By Qiao Peng & Vickey Zhou
Tensions over economic and trade were heating up between China and the United States during 2020. We noticed some U.S. enforcements against Chinese entities in 2020, which could influence entities in the U.S. and other countries, which is why we would like to draw your attention to the potential legal risks.
In this article, we will first give a background overview of the main enforcements, including the inclusions into restrictive lists by the BIS (Bureau of Industry and Security) and DoD (Department of Defense), and prosecutions by the DOJ (Department of Justice) and the SEC (Security and Exchange Commission) regarding trade secrets as well as the FCPA (Foreign Corrupt Practices Act).
You can find our preliminary risk indications and suggestions to follow up, specifically for four concrete situations:
- If you have Chinese clients included in the Entity List or Military End User List;
- If you have Chinese clients included in the list of Communist Chinese Military Companies;
- If you are a company of a third-party country, dealing with U.S. business partners; and
- If you are a multinational with subsidiaries in China.
Brief Review of 2020 U.S. China-related Main Enforcements
|Inclusions in the Entity List|
Inclusions in the List of Military End User
|BIS||EAR (Export Administration Regulations)|
|Inclusions in the List of CCMCs (Communist Chinese Military Companies)||DOD||NDAA (National Defense Authorization Act for Fiscal Year 1999); IEEPA (International Emergency Economic Powers Act)|
|Prosecutions of economic espionage, theft of trade secrets or hacking||DOJ||EEA (Economic Espionage Act)|
|Prosecutions of violations of FCPA||DOJ / SEC||FCPA|
- More than 300 Chinese corporations identified as “Military End Users” and those whose actions have been sanctioned as “contrary to U.S. national security and/or foreign policy interests” by BIS, have experienced different levels of disruptions in cross-border supply chains.
- Around 44 Chinese entities were identified as “Communist Chinese Military Companies” by DOD, and have been facing forced delisting from U.S. capital markets. Their securities trading in U.S. OTC (over-the-counter) markets are also seen as at risk of being shut down.
- Up to 38 prosecutions of economic espionage, theft of trade secrets or hacking were brought by DOJ, involving Chinese entities.
- Several multinationals with subsidiaries in China agreed to pay large settlements to settle DOJ and/or SEC charges that it violated anti-bribery regulations and/or FCPA provisions regarding documentation as well as internal accounting controls.
Risks Indications and Suggestions to Entities of the U.S. and Third-Party Countries
- If you have Chinese clients included in Entity List / Military End User List (hereinafter referred as “the clients”)
Prior license authorization is required for exporting, re-exporting or transferring (in-country) items subject to EAR to the clients. In most cases, the application for the license is denied.
Note the scope of the items subject to EAR. According to EAR §734, not only items located in the U.S., but also items originating from there, but now located elsewhere, and goods and services made outside the U.S. with controlled U.S.-origin inputs are “subject to EAR”.
This is a classic example of the U.S.’s long-arm jurisdiction. Accordingly, for instance, if you are a Dutch company and are selling software to the clients produced in the U.S., or Dutch-made software that is commingled with controlled U.S.-origin software, without obtaining a license from BIS, you are deemed in breach of EAR regulations.
Upon violating the license policy, administrative / criminal / other sanctions may be imposed according to the concrete matters, such as civil monetary penalty, denial of export privileges, exclusion from practice, fine, imprisonment etc.
Another potential risk is that you may face claims of breach of contract, if you decide to stop exporting particular items to your Chinese clients due to avoidance of U.S. legal risk, while you have a supply agreement.
- Check if your Chinese clients have been included in the aforementioned lists. The easiest way is to regularly check the official websites of BIS and DOC, where the current lists and updates are published.
- If they are on the lists, then the next step is to carefully check whether the items you provide to the clients fall in the administration of EAR. Definition and scope of “items subject to EAR” and “violations” can be found in §734.2 and §764. Please note that this may not be straightforward, so that you may want to consult professionals.
We strongly suggest you follow the aforementioned two steps, which can help you determine your current situation and identify legal risks. If any violations have already taken place or may have, you can promptly cooperate with your lawyers to quickly respond or create an emergency plan.
- If you have Chinese clients included in the list of Communist Chinese Military Companies (hereinafter referred as “CCMCs”)
For companies who have CCMCs in their supply chains, knock-on effects may occur as a result of potential financial blocks against the targeted companies by the U.S. government.
Although the CCMCs list is not a sanction list, this list may still lead to enforcements by the U.S. government, as the President is authorized by the NDAA to impose sanctions on CCMCs under the IEEPA. This means, CCMCs may be further added to other sanction lists, for example, the SND List (Specially Designated Nationals and Block Persons List) administered by OFAC (Office of Foreign Assets Control, under the Department of Treasury), which means their assets will be blocked and U.S. persons will generally be prohibited from dealing with them.
In some other cases, U.S. government departments may stop or avoid dealing with those who have CCMCs in their supply chains.
- Be cautious to default risk of CMCCs, especially when they are under further financial sanctions;
- Review your contracts with CMCCs, and check if there are terms on circumstances when you lose commercial opportunities due to sanctions to CMCCs. If there are no such terms, it is suggested you arrange a supplementary agreement, to help yourself limit potential damage.
- If you are a company of a third-party country, dealing with U.S. business partners
As indicated from U.S. prosecutions against Chinese entities last year, we identified several patterns suggesting a relatively high risk of being accused of theft of trade secrets:
- Use intellectual property information of U.S. entities for your own business, when these informatiom were accessed during cooperation with the entities;
- Employ indidivuals previously working for U.S. corporations, who may reveal some intellectual property information of their former employers;
- Consult professionals or professors who engage in research work, who may provide intellectual property information acquired from U.S. entities.
- Particular terms in cooperation / employment / consultancy agreements can reduce risk to a certain extent, for example, exemption clauses.
- From the ex-ante perspective, it is suggested that you set up a compliance mechanism, especially targeting internal activities involving business cooperation / employment / consultancy. This can help you monitor potential risk and discover compliance failures.
- If you are a multinational with subsidiaries in China
The cost of breaking the law is notably high in most FCPA cases and most companies charged under FCPA choose to pay millions (even billions) in penalties to resolve investigations and/or prosecutions.
The FCPA presents another example of the U.S. long-arm jurisdiction (the first is mentioned in part 2.1). The national jurisdiction includes not only domestic issuers and entities, but also foreign issuers registered with the SEC. As for territorial jurisdiction, if an entity directly or indirectly engages in any activities that may prompt a bribery payment, the FCPA could also be applied.
There is a broad range of jurisdictional conduct that may trigger anti-bribery provisions. From cases last year, we saw several multinationals fined for bribery behaviors of their Chinese subsidiaries. As the DOJ has being paying close attention to companies with “Chinese factors”, those companies may face accounting and compliance investigations.
- Additional internal investigation regarding bribery is suggested to be done, under the assistance of external lawyers. We also suggest you arrange targeted trainings for employees who may respond to government investigations.
- An effective compliance mechanism can strengthen the company's internal control, thereby effectively detecting and preventing violations of overseas anti-corruption laws. Whether there is a sound compliance system is also an important consideration for the DOJ and SEC when measuring fines for violations of the FCPA. In many cases, reports submitted by companies that proved the integrity and effectiveness of their compliance systems greatly reduced fines.
It should be noted that compliance mechanisms copied from other companies may be inefficient and even ineffective. The mechanism should be designed based on the company’s specific needs, risks, challenges and other objective conditions. Furthermore, it is necessary to check and evaluate the effectiveness of the existing compliance system at regular intervals, and to check for blind spots and update accordingly to meet new requirements of the objective situation and the needs of law enforcement.
R&P China Lawyers is a full-service law firm with a strong compliance practice. The firm advises clients on compliance in their supply chains and supports the development of internal and external compliance systems. It also represents companies that are the target of a complaint or government investigation. For more about our practice, please email Ms. Peng Qiao ([email protected]) or your usual contact at R&P China Lawyers. R&P can also assist with general compliance matters.