王峰 周昕 戴梦皓 合规业务部 金杜律师事务所
At the beginning of 2021, China issued another important statute on trade compliance – the Rules on Counteracting Unjustified Extra-territorial Application of Foreign Legislation and Other Measures (the “Rules”), following the promulgation and implementation of the Provisions on the Unreliable Entity List (“UEL Provisions”) and the Export Control Law and other relevant laws and regulations in the second half of last year. The Rules have attracted wide public attention and media coverage since its introduction. China has not yet issued any prohibition order on the application of any specific extra-territorial laws in accordance with the Rules, and the enforcement requirements of the relevant provisions thereof are still up in the air. However, a number of enterprises have already encountered various problems in practice. In this article, we will continue to discuss the following key issues upon the implementation of the Rules by referring to similar rules and relevant cases in other countries.
1. What extra-territorial laws will be the targets of the Rules?
The implementation of the Rules has led to intensive discussions on what extra-territorial laws might be targeted and its possible impacts. According to Article 2 of the Rules and the relevant press conference held by MOFCOM, the Rules apply to situations where the extra-territorial application of foreign legislation and other measures unjustifiably prohibits or restricts the citizens, legal persons or other organizations of China from engaging in normal economic, trade and related activities with a third State (or region) or its citizens, legal persons or other organizations. (e.g. the widely-known regulations on US economic sanctions against Iran, Cuba, North Korea, and other countries and regions). In addition, pursuant to Article 7 of the Rules, the targets thereof must be the relevant foreign legislation and other measures specified under the prohibition order. The Rules seem structurally identical with that of the EU’s Blocking Statute, that is, specifying the targeted laws and regulations that restrict Chinese entities from engaging in trade with entities or individuals from a third country.
In our first article, we briefly discussed the historical background of the enactment of EU’s Blocking Statute. Back in 1996, the US successively promulgated the Cuban Liberty and Democratic Solidarity Act (also known as the “Helms-Burton Act”) and the Iran and Libya Sanctions Act (also known as the “D ‘Amato Act”), imposing restrictions on the commercial cooperation between third-country enterprises and Cuba, Iran, and Libya. This had a direct impact on the normal commercial exchanges between EU enterprises and relevant countries. The EU’s introduction of the Blocking Statute then was more about protecting the normal trade between EU enterprises and third countries such as Cuba and Iran, than completely targeting the relevant unilateral US sanctions. Thus, for a very long time, the targets listed in the annex to the EU’s Blocking Statute were limited to Helms-Burton Act and D ‘Amato Act. This situation remained unchanged until the unilateral withdrawal of the US from the Joint Comprehensive Plan of Action (the “JCPOA”) in 2018 and its renewed unilateral and comprehensive sanctions against Iran, since when relevant provisions such as the Iranian Transactions and Sanctions Regulations (the “ITSR”) were added to the annex to the EU’s Blocking Statute.
However, the Rules are different from the EU’s Blocking Statute in legislative background – where Chinese enterprises are unable to trade with specific countries and regions due to US sanctions, and face US restrictions and sanctions. Since 2018, as the US tightened its export control policies towards China, more and more Chinese entities have been put in the export control list. Especially in 2020, the US has rolled out special sanctions for specific Chinese enterprises and regions, making China a key target of its export control and sanctions. Meanwhile, in addition to US entities, the targets of the US export control and sanctions laws usually also cover controlled acts and transactions having US connections (such as trading goods, technologies, and software of US origin, settlement by the USD clearing system, transportation by US ships, and substantive commercial activities involving employment of US persons in some cases), and even major transactions among third countries with no US connections. As a result, the current US export control and sanctions against China will not only restrict the transactions between enterprises in these two countries, but also affect the transactions between Chinese enterprises and those from third countries and regions such as the EU. Therefore, whether the prohibition or restriction under the Rules will be extended to include “protecting Chinese entities from abnormal business interruption by third countries” may be a key issue for future discussion. If so, then, although the current wording of the Rules is similar to that of the EU’s Blocking Statute, the specific targets and effects in its future implementation may be completely different from the latter. Companies in third countries and regions that conduct business with Chinese enterprises must also pay attention to the possible consequences brought by the Rules.
In addition, the current provisions of the Rules only target the extra-territorial rules that restrict the relevant economic and trade exchanges between “China and third countries”, without referring to the extra-territorial rules that affect the economic and trade exchanges between Chinese enterprises and between enterprises in China and a target country. However, as mentioned above, the sanctions regulations of relevant countries are often not specifically targeted. For example, the US sanctions law, by providing for specific US connections and even specific requirements of secondary sanctions, not only restricts transactions between China and third countries, but also transactions between Chinese and US enterprises, and even between Chinese enterprises. Under such circumstance, enterprises need to pay attention to, study, and evaluate the possible impact brought by the prohibition order targeting specific laws and regulations on companies in China and countries imposing sanctions.
2. What obligations shall enterprises assume under the Rules?
Since the implementation of the Rules, what obligations enterprises will undertake under the Rules has become a key issue concerned about by domestic and foreign enterprises (including many financial institutions). Only in terms of the provisions of the Rules, enterprises are obliged to:
- Not to comply with foreign legislation (i.e., the obligation to counteract); and
- File a report with respect to any targeted restrictive regulations.
However, in practice, a series of issues on how to fulfill the above obligations need to be further clarified, for instance:
- How do we define the Chinese citizens, legal persons or other organizations as mentioned in the Rules? Are Chinese individuals working abroad, overseas branches of Chinese companies, subsidiaries or non-legal person branches of foreign companies in China, or overseas companies as permanent establishments in China (if required by tax laws) required to fulfill relevant obligations?
- To what extent shall the obligation of non-compliance with foreign legislation be fulfilled? For example, does signing a contract with specific compliance clauses constitute non-compliance with the prohibition order?
- Under what circumstances should a report be filed with relevant competent authority? Is it based on the relevant promulgated regulations that you know or should know, or is it based on the relevant restrictions specifically encountered in business or operation activities?
In the current Rules, there is no clear explanation for the above issues. However, the interpretation and enforcement of foreign countries on such issues in anti-boycott enforcement may serve as important references for China in its counteraction law enforcement in the future.
First, with respect to subjects under jurisdiction, in principle, those subject to anti-boycott/counteraction compliance obligation in each country are entities in that country, though countries may have different interpretations of such subjects. Take the US for example. In accordance with Section 1 (b) of Part 760 of the Export Administration Regulations (“EAR”), the US entities subject to the US anti-boycott obligation under the US law include not only the overseas subsidiaries and branches of US companies, but also the subsidiaries, branches and offices of foreign companies within the US, which have extensive coverage. Only an individual US national who is resident outside the US and who is employed by a foreign company may be exempted from the anti-boycott obligation. This is in contrast to the EU’s Blocking Statute. Although permanent foreign residents in the EU are obliged to comply with the EU’s Blocking Statute, branches of foreign companies in the EU are not subject to the EU’s Blocking Statute in accordance with Question 21, Section 4 of the Guidance Note of the Blocking Statute, which exempts the EU branches of many US companies (including branches of many US banks in Europe) from complying with the Blocking Statute. Will China prefer an expansive US-style explanation or a conservative EU-style definition in its interpretation of the subjects in subsequent enforcement? Foreign companies with branches in China need to keep an eye on this.
Second, with respect to the scope of blocking obligation, any intentional acceptance of a boycott request by another country against US friends or US entities constitutes a violation of the US anti-boycott law, which includes agreeing to comply with the boycotting party’s sanctions and boycott rules in contractual terms, and using the boycotting party’s boycott request as a material consideration in making business decisions. In addition, the US anti-boycott law imposes high fines on violations of relevant obligations thereunder, forcing companies to give up complying with other countries’ boycott regulations. For example, in 2019, the US imposed a total fine of USD 700,000 on the representative office of Kuwait Airways in the US for violating the US anti-boycott law by refusing to sell tickets to passengers with Israeli passports in accordance with Kuwaiti laws. In contrast, the EU’s Blocking Statute is relatively vague in its definition of violations. However, according to Question 21, Section 4 of the Guidance Note of the Blocking Statute, requesting from the US a license based on the blocked statute implies recognizing the jurisdiction of the blocked US statute, which constitutes a violation of the Blocking Statute and should be prohibited. In addition, instead of impose penalties on the EU companies, the EU further states in the Note that it prefers to use the Blocking Statute to seek conversations with the US to clarify the exact extent of compliance under the sanctions law and protect the interests of EU companies. It also prefers to help EU companies obtain exemptions from the US government through imposing pressure by the Blocking Statute. For China, it is an important task to define the compliance obligations under the Rules in the future in order to achieve its legislative purpose without imposing excessive compliance costs on enterprises or affecting China’s future foreign investment environment.
In addition, with respect to the reporting obligation, the US anti-boycott law provides that whenever a party accepts a boycott request of any kind, such as a request to enter into a contract with specific terms or to issue a letter of commitment, it shall file a report quarterly on a case-by-case basis in accordance with the relevant requirements of Section 5 of Part 760 of the EAR, regardless of whether agreeing to accept the boycott request. BIS may impose penalties on entities that fail to meet their reporting obligations. For example, when Mitsui Plastics sold goods to the United Arab Emirates in 2011, the shipping documents of seven shipments requested by the buyer included a certificate to prove that the carrying vessels meet the UAE’s port of call compliance requirements, but Mitsui Plastics failed to report the information to the Office of Antiboycott Compliance (“OAC”). As the certificate contained a statement that there should be no goods of Israeli origin included, it was ultimately determined by the OAC that such information should be reported. In February 2018, BIS imposed a penalty on Mitsui Plastics for its failure to filing the report, and the case ended with Mitsui Plastics paying a settlement of nearly USD 30,000 to BIS. The reporting requirements in the EU’s Blocking Statute are relatively lenient, of which the specific contents are very similar to those in the Rules. The EU’s Blocking Statute stipulates that the relevant entities be required to report to the relevant authorities within 30 days when their relevant business activities are affected by direct or indirect restrictions, but the EU neither defines the circumstances under which business activities are affected, nor sets any penalty for failure to fulfill the reporting obligation. From the wording of the Rules, Article 5 and Article 13 show that the Rules have characteristics of both the EU and US statutes in regimes. With similar timeframe with EU’s Blocking Statute, the Rules incorporated penalty requirements under the US anti-boycott law. However, how to truly ensure effective implementation of the counteracting regulation, and whether there is a need to establish special enforcement authorities and to unite all relevant departments to effectively regulate the failures to comply with reporting obligations and violations of the prohibition order are all issues that may need to be considered in the future.
3. How do we apply remedies under the Rules?
The Rules set out the application for exemption and judicial remedies as the two major ways of relief in the face of overseas regulations on sanctions. These two remedies are very important in the daily business of enterprises in terms of how they are applied and operated specifically in future practice.
In terms of the application for exemption, many financial institutions tend to be relatively conservative or overly compliant in their business practices out of concerns about strong regulation of the US Office of Foreign Assets Control (“OFAC”) over sanctions. In practice, many financial institutions often refuse to assist with payment arrangements on the basis of their internal compliance policies for transactions involving a country imposing sanctions or a sanctioned subject, even if the relevant transaction has been granted a corresponding license (such as the “U-turn license” previously applied in transactions involving Cuba) or the transaction does not involve any US connections or secondary sanctions. After the relevant prohibition orders under the Rules are introduced and implemented, can the relevant financial institutions apply for exemption with standards higher than the OFAC compliance requirements? Or can they continue to implement their internal compliance policies with higher compliance requirements than those required by the relevant laws after obtaining the exemption? Both the financial institutions and affected enterprises need to consider making necessary adjustments.
In terms of litigation remedies, although the EU’s Blocking Statute has a mechanism on litigation remedies and indemnity similar to those in the Rules, it is primarily a reciprocal measure to the mechanism set out in Section 302 of Chapter III of the Helms-Burton Act which stipulates that US citizens may claim for compensation from their counterparties in transactions involving certain Cuban assets through litigation. Since the effectiveness of Chapter III of the Helms-Burton Act was not restored until May 2019 by the current US government, the litigation remedies and indemnity mechanism in Article 6 of the EU’s Blocking Statute has not really been implemented in practice. As such, it may not be a good reference for China in the subsequent practice. In legal proceedings, even with the provisions of the current Rules, there will be a series of challenges in the specific operation, such as:
- Although the provisions of the Rules imply that the relevant litigation is infringement litigation, in cases involving contract performance, are parties allowed to claim for continued performance of the contract for breach of contract?
- How should the amount of damages be calculated and is it necessary to consider the expected loss of benefits?
- How should the relevant domestic judgment be enforced in cases where the parties are located outside China?
These are all key issues to be considered in the subsequent implementation of the Rules.
The US and the EU both has its own focus on the practical implementation of the relevant similar remedies. The US anti-boycott law also has an exemption application mechanism, enabling US persons to avoid the risk of being subject to local legal penalties when conducting relevant business in the boycotting party. However, the standard for exemption applications under the US anti-boycott law is based on the “principle of minimum compliance”, that is, if a US person has to comply with the boycott provisions, he/she should also try not to comply with the relevant obligations to the extent possible. For example, the boycott exemption requires that the exempted goods or services be sold or provided only in the boycotting country, and the items be identifiable. In the EU, it is more common to bring proceedings based on the Blocking Statute to ensure that the business of a particular subject in the EU can continue to be carried out. For example, in the case of Bawag, Austria forced the Austrian bank through litigation and investigation pressure to obtain an exemption from OFAC that kept the accounts held by Cuban citizens in the bank from closing. Similarly, in the case of Telekom Deutschland, the German court issued a prohibition order requiring Telekom Deutschland to resume its telecommunications services to Bank Melli Iran subject to sanctions. These relevant cases are good references for China to better use the relevant mechanisms to protect the interests of domestic enterprises in the future.
4. What should enterprises do now?
As China has no such kind of statute as the Rules, and the issuance of official prohibition order is still pending, we suggest that enterprises make the following preparations by referring to the relevant experience of foreign countries in anti-boycott compliance.
First, enterprises should review their existing standard contracts, compliance rules and other documents, to see whether there is any defect in wording and expressions. For many foreign-invested enterprises, the applicable contract templates and compliance rules usually follow the requirements of overseas head offices, and most of the standard clauses thereof are directly borrowed from the relevant rules and regulations of head offices, in which some of the laws may be targets of the Rules. As stated above, the overseas anti-boycott and blocking compliance experience shows that provisions in written documents such as rules and contracts specifically requires enterprises to abide by the control, sanctions, and boycott requirements of other countries are likely to be directly deemed as violation of blocking obligations, which may entail risks in the future, including administrative penalties and civil damages. Therefore, it is necessary to make a comprehensive adjustment to the expression of relevant written documents. It should be noted that such expression can be found not only in contracts, but also in the public statements of the enterprises, the commitment letters to a third-party partner, and other similar documents.
Second, we recommend that enterprises carefully assess the relevant risks and feasibility of domestic businesses based on the “principle of minimum compliance” for the time being by referring to relevant regulations. As we mentioned before, in practice, due to the lack of understanding of the export control and sanctions policies of relevant countries, enterprises now often exercise “over-compliance” with requirements much stricter than the requirements of relevant regulations in their business operations to avoid risks. However, such over-compliance practice lacks a solid basis even by the relevant control and sanction rules, and may even become a “trap” that causes enterprises to bear liability for damage after the implementation of the Rules. Enterprises are advised to assess the actual risks of existing domestic business and determine its feasibility based on the actual restrictions of relevant control and sanction rules, so as to avoid non-compliance with the Rules due to their over-compliance.
Lastly, enterprises are advised to pay close attention to the latest development of legislation – not only the prohibition order to be issued and the interpretation of relevant laws, but also the related rules and other ancillary documents, including the interconnection between the Rules and the UEL Provisions. Although the relevant obligations under the Rules are currently undertaken by domestic entities, the overseas head offices of many multinationals must consider and evaluate the correlation of the UEL Provisions targeting overseas entities and their performance of the liability of damage under the Rules as the overseas judicial relief mechanism is still available.
Following the implementation of the Rules, China has adjusted its existing export control and trade compliance rules in a full spectrum to cater to the international standard practice. More specified explanation and interpretation are expected to be introduced in the near future to help further clarify the relevant rules. We will continue to follow the development of legislation and keep you updated.