Four Key Issues on China’s Unreliable Entity List

Written by: Wang Feng, Dai Meng hao     Regulatory& Compliance Group

With the introduction and implementation of the Provisions on the Unreliable Entity List (the “UEL Provisions”) by the Ministry of Commerce of the PRC (MOFCOM) on 19 September 2020, China’s legislation on the Unreliable Entity List (UEL), which started in May last year, has finally made substantial progress. As the first blacklist for trade control and sanction in China, it has drew intensive attention from multinationals in terms of its follow-up implementation and the regulatory scope. In light of this, we would like to explore several issues of common concern that may arise in the implementation of the UEL Provisions based on the UEL Provisions, the regulations on anti-boycott in trade control of some foreign countries and regions and our experience. We also look forward to further discussion with you.

Issue 1: How do we define the purpose and role of the UEL?

This issue has attracted wide attention from the industry as early as the introduction of the UEL system last year. According to the UEL Provisions, for the reasons for trade control, the UEL emphasizes more on the reasons for anti-boycott compared with the control and sanctions lists of foreign countries, while for regulatory measures, it is more of a comprehensive sanction list than simply an export control list.

Firstly, according to Article 2 of the UEL Provisions, the reasons for being included in the UEL are as follows:

• Endangering national sovereignty, security or development interests of China; (i.e. considering China’s national interests);
• Applying discriminatory measures, which violates normal market transaction principles and causes serious damage to the legitimate rights and interests of Chinese entities; (i.e. considering the boycotting against the unilateral sanctions and controls imposed by other countries on Chinese enterprises).

Comparing with the criteria for being included in the current export control and sanctions blacklists of the U.S. and the EU, we can see that the emphasis on anti-boycott (i.e. prohibiting from complying with the regulations on sanction of another country) is a unique feature of the UEL; while the blacklists of the U.S. and the EU emphasize more on national security and the management on end-users and end-uses.

For example, pursuant to § 744.11 of the U.S. Export Administration Regulations (EAR), the Bureaus of Industry and Security (BIS) of the U.S. Department of Commerce may place a foreign entity on the Entity List for the following reasons:

• Supporting persons engaged in acts of terror;
• Engaging in actions that could enhance the military capability of, or the ability to support terrorism of governments that have been designated by the Secretary of State as having repeatedly provided support for acts of international terrorism;
• Transferring, developing, servicing, repairing or producing conventional weapons in a manner that is contrary to United States national security or foreign policy interests or enabling such transfer, service, repair, development, or production by supplying parts, components, technology, or financing for such activity;
• Preventing accomplishment of an end use check conducted by or on behalf of BIS or the Directorate of Defense Trade Controls (DDTC) of the Department of State by: precluding access to; refusing to provide information about; or providing false or misleading information about parties to the transaction or the item to be checked; and
• Engaging in conduct that poses a risk of violating the EAR when such conduct raises sufficient concern that the End-User Review Committee (ERC) believes that the possible imposition of license conditions or license denial enhances BIS’s ability to prevent violations of the EAR.

In general, the criteria for inclusion in the U.S. Entity List can be divided into two categories, namely, “affecting the U.S. national interests” and “end-user and end-use risk control”. Similarly, according to the Basic Principles on the Use of Restrictive Measures (Sanctions) (“EU Sanctions Principles”) issued by the EU in June 2004, the EU’s sanctions list has been formulated under the same principle[1], and anti-boycott is not a consideration for inclusion in the EU sanction list. It does not mean that the U.S. and the EU attach little attention to the boycott against unilateral sanctions imposed by other countries. Instead, they have focus on the enforcement of anti-boycott on their domestic enterprises, rather than controlling overseas entities through implementing control lists. In China, it is specified in the Export Control Law (Draft) the control list under the Export Control Law, whose listing criteria are similar to those under the blacklist rules of the U.S. and the EU[2]. However, after the Export Control Law becomes effective, whether its control list and the current UEL will be used separately or combined may worth our attention.

In terms of regulatory measures, according to Article 10 of the UEL Provisions, the entities on the UEL may be subject to:

• Restricting or prohibiting the foreign entity from engaging in China-related import or export activities;
• Restricting or prohibiting the foreign entity from investing in China;
• Restricting or prohibiting the foreign entity’s relevant personnel or means of transportation from entering into China;
• Restricting or revoking the relevant personnel’s work permit, status of stay or residence in China;
• Imposing a fine of the corresponding amount according to the severity of the circumstances; and
• Other necessary measures.

In summary, the scope of the above restriction covers import and export, investment, and travel; the authorities are empowered to impose administrative fines. Compared with the U.S. Entity List that only restricts the transfer and related transactions of items subject to EAR, it seems that the current controls of the UEL are more similar to the restrictive measures under economic sanctions administered by the Office of Foreign Assets Control (OFAC) of the U.S. Department of the Treasury. Taking the Specially Designated Nationals and Blocked Persons List (SDN List) as an example, the restrictive measures imposed by the OFAC cover transactions in the following aspects:

• Import and export;
• Shipping;
• Securities investment;
• Personal travel;
• Investment;
• All types of financial services;

It is also prohibited to provide assistance to the transactions, such as services of commercial and legal consulting, transportation, freight forwarding, insurance, and financing which may benefit the sanctioned parties. However, civil penalty is generally not included in economic sanctions, as the SDN List is for identification rather than punishment, and the U.S. does not automatically have jurisdiction over extraterritorial entities. In terms of the comprehensiveness of the scope of control and the prudency of legislation, the systems settings under the U.S. sanctions law may be a reference for the further improvement of the China’s UEL system.

Issue 2: Is it necessary to adjust the applicable parties of the UEL?

The applicable parties of the UEL are also much concerned by the industry. Literally, the UEL Provisions are only applicable to a “foreign entity”, i.e. an enterprise, other organization, or individual of a foreign country. In light of this, two questions may call for further discussion:

Firstly, if “violating normal market transaction principles” is to comply with another country’s policy of export control and sanction, how to ensure the foreign entity is more willing to accept China’s anti-boycott requirements?

Secondly, how does China regulate a Chinese entity’s compliance with the export controls and sanctions of another country?

For the second question, pursuant to China’s General Provisions of the Civil Law, the Company Law, the Foreign Investment Law and other relevant provisions, a foreign-invested enterprise established by a foreign investor in China is a Chinese entity in nature. Does that mean it is generally not a “foreign entity” under the UEL Provisions? In addition, the UEL Provisions do not specify whether entities domiciled in Hong Kong SAR*, Macao SAR and Taiwan region shall be treated in the same manner as foreign entities, and China’s current legal system also denies such recognition. Given the common commercial arrangements of enterprises, it requires a lot of wisdom to deal with the following arrangements aiming to circumvent China’s anti-boycott requirements in the future enforcement of the UEL.

• Foreign entities supply relevant items to their Chinese subsidiaries, which take “cut-off” measures to cease business transactions with Chinese enterprises unilaterally sanctioned by other countries;
• Enterprises in Hong Kong SAR, Macao SAR and Taiwan region, including affiliates and subsidiaries set up by foreign entities in relevant regions, cut off business transactions with enterprises in Mainland China on the grounds of complying with export controls and sanctions of other countries.

In view of this, considering the diversity of international trade and commercial activities nowadays, if the UEL is only applicable to foreign entities that “cut off” supplies to Chinese companies, it may directly compromise the effectiveness of anti-boycott measures under the UEL. To this point, the US anti-boycott laws and the EU’s Blocking Statute (Council regulation (EC) No 2271/96) provide perfect solutions as they directly target entities within their jurisdiction, which is worth learning by China in its future administration of the UEL.

Take the US anti-boycott law enforcement as an example. Apart from the anti-boycott regulations of the Internal Revenue Service, the relevant provisions of BIS, the main anti-boycott law enforcement department, are set forth in Part 760 of EAR. Pursuant to § 760.1 of the EAR, the “US person” under this part includes any US individuals, domestic concerns (including US government agencies, companies and other entities) and its “controlled in fact” foreign subsidiaries, partnership, affiliates and other foreign establishment, as well as any domestic (including the Commonwealth of Puerto Rico, or any territory or possession of the United States) establishment of a foreign concern, which shall all abide by the relevant anti-boycott provisions. The US anti-boycott law enforcement has the following characteristics based on this definition of the “US person”:

• BIS has the authority to conduct effective anti-boycott investigations in the U.S. and impose direct penalties on relevant US entities (the penalty amount for violating anti-boycott requirements equals to that for violating export controls), which serves as a strong deterrence to relevant entities. In particular, from the perspective of jurisdiction, the business of the “U.S. person” is normally more connected to the US jurisdiction. Therefore, when faced with the “dilemma” of complying with the sanctions law of other countries and at the same time violating the anti-boycott laws of the U.S., the “U.S. person” is more inclined to follow the U.S. anti-boycott rules rather than the sanctions law of other countries.
• Since the “U.S. person” includes overseas subsidiaries of US companies, this also effectively prevents relevant domestic companies from circumventing US anti-boycott requirements through transaction arrangements with foreign branches and subsidiaries.

The EU’s Blocking Statute also has similar provisions on relevant anti-boycott law enforcement. In accordance with Article 5 of the Blocking Statute, no entity within the EU shall comply, whether directly or through a subsidiary or other intermediary, with any foreign sanction explicitly prohibited by the Blocking Statute. In addition, pursuant to the domestic legislation of the EU countries, any violation of the Blocking Statute is subject to huge administrative penalties and even criminal liabilities [3]. This is enough to ensure that entities within the EU have incentive to comply with anti-boycott requirements, which guarantees its effective implementation, and to a certain extent, forces other jurisdictions to make certain compromises when enforcing laws against such relevant entities, thus protecting the interests of relevant entities within the EU. For example, in the case of BAWAGP. S. K. (BAWAG), the Austrian government made it clear that BAWAG, located in Austria but controlled by a US company, should be punished for closing the bank accounts of certain Cuban citizens under the Cuban Assets Control Regulations (“CACR”), forcing the US government to finally agree to grant BAWAG an exemption to the CACR sanctions [4].

Nevertheless, considering that the UEL Provisions are just China’s first attempt on anti-boycott legislation, we believe that such issues will be clarified and solved in future legislation.

Issue 3: How do we define the “normal market transaction principles”?

As the criteria for putting an entity on the UEL include “suspending normal transactions with an enterprise, other organization, or individual of China or applying discriminatory measures against an enterprise, other organization, or individual of China, which violates normal market transaction principles and causes serious damage to the legitimate rights and interests of the enterprise, other organization, or individual of China”, the definition of “normal market transactions” is of great concern to many enterprises.

In the current practice of international trade, although some enterprises may overreact by exercising “excessive compliance”, on many occasions, a special trade compliance clause is generally incorporated in a contract, explicitly specifying that a country’s export controls and sanction requirements should be followed, and setting conditions for termination of the contract based on the relevant export controls and sanction requirements. Under this circumstance, when a certain country imposes relevant export controls or sanctions on a specific Chinese enterprise, the foreign contracting party may directly terminate the contract based on relevant terms. Whether the “cut-off” that occurs under a specified circumstance in a contract should be recognized as “violating normal market transaction principles” is neither clearly stated in the UEL Provisions nor by the subsequent press conference held by the MOFCOM. However, if such act is recognized as “violating normal market transaction principles”, the validity of the abovementioned compliance clause will be challenged. Pursuant to Paragraph 5, Article 52 of the Contract Law, a contract term shall be null and void when it violates the compulsory provisions of laws and administrative regulations. However, the UEL Provisions are only departmental rules, inferior to the laws and administrative regulations by the hierarchy of laws. Thus, it is inadequate to rely solely on the UEL Provisions to negate the validity of relevant terms. In contrast, the criteria for identifying anti-boycott violations adopted by the current US anti-boycott laws and the EU’s Blocking Statute may be a good reference for our future legislation.

In terms of the US anti-boycott rules, pursuant to EAR 760.1(e) and 760.2, “intent” is a necessary element of any violation of any of the prohibitions under the anti-boycott rules, which refers to taking or knowingly agreeing to take certain specified actions with intent to comply with, further, or support an foreign boycott or sanction, including:

• Contractually agreeing to abide by the sanctions and boycotts of certain foreign countries;
• Taking the boycotts as an important consideration for business decision-making;
• Accepting the boycott clause contained in a letter of credit (L/C) and use it as a condition for performance in L/C transactions;

As is shown in relevant examples, it is a clear violation under the US anti-boycott laws to accept the compliance clause regarding sanctions imposed by a third country and then refuse to conduct transactions, which may be directly punished by BIS. In addition, the anti-boycott obligations of US entities also include reporting the boycotts and relevant information received from foreign countries to BIS on a regular basis. Failure to deliver truthful reports as required may lead to administrative penalties by BIS on relevant entities even if they do not violate the prohibitions under the US anti-boycott laws. Relevant provisions under the US anti-boycott laws have not only specified the violations thereunder, but also enabled competent authorities to monitor the real-time dynamics and impacts of sanctions and export controls of other countries through the mandatory reporting mechanism.

There are more diversified measures under EU’s Blocking Statute. Pursuant to Articles 4 to 6 of the Blocking Statute, the prohibitions and remedies thereunder include:

• Invalidating foreign anti-boycott laws within the EU, including rejecting the recognition and enforcement of any judgment or decision based on relevant sanctions and boycotts;
• Enjoining EU entities from complying with foreign sanctions law obligations, including explicitly agreeing to be subject to relevant sanctions such as providing for corresponding clauses in contracts;
• Entitling EU entities to claim damages from the relevant party within EU jurisdictions when they suffer losses due to sanctions imposed by a foreign country, and to take actions against the assets of relevant parties within the EU.

The measure in Paragraph 2) is similar to that under the US anti-boycott laws, while the measure in Paragraph 3) is unique and of great reference value as many Chinese enterprises are now on the Entity List and face the risk of supply “cut-off”.

The more matured and well-developed anti-boycott legislation and systems of the U.S. and the EU set great examples for the future enforcement of the UEL. We believe that the uncertainty concerning the UEL will be further clarified in future legislation, possibly by introducing a new law or administrative regulation of a higher hierarchy.

Issue 4: What preparations should enterprises make at present?

Since the UEL Provisions have entered into force as of the date of promulgation, how to balance the compliance with the requirements under the UEL Provisions and the requirements of relevant overseas export control and sanctions is now a major concern by many enterprises. At this stage, preparations may be made from the following aspects:

First of all, it is necessary for relevant enterprises to confirm the risks on actual export control and sanctions that may arise from transactions with entities within the PRC. Given the complicated export control and sanctions policies of the U.S., the EU and other countries and regions, many enterprises have conducted “excessive compliance” in practice and terminated all the dealings with the sanctioned enterprises. However, upon careful analysis of the transaction nature, we may find that although the counterparty is a restricted enterprise in form, it does not violate the export control and sanction regulations of relevant countries. Blindly cutting off business interaction without risk assessment is likely to increase the risk of inclusion in the UEL. Therefore, for enterprises concerned, the most urgent task may be to carefully assess the risks of transactions based on the material commercial arrangements and the understanding of their own products, business and actions.

Secondly, relevant enterprises should resort the relevant compliance terms of existing transaction contracts. For many foreign enterprises, their compliance terms are often drafted based on the relevant compliance requirements of the country where they or their parent is located. If China’s UEL system and the subsequent anti-boycott legislation are further clarified, and are established with reference to the relevant systems of the U.S. and the EU, the direct reference of such terms in the contracts may constitute a violation of the relevant provisions under the UEL and may be subject to the risk of inclusion in the UEL. In this case, professional export control and anti-boycott lawyers may be consulted to adjust the wording of the compliance terms, so as to avoid unnecessary legal risks.

Thirdly, the relevant enterprise may need to consider anti-boycott filings and exemption applications in their own jurisdictions. Be it under the U.S. anti-boycott law or the EU Blocking Statute, there are certain exemptions in the circumstances where non-compliance with the boycott requirements of other countries may cause significant damage to entities in this jurisdiction, allowing conditional compliance with the boycott requirements of relevant parties. However, the requirements for exemption are relatively strict, and the applicable conditions for exemption are often closely related to the specific conditions of the transaction with many restrictions. For example, under the U.S. anti-boycott law, when applying for exemption under local import laws, goods or related services that can enjoy exemption are required to be sold or performed only in the country where boycott applies, and the related items need to be identifiable. Enterprises may consult professional anti-boycott lawyers to evaluate whether the relevant transactions may apply the exemption from boycott.

Finally, it may be necessary for the affiliates of relevant enterprises in the PRC to prepare contingency plans after the implementation of the UEL. According to the UEL Provisions, once a relevant foreign entity is included in the UEL, the Chinese government may terminate its import and export and other business related to China, which of course includes the business carried out between the foreign entity and its Chinese affiliates. Although the UEL Provisions do not specify the punishment on the violating Chinese entities engaged in transactions, as the Export Control Law is about to be implemented, it is likely that the punishment in Article 37 of the Export Control Law (Draft) concerning transactions with illegal and blacklisted entities will apply to the transactions with the entities on the UEL. In addition, the affiliates in China are likely to be regarded as compliance obligors under the anti-boycott laws of other jurisdictions, such as the U.S. and the EU, due to their control relationship. Their compliance with the relevant regulations of China’s export control may directly cause them to violate the anti-boycott rules of the U.S., the EU and other countries and regions, thus making themselves face the risk of being punished. It remains a question for multinationals on how to properly resolve the conflicts between trade control and anti-boycott rules among different jurisdictions.

Summary

The introduction of the UEL Provisions indicates that the new trade control system of China has made substantive development. Although there are still some points in the UEL Provisions that need further discussion and refinement, we believe that with the subsequent release of the Export Control Law and its supporting rules, the relevant system will be gradually improved. We will follow closely and share our insights on the progress of China’s trade control legislation.

[1] Basic Principles on the Use of Restrictive Measures (Sanctions) , Article 3: If necessary, the Council will impose autonomous EU sanctions in support of efforts to fight

terrorism and the proliferation of weapons of mass destruction and as a restrictive measure to

uphold respect for human rights, democracy, the rule of law and good governance.

[2] Article 18 of the Export Control Law (Draft): The State’s export control authority establishes a control list for importers and end users that fall under any of the following circumstances:

(I) Violating the end-user or end-use management requirements;

(II) Being likely to endanger national security;

(III) Using controlled items for any terrorist purpose.

[3] For instance, French law imposes six-month imprisonment on violation of the Blocking Statute, while German law prescribes penalties up to EUR 500,000 for such violation.

[4] https://www.reuters.com/article/austria-bawag-cuba-idUSL0450488520070504