• 7-year denial order imposed against Chinese telecommunications equipment maker
• Denial order strictly limits business with company
• Action comes as U.S. imposes other trade restrictions on China

On April 16, U.S. Commerce Secretary Wilbur Ross announced a seven-year denial order (the Order) against Chinese telecommunications company Zhongxing Telecommunications Equipment Corporation (ZTE).  The Order prohibits ZTE from engaging in virtually any trade or other activities involving U.S.-origin goods or technologies.

ZTE Previously Agreed to $1.19 Billion Penalty Related to Sales to Iran, North Korea

In a previous blog post, we reported on the penalty that ZTE agreed to in March 2017 related to violations of U.S. economic sanctions and export controls.  Those violations involved shipments of U.S.-origin products to Iran and North Korea.  The number of violations, and the alleged conspiracy by ZTE personnel to cover up the violations, prompted the huge penalty.

In addition to the massive financial penalty ZTE paid, the company agreed to a seven-year denial of export privileges that was suspended subject to ZTE meeting certain probationary conditions.  Among other conditions, ZTE was required to provide cooperation – including truthful disclosures – to the U.S. government.

ZTE Misled U.S. Government, Violated Probation, and Triggered Imposition of Denial Order

According to the U.S. government, in submissions to the government that ZTE made in November 2016 and July 2017, ZTE pledged to take disciplinary action against 39 company employees and officials.  In February 2018, the U.S. government requested additional information from ZTE about these actions.  In March 2018, ZTE notified the U.S. government that most of those disciplinary actions had not occurred.

The government did not take long to respond.  In announcing the Order, Secretary Ross asserted that ZTE had repeatedly made false statements to the U.S. government.  The Secretary characterized the behavior as “egregious.”

The Order is comprehensive and prohibits ZTE from engaging in the following:

• Any transaction involving any commodity, software or technology (any of which is an “item”) exported or to be exported from the United States; and
• Using, selling, storing, or servicing any item that was or will be exported from the United States.

The Order prohibits not only future transactions involving a U.S.-origin item, but also current transactions, including any action involving a U.S.-origin item already in ZTE’s possession.  Press reports suggest that ZTE may obtain up to 30% of its parts and components from U.S. manufacturers.  Under the Order, all of that inventory now appears to be off limits to ZTE.  (Perhaps not surprisingly, press reports indicate that trading of ZTE stock was halted on exchanges in Hong Kong and in China.)

The flip side of the Order is its impact on the U.S. and other persons who could otherwise provide U.S.-origin items to ZTE, or help ZTE try to sell such items.  In this respect, the Order prohibits any person from engaging in the following:

• Exporting a U.S.-origin item to ZTE;
• Taking any action to facilitate or otherwise support ZTE’s efforts to acquire a U.S.-origin item;
• Taking any action to facilitate ZTE in selling a U.S.-origin item; and
• Any transaction to service a U.S.-origin item owned or controlled by ZTE.

Denial Order Issued in Midst of Trade Tensions with China

There is no indication that the Order was issued as part of a larger strategic initiative by the U.S. government to regulate trade more tightly with China.  But it does fit a pattern of U.S. government hostility toward Chinese and China-affiliated technology companies.

Nowhere is this more apparent than in the context of transactions reviewed for national security concerns by the Committee on Foreign Investment in the United States (CFIUS).  Since October 2017, based on recommendations from CFIUS, President Trump has blocked the merger of Broadcom and Qualcomm (see our March 2018 article here), the attempted acquisition of MoneyGram by Ant Financial (see our January 2018 article here), and the proposed purchase of Lattice Semiconductor by the Canyon Bridge Fund (see our October 2017 article here).

As to ZTE itself (along with fellow Chinese technology giant Huawei), as early as 2012, the U.S. House of Representatives identified it as a potential security risk that “cannot be trusted to be free of foreign state influence and thus pose[s] a security threat to the United States.” A copy of the 2012 House Report is available here.

U.S. Companies Must Understand and Control All Business Relations with ZTE

Given the breadth of the Order, any U.S. company or individual that has business with ZTE needs to promptly understand the scope of that business and act accordingly.  In many cases, acting accordingly will mean immediately halting business.  The provision of some professional services to ZTE may still be permitted, though a service deemed to facilitate action by ZTE with respect to a U.S.-origin item is likely to be prohibited.

Compliance personnel should work with their engineering and supply chain colleagues to identify potential exposure.  There is no grace period to the Order – obligatory compliance started on April 15 when the Order was issued.