Lending in Canada’s Defence and Dual-Use Sector: Aligning Risk and Structure
Canadian lenders are increasingly encountering borrowers that operate in the defence or defence-adjacent sector. Many of these businesses are otherwise conventional middle-market credits with established operations, contracted revenue streams and long-term customer relationships. Despite this, transactions frequently slow down or fail for reasons that are not tied to credit fundamentals. The hesitation tends to arise from perceived regulatory complexity, uncertainty around enforcement and sensitivity to reputational considerations.
In practice, the issue is less about heightened risk and more about imprecise characterization. Defence-related exposure in Canada does not present a uniform or inherently elevated risk profile. What it does present is a set of unique regulatory and operational considerations that are often insufficiently understood within traditional lending frameworks.
The Dual-Use Reality in Canada
A central source of this disconnect is the absence in Canada of a single, clearly bounded concept of “defence contractor.” Unlike the United States, where that category is more formally delineated through procurement and regulatory regimes, Canadian businesses frequently fall within a broader dual-use landscape. These are companies that develop goods, software or technologies with both civilian and military applications. Advanced manufacturing, aerospace components, cybersecurity tools, data analytics platforms and logistics services can all fall within this category, often without the business identifying itself as a defence supplier in any conventional sense.
As a result, these borrowers may be subject to Canadian export controls, the Controlled Goods Program or allied regulatory frameworks. In Canada, export controls are primarily administered under the Export and Import Permits Act and the Export Control List. The Controlled Goods Program governs access to certain defence-related goods and technology within Canada.
In addition, U.S. regimes such as the International Traffic in Arms Regulations (“ITAR”) may apply where U.S.-origin defence articles, technical data or services are involved, regardless of where the relevant business is located. These regulatory overlays often emerge during the course of a transaction rather than at the outset, particularly where underwriting has proceeded on the assumption that the business is purely domestic in nature.
Where Traditional Underwriting Requires Adjustment
Traditional underwriting approaches do not always capture the implications of this regulatory environment. Customer concentration analysis, for example, is not in itself determinative. Even where a borrower’s direct counterparties are Canadian or allied entities, the end use, end user and ultimate destination of its products or technology may engage Canadian export controls or foreign regimes such as ITAR. This creates a layer of compliance exposure that is not readily apparent from financial reporting alone.
Collateral analysis can also require a more nuanced approach. Traditional assumptions about transferability and realization do not always apply where assets include controlled technology, technical data or proprietary assets that may be subject to certain restrictions. Effective collateral analysis therefore requires assessing how the borrower manages access controls, licensing obligations and compliance protocols that directly affect a lender’s ability to step into, hold or dispose of collateral. This type of operational diligence helps distinguish between borrowers with mature compliance infrastructures and those for whom regulatory exposure represents a material risk. These potential constraints do not negate the value of the collateral, but they do affect timing, process and recoverability in ways that are not typically reflected in standard security assumptions.
Similarly, enforcement analysis warrants closer attention at the structuring stage. Remedies that appear straightforward in documentation may, in practice, involve additional regulatory steps or operational constraints, particularly where ongoing compliance is required to maintain or transfer regulated assets. This does not render enforcement impracticable, but it does mean that enforcement mechanics should be considered as part of the initial transaction design rather than as a secondary assumption.
A More Precise Approach to Risk Allocation
Lenders with experience in this sector tend to approach these issues as matters of risk allocation rather than risk avoidance. Instead of relying on broad representations or attempting to exclude defence-related exposure altogether, they focus on the borrower’s underlying compliance infrastructure. This includes internal controls, export classification processes, employee screening and access protocols, and ongoing monitoring and reporting systems. Tailored covenants and information rights, aligned with those systems, provide a more reliable framework than generalized assurances that may not remain accurate over time.
Importantly, these lenders also distinguish between legal risk, reputational risk and credit risk. Each engages different considerations and should be assessed independently. Not all regulatory triggers carry the same implications, and not all defence-adjacent businesses present comparable profiles. Transactions are more likely to proceed where those distinctions are identified early and reflected in the structure and documentation of the deal.
Conclusion: Clarity Over Caution
Lending into the defence and dual-use sector in Canada is not a standardized exercise nor is it suitable for every lender. However, it is also not a sector that warrants categorical avoidance. Transactions tend to run into roadblocks where regulatory considerations are identified late or addressed indirectly. Successful transactions analyze compliance obligations, collateral limitations and enforcement mechanics directly and incorporate them into the transaction from the outset.
From a legal perspective, the role is not to engineer workarounds but to ensure that the transaction accurately reflects the regulatory environment in which the borrower operates. Effective execution in this space depends on integrating legal, credit and compliance analysis early in the process, and on avoiding assumptions drawn from less-regulated sectors that do not translate cleanly to this context.
The Financial Services Group at Aird & Berlis LLP advises lenders on transactions in regulated sectors, including defence and dual-use industries. Please contact the authors or a member of the group if you have questions or require assistance.
