Canada clarifies application of sanctions laws

Global Affairs Canada (GAC) has published guidance on the deemed ownership provisions of Canada’s economic sanctions legislation. The guidance provides important details on when an entity which is not itself on Canadian sanctions lists may nevertheless be subject to sanctions prohibitions.

The guidance confirms that the sanctions analysis extends well beyond formal majority ownership of an entity. It introduces an aggregate approach to the traditional 50% ownership threshold and provides guidance on when board rights, contractual arrangements, minority shareholdings, and other indicia of de facto influence may establish “control” of the entity, triggering sanctions restrictions. The result is that sanctions-screening exercises require an examination of both formal ownership and the practical realities of control.

What you need to know

• Unlisted entities may be caught by Canadian sanctions laws. Under the Special Economic Measures Act (SEMA) and the Justice for Victims of Corrupt Foreign Officials Act (JVCFOA), property owned, held, or controlled by an entity is deemed to be owned by the person who controls that entity. If that person is listed, a prohibition on dealing extends to the entity even though the entity is not itself listed.
• 50% formal ownership is assessed collectively. GAC will aggregate the legal interests of multiple listed persons. If listed persons collectively hold 50% or more of an entity’s shares, ownership interests, or voting rights, the entity will be deemed to be controlled by those listed persons.
• Less than 50% formal ownership is not a safe harbour. Control may also exist where a listed person can impact the composition or powers of an entity’s board or where, having regard to all the circumstances, it is reasonable to conclude that the person can direct the entity’s activities, even if they do not legally own or control the entity.
• Substance matters, not just formal ownership. GAC’s guidance endorses a contextual approach to assessing “control” and identifies shareholder agreements, dominant influence, buyback rights, transfers around the time of designation, the use of closely connected persons, and opaque corporate structures as factors that are potentially relevant to assessing whether an entity exercises de facto control.
• Due diligence needs to go beyond corporate searches. Given the emphasis on de facto control, sanctions compliance programs require rigorous due diligence to understand the parties involved in a proposed activity.

Why deemed ownership matters

Canadian sanctions legislation restricts dealings in property owned or controlled (directly or indirectly) by listed persons. The deemed ownership provisions extend those restrictions by stipulating that, in effect, where a person controls an entity, property that is owned, held or controlled by the entity is also deemed to be owned by that controlling person.

The consequences of these provisions can be significant. A company does not need to appear on a Canadian sanctions list for dealings with its property to be prohibited. An unlisted subsidiary, affiliate, or other entity may be subject to the same dealings prohibition applicable to a listed person.

GAC’s guidance focuses on the three statutory routes by which ‘control’ can arise.

The 50% rule and aggregation of listed interests

The first control criterion applies where a person holds (directly or indirectly) 50% or more of an entity’s shares or ownership interests, or 50% or more of its voting rights.

GAC states that the interests of listed persons are to be aggregated. For example, where two listed persons collectively own 50% of an unlisted entity, but neither individually owns 50% or more, that entity is considered owned by listed persons and the dealings prohibitions applicable to them extend to the entity.

Aggregation is intended to address sanctions circumvention, including attempts to divide ownership among multiple designated persons to avoid a formal control threshold.

The guidance makes it equally clear that 50% is not a safe harbour. Even where a listed person falls below that threshold, either of the other two control criteria may apply.

That is a significant departure from US sanctions, where the Office of Foreign Assets Control (OFAC) applies a “50% Rule” to deem only entities owned 50% or more by listed persons, individually or in the aggregate, as designated persons.

Control without majority ownership

The second criterion asks whether the person can (directly or indirectly) impact the composition or powers of the entity’s board. This may include the right or ability to appoint or remove a majority of directors; an agreement giving a person control over a majority of shareholder voting rights; or the ability of a major shareholder to appoint a majority of directors despite holding less than 50% of the shares.

For example, where a listed entity holds only 40% of another company but a shareholder agreement gives the listed entity power to appoint a majority of the company’s directors, the dealings prohibition will still apply to the company.

De facto control broadens the inquiry

The third criterion is potentially the most fact-intensive. Control will exists if, “having regard to all the circumstances”, it is reasonable to conclude that a person is able (directly or indirectly) and through any means, to direct the entity’s activities.

A non-exhaustive list of factors identified in the guidance includes:

• whether a listed person is the largest shareholder relative to the other shareholders;
• contractual rights or corporate documents giving the person dominant influence over the entity;
• a buyback clause benefiting a listed person;
• a transfer of shares before or after designation, particularly where there is no compelling evidence of an independent transfer for fair market value;
• the use of a closely connected person, including a family member, business partner, or former employee, as the new owner; and
• trusts, shell companies, or limited liability companies used to obscure links to a listed person.

These factors make a sanctions analysis less mechanical. The question is whether, as a practical matter, a listed person remains able to direct an entity’s activities. Circumstances surrounding a change in ownership can matter as much as the resulting legal ownership. The timing of a transfer, relationship between transferor and transferee, consideration paid, and evidence of the transferee’s independence may all become important elements of sanctions due diligence.

Implications for transactions and sanctions compliance

The guidance has practical consequences for companies assessing counterparties, investments, and other commercial relationships.

A search of Canadian sanctions lists remains necessary but not sufficient. Where a counterparty has significant ownership by a listed person, or there are other links to listed persons, the analysis may require examination of the counterparty’s full ownership structure and governance arrangements. That can include shareholder agreements, voting arrangements, director appointment rights, and other contractual mechanisms capable of conferring influence or control, as well as contextual factors that may indicate de facto control.

It is important to recognize that Canada’s “control” rule extends farther than its US counterpart 50% Rule. Because compliance with US sanctions administered by OFAC is often the default standard for capital markets and other multinational financial transactions, it would be typical to employ screening and due diligence procedures designed only to identify entitles owned 50% or more by listed persons. In circumstances where compliance with Canadian sanctions is required, however, such procedures may be deficient and could put Canadian persons at risk of a violation by failing to identify a person deemed to be designated by virtue of a listed person’s control.  

Aggregation also means that diligence should identify all listed ownership interests, rather than stopping once no individual listed shareholder reaches 50%. Two or more otherwise minority positions can collectively engage the deemed ownership rule.

Looking beyond the ownership percentage

The takeaway from the guidance is clear: sanctions diligence does not end at the capitalization table. The 50% threshold supplies a clear route to deemed ownership, including through aggregation of listed interests. But an interest below 50% can still result in control where governance rights or surrounding circumstances suggest a listed person can direct an entity’s activities.

For businesses involved in acquisitions, financings, investments, joint ventures, and other transactions with parties that have connections to sanctioned persons, the guidance underscores the importance of understanding not only who owns the counterparty, but who actually controls it.