China’s Banned Entities: Exporters BEWARE

As has been well reported, on October 9, the United States’ Bureau of Industry and Security (BIS) added 28 Chinese entities to its Export Administration Regulations banned entity list. For the official federal register notice of this banning go here.

The reason given for placing these Chinese entities on the banned list relates to their alleged connections with human rights abuses by the Chinese government against its own citizens within the borders of the PRC. The  Federal Register notice states: “these entities have been implicated in human rights violations and abuses in the implementation of China’s campaign of repression, mass arbitrary detention, and high-technology surveillance against Uighurs, Kazakhs, and other members of Muslim minority groups in the XUAR.”

This is the first time the entity list has been used for this type of human rights issue.

Twenty of the entities on the list are public security bureaus operating in Xinjiang Autonomous Region: The Xinjiang Uighur Autonomous Region (XUAR) People’s Government Public Security Bureau, eighteen of its subordinate municipal and county public security bureaus, and one other subordinate institute. The other eight entities are manufacturers and service provides in the surveillance sector, with an emphasis on entities that provide AI based facial recognition technologies used in”high-technology surveillance.”  The list of these companies includes all the major players in China in this sector: Dahua Technology; Hikvision; IFLYTEK; Megvii Technology; Sense Time, Xiamen Meiya, Pico Information Co. Ltd.; Yitu Technologies; and Yixin Science and Technology Co. Ltd.

The Chinese government of course sees this as improper interference in its domestic affairs and has demanded the U.S. reverse these entity bans: “China demands US reverse decision to blacklist tech giants over ‘brutal suppression’ of Xinjiang Muslims as Hikvision and others bear brunt of action.”  For this reason, nobody believes the Chinese government will enforce this rule within China. Moreover, any contract, license or other agreement that seeks to enforce the ban will be treated by Chinese government agencies (MPS national and local) and by the Chinese courts as void and unenforceable.

This then leads to a conflict between U.S. (and often EU) law and Chinese law, analogous to what I discussed in my recent post, China’s New Cybersecurity System: There is NO Place to Hide. Here is the problem: under U.S. Export Administration rules, it is not enough for an American company (this most emphatically includes U.S. companies owned by foreign companies and investors) to terminate sales of controlled items to the entities set out on the list. The U.S. exporter must also prevent an evasion of the rules that would occur if a sale is made to a Chinese entity that then transfers the controlled items within China. The entity ban notice is clear on this: “For all twenty-eight entities, the license requirements apply to any transaction in which items are to be exported, reexported, or transferred (in country) to any of the entities or in which such entities act as purchaser, intermediate consignee, ultimate consignee, or end user.”

The usual way to prevent a subsequent illegal transfer or sale is through a contract or other agreement that requires the Chinese buyer NOT to transfer the controlled items to any of the entities on the banned entity list. Violation of this contract would subject this buyer to various penalties if such a violating transfer is discovered. This then sets out the legal conflict. As I explain above, this exact type of restriction will be treated by the Chinese government and its courts as void and unenforceable, which essentially makes it meaningless. Enforcement within China is required because the PRC will not enforce foreign judgments from the U.S. See China Enforces United States Judgment: This Changes Pretty Much Nothing. Even in cases where the PRC might enforce a foreign arbitration award, Chinese courts will not enforce any foreign award that would be void and unenforceable in China.

This situation sets out the conflict. It is not possible for any U.S. exporter to comply with the banned entity list rules when exporting to any entity in China of any item covered by the entity list. This is because it is impossible by contract for any U.S. exporter to prevent a subsequent transfer of the controlled item within China to a banned entity. Moreover, the risk of such transfer is high. Consider three likely scenarios:

1. The Chinese government will assign an entity not on the banned entity list to import the controlled item or technology. That entity will then be able to transfer what it imports to other entities in China without restriction.

2. Most of the entities on the new list are provincial and lower-level security agencies under the ultimate control of China’s Ministry of Public Security (MPS). The MPS has the power to simply order an unlisted public security agency to purchase the controlled item/technology. That agency will then transfer the controlled item to onc of the banned Xinjiang public security agencies. Since this is an internal agency transfer, it is unlikely the transfer will be noted. Any attempt by a foreign seller to control the dispostion of the items would simply be ignored by the Chinese courts.

3. Many of the commercial entities on the list have extensive connections to other large companies operating in China. For example, Megvii is backed by AliBaba. So within China, AliBaba or one of its many Chinese controlled VIE entities that would have the power to purchase the controlled items on behalf of Megvii. So long as the transfer takes place in China in a transaction between Chinese entities, no contract with the U.S. exporter seeking to block such a transfer would be enforceable in China. For this reason, as a legal matter, the transfer is not restricted.

Export control laws in the past have been concerned with dual use technologies for which there is a general international consensus that controls on proliferation are appropriate. This recent entity list classification is concerned with an entirely different type of concern: human rights within China. It is therefore clear that the provisions will not be enforced in China.

This then means that any U.S. entity that exports any controlled item or technology to China faces the significant risk that its exports will violate U.S. export control laws. Any attempt to reduce this risk by contract or other agreement directly conflicts with Chinese law and will therefore not be enforced. So the two legal systems are in direct conflict.

There is no way to mitigate this conflict.

But wait, there’s more.

Not only is there no way to avoid the conflict, there is no way for a U.S. exporter to confidently determine what product or technology is subject to the entity list ban. Even low-tech commercial items can come under the ban in ways that are impossible to predict. As explained by the U.S Bureau of Industry and Security:

Many commercial goods are not on the [controlled list] and do not have an ECCN [controlled list identifier]. These goods are designated as EAR99. EAR99 items generally consist of low-level technology, consumer goods, etc. and do not require a license in most situations. However, if your proposed export of an EAR99 item is to an embargoed country, to an end user of concern, or in support of a prohibited end use, you may be required to obtain an export license.  See Page 5 of this.

This means every exporter to China must assume it will need an export license for every product or technology exported to China. This sounds extreme, but as explained above, this is the result. But will obtaining a license be sufficient for protection? Under the U.S. export license system, an exporter is required to provide that its buyer will comply with the restrictions of any such license. But because enforcement of such licenses within China will not be possible because the Chinese courts will not enforce them and because China’s Ministry of Public Security and the Chinese military are simply not subject to the jurisdiction of the courts in any case, companies remain in this quandary without guidance.

This is the conflict, and it is a conflict that cannot be resolved under the current legal system. No Chinese entity will suffer from violating the rules or its contract. In fact, the Chinese violators will be rewarded in China. So who will suffer for the violation? It will be the U.S. exporter. The sanctions are severe and the risk is high. Can Your Business Afford/Stomach the China Risks?