of government is a Designated Person, and all property owned by the subdivision they may control (by virtue of the application of paragraphs 2.1(2)(b) or (c)) would thereby be deemed to be owned by them.
The Act proposes 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”);
- amendments to enhance the Canadian government’s legislation implementing a publicly accessible beneficial ownership registry; 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 – An Effort to Bring Clarity Instead Raises New Issues
While the Act attempts to provide objective, albeit very broad, criteria for the determination of ownership, there remains significant ambiguity in the application of the amendments. Furthermore, the Act does not contemplate amendments to the existing country-specific regulations under SEMA and the Magnitsky Act. These regulations will likely need to be amended in order to reflect the new rules contemplating dealing with property deemed to be owned by Designated Persons.
Businesses should be carefully reviewing their due diligence and screening protocols in light of these important changes to Canadian sanctions laws. This includes the due diligence conducted on counterparties, targets and business partners in acquisitions, joint ventures, underwriting, financings, and other investment and commercial transactions.
It will also be important to reassess any past determinations received from GAC or legal opinions confirming that an activity in relation to non-sanctioned entity wholly or partly owned by a Designated Person is not prohibited under Canadian sanctions measures, as these determinations may be affected by the changes proposed in the Act.
So far, the Canadian government has not made any announcements regarding the issuance of guidance on the interpretation of these provisions, or the amendment of the country-specific sanctions regulations to align them with these proposed changes.
 The first reported decision considering the issue of when an entity is considered to be under the “control” of a listed entity, Angophora Holdings Limited v. Ovsyankin, 2022 ABKB 711, was released last year by the Court of King’s Bench of Alberta. While the Court’s decision is not determinative of the control issue or necessarily precedential, it may provide some guidance as to the assessment of control and the likely development of the jurisprudence. Please see our review in Courts take on the “control question” under Canadian economic sanctions for further details.
 OFAC Revised Guidance on Entities Owned by Persons Whose Property and Interests in Property are Blocked, issued April 13, 2014.
 See, for example, Council Regulation (EU) No 833/2014 of 31 July 2014 concerning restrictive measures in view of Russia's actions destabilising the situation in Ukraine, Article 5aa of which provides:
- It shall be prohibited to directly or indirectly engage in any transaction with:
(a) a legal person, entity or body established in Russia, which is publically controlled or with over 50 % public ownership or in which Russia, its Government or Central Bank has the right to participate in profits or with which Russia, its Government or Central Bank has other substantial economic relationship, as listed in Annex XIX;
(b) a legal person, entity or body established outside the Union whose proprietary rights are directly or indirectly owned for more than 50 % by an entity listed in Annex XIX; or
(c) a legal person, entity or body acting on behalf or at the direction of an entity referred to in point (a) or (b) of this paragraph.
 UK Financial Sanctions: General guidance for financial sanctions under the Sanctions and Anti-Money Laundering Act 2018.