The Rules, along with the recently promulgated Unreliable Entity List Regulation and the PRC Export Control Law, form the pillars of China’s new trade regime, acting as both sword and shield to further and protect its national, economic, security, and development interests. Although the Rules are short - a mere 16 articles - they raise a host of questions and legal complexities for both Chinese and multinational companies as they engage in cross-border business.
The Process
The Rules, on their face, are similar to the European Union’s Blocking Statute, and apply where “extra-territorial application of foreign legislation and measures…in violation of international law and the basic principles of international relations…unjustifiably prohibits or restricts [Chinese parties] from engaging in normal economic, trade, and related activities with a third country (or region), or the citizens, legal persons, or other organizations thereof”. The onus is on Chinese parties to notify MOFCOM within 30 days of encountering foreign legislation that affects their business activities. The Rules are phrased such that this obligation can reasonably be interpreted to include not only purely domestic Chinese companies, but also onshore operations of multinational companies.
After receiving a notification, a MOFCOM-led interagency “work mechanism” evaluates if the foreign laws are unjustifiably applied to Chinese stakeholders. The work mechanism may instruct MOFCOM to issue prohibition orders against recognition, enforcement, or compliance with such foreign laws.
Chinese parties may apply to MOFCOM to exempt compliance with a prohibition order. The work mechanism also has the authority to suspend or rescind prohibition orders as appropriate.
The Remedies
Chinese parties that fail to discharge the notification obligation, or fail to comply with a prohibition order, may be subject to administrative penalties and fines. Non-Chinese parties are not likely to be subject to administrative remedies. However, where any party (foreign or Chinese) takes action in compliance with foreign laws and “infringes upon the legitimate rights and interests” of a Chinese party, or benefits from a judgment or ruling made in accordance with foreign laws that causes losses to a Chinese party, the Chinese party may institute legal proceedings before a Chinese court to seek compensation.
What now?
The Rules raise a number of key questions and considerations for any business involved in cross-border business with China:
What foreign laws trigger application of the Rules?
Unlike the EU blocking statute, which sets out a specific annex of foreign laws that trigger its application, the Rules only set forth general criteria that the work mechanism should consider when considering issuance of prohibition orders. And whereas the Rules are widely regarded as likely to apply to the application of “secondary sanctions”, such as the United States’ OFAC-administered sanctions programs, it is not clear whether the Rules apply to foreign laws that subject Chinese parties to primary sanctions, where such laws hinder or prevent parties from a third country from engaging with such sanctioned Chinese parties.
Who is subject to the process and remedies under the Rules?
As noted, the Rules place the reporting onus on Chinese parties who are affected by the application of foreign laws. The Rules do not, on their face, give non-Chinese parties the right to engage with MOFCOM on the Rules, or to apply for exemption from compliance with a prohibition order. For multinational companies that maintain a rigorous corporate veil with their Chinese subsidiaries, this raises the question of whether and with what impact to have their Chinese entities engage with MOFCOM on their behalf.
Likewise, the fact that offshore entities are subject only to civil liability, and not administrative remedies, may require multinational companies to evaluate their supply chains, and reconsider the roles of their Chinese subsidiaries in those supply chains. Also, even where a multinational company is sued in a Chinese court for violation of the Rules, in the absence of onshore assets, query whether Chinese courts may be more inclined to critically evaluate corporate veils in an effort to recover from a party’s Chinese operations.
Have the Rules effectively changed the landscape for dispute resolution?
By specifically allowing Chinese parties to bring suit in Chinese courts for compensation or to recover losses associated with the enforcement of foreign laws, do the Rules force parties to rethink their approach to dispute resolution? Typically, cross-border business transactions are governed by contract, and a well-drafted arbitration clause should prevail over Chinese court jurisdiction. Query, however, whether the Rules provide Chinese courts with the basis to deny an otherwise effective arbitration clause. Or does the language in the Rules encourage a Chinese party to shoehorn what is essentially a contractual breach into a tortious claim brought in a Chinese court? Also what would a Chinese court do in a situation where a contract between parties expressly appoints a foreign governing law that contradicts the Rules?
Do the Rules actually create an opportunity for greater diplomatic engagement?
The Rules provide that where a Chinese party faces “significant losses” from non-compliance with foreign laws, “relevant government departments may provide necessary support”. What type of government support is meant by this, however, is unclear. In situations where, for instance, Chinese financial institutions risk loss of US dollar clearing licenses, the language in the Rules may actually portend more extensive state-to-state engagement.
In what manner and how actively the Chinese government ultimately wields the Rules is unclear, particularly in the absence of implementing guidelines. Indeed, the true impact of the Rules may depend on the winds of international diplomacy, largely outside the control of both Chinese and multinational companies. What is clear, however, is that with the rapid and successive adoption of the Rules, the Unreliable Entity List Regulation, and the PRC Export Control Law, China is taking affirmative steps to ensure that it has the necessary framework to engage and counter others in the global marketplace.
