China Publishes “Unreliable Entities” Rules Targeting Foreign Enterprises

On September 19, 2020, China’s Ministry of Commerce (“MOFCOM”) released regulations governing its proposed Unreliable Entities List. The List seeks to protect China’s national security and economic interests by penalizing any foreign enterprise, organization, or individual who endangers China’s national security or development, ceases to do business with Chinese counterparts “in violation of normal market transaction principles,” or otherwise discriminates against Chinese companies and consumers. Inclusion on the List can result in fines, import-export bans, investment restrictions, travel prohibitions, and reputational damage, among other things.

The MOFCOM regulations were issued one day after the United States announced plans to ban certain U.S. business to business transactions with Chinese-owned apps WeChat and TikTok. (The prohibitions related to TikTok were subsequently delayed by the Trump Administration and those related to WeChat were enjoined by a U.S. federal court pending litigation challenging the prohibitions). China first announced the creation of an Unreliable Entities List in May 2019, shortly after the U.S. added Huawei and many of its global affiliates to the U.S. Commerce Department’s Entity List—which effectively bars Huawei from receiving U.S.-origin goods, software, and technology as well as certain foreign-produced items that are the direct product of certain U.S.-origin software and technology without a license. At the time, China explained that the Unreliable Entities List was meant to combat “unilateralism,” “trade protectionism,” and supply interruptions to Chinese firms.

The MOFCOM Regulations

The new MOFCOM regulations indicate China’s Unreliable Entities List will include any foreign entity or individual that (1) endangers China’s sovereignty, security, or development interests; or (2) seriously harms the legitimate interests of Chinese entities or individuals by halting normal transactions with, or taking discriminatory measures against, their Chinese counterparts in violation of “market principles.”

MOFCOM will lead an inter-agency task force (the “working mechanism”) managing the Unreliable Entities List. The task force decides whether an entity appears on the Unreliable Entities List and is in charge of investigating foreign entity conduct, either on its own accord or after receiving complaints from market participants. The task force has the power to issue inquiries, examine documents, and take any other “necessary” action. Foreign entities subject to investigation are entitled to “make statements and [offer a] defense.” The task force, however, can add a foreign entity to the Unreliable Entities List without an investigation if the “facts are clear.”

The task force decides whether a foreign entity should be added to the Unreliable Entities List by examining (1) the damage caused to China’s security and development interests; (2) the damages inflicted on the legitimate rights and interests of Chinese enterprises and individuals; (3) whether the foreign entity’s actions were consistent with international economic norms and trade rules; and (4) other unspecified factors. When the task force decides to include a foreign entity on the Unreliable Entities List, it will issue an announcement highlighting the risk of transacting with the relevant entity. The task force may also impose fines, prohibit further investment in China, bar imports and exports, restrict travel, decline work permits, ban residency, and take “other necessary measures.” The regulations do not explain how fines are calculated or when punitive measures are appropriate, noting only that this depends on the “actual circumstances.”

The task force may give an entity named to the Unreliable Entities List a grace period to correct the offending behavior and remedy any harm caused. To the extent the entity is subject to punitive sanctions, those sanctions take effect only when the offending behavior continues after the grace period.

If remedial steps are taken by the entity concerned before the end of the grace period, the task force will remove the foreign entity from the Unreliable Entities List. The foreign entity may also apply for removal from the Unreliable Entities List in which case the task force will take a decision “based on the actual circumstances.” The regulations provide no other information regarding removal. In “special circumstances,” and subject to approval by the task force, Chinese enterprises or nationals may apply for permission to transact with foreign entities or individuals subject to import or export restrictions because of their inclusion on the Unreliable Entities List.

Implications

Shortly after issuing the regulations, MOFCOM rejected the notion that the regulations are a response to U.S. actions against Huawei, TikTok, WeChat, and other Chinese companies. MOFCOM also said that it did not have a timetable for announcing the first iteration of the Unreliable Entities List or a pre-determined set of companies for inclusion. State-owned media, however, reports that the first Unreliable Entities List may already be drafted, that it is likely to target foreign entities that cut off supplies to Chinese businesses (possibly as a result of U.S. imposed trade restrictions), and that the task force could release it “if the U.S. continues to escalate its crackdown campaign.”

The regulations and the underlying trade tensions put U.S. and other foreign corporations into a difficult position, requiring a delicate balancing act between compliance with U.S. trade laws and China’s requirements for continued supply. On the one hand, failure to comply with U.S. restrictions on transacting with certain Chinese firms exposes foreign entities to potential criminal or civil penalties, including fines, the most draconian of which is the loss of U.S. export privileges, and the ability to procure U.S. goods. On the other hand, failure to comply with China’s requirements of continued supply may result in fines and a ban from the Chinese market.

Companies considering changes to their international operations impacting trade with China should now proceed with caution and in consultation with experienced counsel as required.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Ben Bradshaw, an O’Melveny partner licensed to practice law in California and the District of Columbia, Riccardo Celli, an O’Melveny partner licensed to practice law in the Capital Region of Brussels, the Law Society England & Wales, and Roma, Courtney Dyer, an O’Melveny partner licensed to practice law in the District of Columbia and New York, Andrew Frackman, an O’Melveny partner licensed to practice law in New Jersey and New York, Greta Lichtenbaum, an O’Melveny partner licensed to practice law in the District of Columbia, Philip Monaghan, an O’Melveny partner licensed to practice law in the Capital Region of Brussels, Hong Kong, the Law Society England & Wales, and the Law Society Ireland, Anna T. Pletcher, an O’Melveny partner licensed to practice law in California, Katrina Robson, an O’Melveny partner licensed to practice law in California and the District of Columbia, Ian Simmons, an O’Melveny partner licensed to practice law in the District of Columbia and Pennsylvania, Michael Tubach, an O’Melveny partner licensed to practice law in California and the District of Columbia, Christian Peeters, an O’Melveny of counsel licensed to practice law in the Capital Region of Brussels and Germany, Rechtsanwalt, Courtney C. Byrd, an O’Melveny counsel licensed to practice law in the District of Columbia and Maryland, Kieran Humphrey, an O'Melveny counsel licensed to practice law in Hong Kong, England & Wales, and Australia, Stephen McIntyre, an O'Melveny counsel licensed to practice law in California, Philippe Nogues, an O’Melveny counsel licensed to practice law in the Capital Region of Brussels and Paris, Charles Paillard, an O’Melveny counsel licensed to practice law in France and Hong Kong, David J. Ribner, an O’Melveny counsel licensed to practice law in the District of Columbia and New York, Scott Schaeffer, an O’Melveny counsel licensed to practice law in California and the District of Columbia, Lining Shan, an O’Melveny counsel in the firm’s Beijing office, and Sergei Zaslavsky, an O’Melveny counsel licensed to practice law in the District of Columbia and Maryland, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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