China's "Unreliable Entity List" Will Be In A Dilemma When Multinational Companies Respond To US Sanctions And "Long-Arm Enforcement"

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Morrison & Foerster LLPChina has recently introduced unreliable entity list ("Entity List") regulations to provide a framework for China's upcoming list of economic sanctions. As early as October 2018 and March 2020, China has implemented "blocking regulations" to prohibit entities located in China from unilaterally cooperating with foreign civil and criminal investigations. The latest entity list system, along with a number of other measures, is designed to deter and punish commercial organizations to prevent them from cooperating with foreign government actions that are deemed harmful to China's business and government interests.

China’s entity list system is similar to the economic sanctions and export control systems implemented by the Office of Foreign Assets Control of the U.S. Department of the Treasury, the U.S. Department of State, and the U.S. Department of Commerce. Both are list systems with licensing and delisting mechanisms. Both can authorize the relevant government to unilaterally restrict financial transactions, trade and visa privileges, and all are designed to prevent individuals and entities from taking actions that the government believes violates national security, foreign policy, and economic interests.

According to the Chinese Ministry of Commerce ("Ministry of Commerce"), the entity list system is not intended to target any specific country or entity. However, multinational companies that wish to comply with the sanctions imposed by the United States on Chinese individuals or entities or cooperate with the United States in civil or criminal investigations of Chinese business activities are more likely to be targeted. Multinational companies should consider how to comply with US law enforcement requirements, while balancing the conflicting risks brought by China’s new entity list system and other latest measures described below.

background

On May 31, 2019, the Ministry of Commerce announced for the first time the establishment of an entity list system, which was the tenth day after the US Department of Commerce added Huawei Technologies Co., Ltd. to its entity list. On September 18, 2020, the US Department of Commerce implemented an executive order to restrict the use of WeChat and Douyin software in the United States. On the following day, September 19, 2020, the Ministry of Commerce promulgated the "Regulations on the List of Unreliable Entities" ("List of Regulations").

The "List Regulations" require central government agencies to establish an inter-departmental task force ("working mechanism") to implement the entity inventory system. The inter-departmental task force has not yet been established, but it will have extensive powers to investigate the behavior of foreign entities to determine whether they need to be included in the entity list. How the task force obtains records from foreign entities located overseas and the scope of the records are still open for discussion. At present, the Chinese authorities have not established a mechanism similar to the US authorities’ overseas summoning powers for obtaining overseas records of foreign entities.

Activities that may lead to being included in the entity list

Article 2 of the "List Regulations" defines "foreign entities" as foreign enterprises, other organizations or individuals. This article takes corresponding measures against the following actions of foreign entities:

(1) Endanger China's national sovereignty, security or development interests; and

(2) Violating the principles of normal market transactions, interrupting normal transactions with Chinese entities, or adopting discriminatory measures against Chinese entities, seriously damaging the legal rights of the entity.

Article 7 stipulates that the inter-departmental task force will consider the following factors to decide whether to include a foreign entity in the list of unreliable entities:

(1) The degree of harm to China's national sovereignty, security, and development interests;

(2) The degree of damage to the legal rights of Chinese enterprises, other organizations or individuals;

(3) Whether it complies with internationally accepted economic and trade rules; and

(4) Other factors that should be considered.

Once the task force makes a decision to be included in the list, it will be announced and effective immediately. The announcement may contain risk warnings to remind the risks of transactions with designated foreign entities.

Restrictions on designated foreign entities

Article 10 stipulates that the inter-departmental task force may take one or more of the following measures against foreign entities included in the entity list:

(1) Restrict it from engaging in import and export activities related to China;

(2) Restrict their investment in China;

(3) Restrict the entry of related personnel and transportation vehicles;

(4) Cancel the work permit, stay or residence qualification of relevant personnel in China;

(5) A fine of a corresponding amount shall be imposed according to the seriousness of the circumstances; and

(6) Other necessary measures.

Correction period and delisting mechanism

Article 9 stipulates that a designated foreign entity can correct its behavior within a specified period of time. During this grace period, the restrictive measures will not be implemented, but if the relevant foreign entity fails to correct its behavior in a timely manner, it will be subject to the aforementioned restrictions and prohibitions without notification.

Article 12 stipulates that the inter-departmental task force may remove the named foreign entity from the entity list at any time at its discretion. The designated foreign entity can also apply to the task force for delisting. Article 13 stipulates that if the designated foreign entity has corrected its behavior, the task force shall immediately remove it. Any delisting decision must be supplemented by an announcement.

Obtained permission to trade with designated entities

If foreign entities are designated, they will be restricted or prohibited from engaging in import and export activities related to China. If Chinese entities must conduct transactions with designated foreign entities, they can apply to the Office of the Interdepartmental Task Force. If approved, you can continue to trade with the relevant foreign entity.

Analysis and prospects

At present, certain necessary implementation details of the entity list system have not yet been determined, including investigation, designation, transaction permit, appeal and delisting procedures, and the specific composition of the inter-departmental task force. It can be expected that in the near future, various implementation rules will be issued one after another to improve the entity list system. As early as May 2020, the State Council of China pointed out that the complete implementation of the entity list system was one of China's four major legislative priorities that year. For reference, the State Council considered China’s “Cyber ​​Security Law” in 2017 as the focus of its legislation, while the Cyber ​​Security Law issued two administrative regulations within one month and two months after the formulation of the Cyber ​​Security Law. There were 27 regulations in two years Level provisions, plus the judicial interpretation of the Supreme People’s Court.

China’s entity inventory system is similar to the economic sanctions and export control systems implemented by the Office of Foreign Assets Control of the U.S. Department of the Treasury, the U.S. Department of State, and the U.S. Department of Commerce. Both are list systems with delisting and licensing mechanisms. Both are unilateral systems of the countries concerned, and both involve the prohibition of financial transactions, trade and visa privileges-a move designed to prevent individuals and entities from taking actions that the government believes violates national security, foreign policy, and economic interests.

Today's business environment is particularly politicized, and the entity inventory system is likely to be used to achieve regulatory goals and foreign policy games at the same time. If a foreign entity (1) is involved in a sensitive geopolitical project related to transactions related to China’s national security and development interests; or (2) is deemed to cause serious damage to a Chinese company of strategic significance, such as providing information to foreign government authorities. Such Chinese companies face higher risks if they are punished or restricted in trade.

In the past two years, China has taken a variety of measures to make multinational companies subject to conflicting pressure when they want to comply with the US or other governments' overseas law enforcement, and the list of entities may also fall into this category. China enacted the International Criminal Judicial Assistance Law in October 2018, requiring that any Chinese individual or entity must obtain approval from the Chinese authorities before providing information or assistance for overseas criminal procedures. Article 177 of China's Securities Law, which came into effect on March 31, 2019, is a civil blocking law and is more targeted. This article prohibits any person from providing documents and information "related to securities business activities" in China to overseas securities regulatory agencies without the prior approval of the State Council.

With the increasing complexity of the regulatory environment, multinational companies wishing to comply with unilateral sanctions and investigation requirements such as the US government, if entities or business records located in China are implicated, they should consider and evaluate conflicting benefits and risks. In order to reduce the risk of being included in the list of entities by the Chinese government, if multinational companies are called by other governments to cooperate with overseas investigations, they should cooperate as much as possible, but they must also comply with China's criminal and civil blocking laws. If the sanctions regulations of other countries require multinational companies to end transactions with Chinese entities, the parties to the transaction should try their best to negotiate a commercially reasonable closing plan and alternative arrangements.

The information provided in this article does not constitute legal advice. For details, please refer to the following terms/notice links. Any information about the People's Republic of China (China) in this article is not intended and should not be considered as an opinion, decision or certification regarding the application of Chinese law. The firm does not have a Chinese legal practice qualification.

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