Proposed Changes to Canadian Sanctions Laws Could Make Due Diligence ‘Practically Impossible,’ Law Firm Says

Canada recently proposed “significant changes” to its sanctions laws -- featuring a new 50% rule similar to the U.S. Treasury Department's -- that could change how companies conduct sanctions due diligence, including on Russia, law firms said this month. The firms said companies may need to review and update their due diligence processes to better identify beneficial owners but warned the proposed laws could make that process exponentially more challenging.

One portion of the draft legislation introduced as part of the country’s 2023 budget implementation bill could mimic Treasury’s 50% rule, which prohibits transactions with any company owned 50% or more by a sanctioned person or entity. Under the Canadian proposal, the country could deem a sanctioned person to have control over an entity if that person holds a direct or indirect 50% ownership stake in the business, McMillan said in an April 26 client alert.

The legislation also would allow Canada to establish that a sanctioned person has control over a business if that person is able to, directly or indirectly, “change the composition or powers” of that entity’s board of directors, the firm said, or if it’s “reasonable to conclude that the person is able to direct the entity’s activities.”

McMillan said these amendments “will deem control to exist in a much broader range of circumstances” than under current Canadian law. As a result, they could “expand the scope of entities and property” subject to Canadian sanctions, Cassidy Levy said, warning that businesses will need to “conduct heightened due diligence to mitigate their risk of sanctions liability.”

“However, doing so will be difficult,” the firm said, “if not practically impossible.”

The 50% or more approach in particular could make Canadian sanctions laws more “consistent” with those implemented by the U.S., McMillan said. But it also said the Canadian test doesn’t “expressly address the possibility that multiple sanctioned persons may individually own less than 50% of an entity but may cumulatively surpass the 50% threshold.”

The firm also said determining whether a sanctioned person has “the powers” to alter the composition of a board of directors “will require complex further assessments of potential deemed ‘control’ arrangements,” including in cases where the sanctioned person holds less than a 50% ownership stake. This proposal is “particularly concerning because of the inclusion of the ‘directly or indirectly’ language,” McMillan said, “and because it will be difficult if not impossible for third parties to ascertain whether a sanctioned entity may have some ability to affect board powers or composition.”

The firm noted shareholders in many private companies are able to nominate a director, and this wouldn’t “constitute control of the entity in any normal usage of that concept.” But under the proposed Canadian law, it “would be deemed to be control regardless of the size of the board.”

Cassidy Levy said this would be a “departure from sanctions enforcement” by the U.S., the U.K. and Canada’s “own enforcement record,” calling it the “most impactful” change of the three deemed ownership proposals. It would make sanctions due diligence “very difficult if not practically impossible for Canadians and persons in Canada seeking to comply with the law.”

The third proposal is “similarly problematic,” McMillan said, adding that it’s unclear which “activities” would be “sufficient” to determine whether a sanctioned person is able to direct the entity’s actions. It’s also not clear “how the reasonableness standard would be applied to a third party that has no access to confidential information about the sanctioned person” or that person's relationship with a separate entity “in which it owns some unspecified minority equity interest.”

McMillan said businesses subject to Canadian law may need to “re-assess their dealings” with entities that have even minor ties to sanctioned people, including in cases “where ownership levels are very low.”

Although Cassidy Levy said Canada’s potential adoption of a 50% rule could make some certain aspects of sanctions diligence “easier,” including by more closely aligning Canada’s laws with those of the U.S., the second test, which could require companies to determine whether a sanctioned person can change the composition of a board of directors, “raises serious concerns.”

“It is difficult to see how Canadians or persons in Canada could reliably and regularly determine if a sanctioned person can appoint one director to a third-party supplier or customer’s board of directors, but that is what would likely be required,” the firm said. It added that “anyone seeking to modify these provisions must act quickly to lobby” Canada’s Department of Finance and members of Parliament before they pass “likely in or before June 2023.”