Department of Commerce Regulatory Changes: Eliminating Export Exemptions and Increasing Compliance Obligations to Gain Insight into Trade Transactions

Dechert LLP

Key Takeaways

The U.S. Department of Commerce, Bureau of Industry and Security (“BIS”), is tightening its export controls with respect to China, Russia, and Venezuela, with the goal of preventing U.S. products from being used for military purposes. Impacted industries include chemicals, semiconductors, sensors and aviation, among others. While many countries are impacted, the rules primarily target exports to China, Russia and Venezuela. BIS is:

  • Eliminating a license exception that allowed for the export of controlled items if they were for civilian end use.
  • Expanding prohibitions on exports to military end users and for military uses.
  • Requiring electronic reporting to the government for all exports of controlled commodities to China, Russia and Venezuela, regardless of value or whether a license is required.
  • Proposing to eliminate reexport deference given to close U.S. allies.

Background

On April 28, 2020, the Commerce Department’s Bureau of Industry and Security (“BIS”) published two final rules and one proposed rule targeting national security controlled exports and reexports to China, Russia, and Venezuela. These rules eliminate license exceptions, require additional export reporting, and expand the restrictions on exports to military end users and for military end uses in those three countries. BIS stated its intent is to gain increased visibility into sensitive export transactions involving China, Russia and Venezuela, in part due to the deliberate fusion of civilian and military technologies in those countries. In collecting more data through license applications and export reporting, BIS may be positioning itself for heightened export enforcement activity. These rule changes also signify the U.S. government’s willingness to take a unilateral approach on export controls to achieve its national security goals towards countries of concern.

Elimination of License Exception CIV

License Exception “Civil End-Users” (“CIV”) will be removed from the Export Administration Regulations on June 29, 2020.1 Until now, this license exception authorized, without the need to seek approval from BIS, the export of items listed on the Commerce Control List (“CCL”) and controlled for national security purposes alone to Country Group D:12 – provided the items would be used only by civilian entities for non-military end uses. Companies in the semiconductor, sensors, advanced manufacturing, aircraft and telecommunications sectors benefited from this license exception, particularly for exports to China and Russia. To comply with CIV, exporters simply needed to conduct their own due diligence to ensure that a customer and its intended end use were civilian. However, that was becoming increasingly difficult, given the commingling of management, funding and research efforts between the military and commercial sectors in those countries.

The elimination of CIV means that exports of national security controlled items destined to Country Group D:1 now need a specific license from BIS, regardless of end use or end user, unless another license exception applies. U.S. companies may need a longer lead time for transactions since they will need to obtain specific licenses from BIS for transactions where previously they could use the CIV license exception.

Reporting Obligations and Expansion of Military Use/User Rules for China, Russia and Venezuela

In the BIS rule titled “Expansion of Export, Reexport, and Transfer (in-Country) Controls for Military End Use or Military End Users in the People’s Republic of China, Russia, or Venezuela,”3 BIS expanded the requirements to obtain specific licenses for exports to military end users and military end uses in China, Russia and Venezuela. These rules are effective June 29, 2020. License applications related to such military end users or uses will continue to be subject to a presumption of denial.

Historically, a license has been required to export specified products:

  • for “military end uses” in China, Russia or Venezuela; and
  • to “military end users” in Russia or Venezuela.4

The new rule expands the license requirement now to include exports to “military end users” in China. Also, BIS has expanded the definition of “military end use.” Previously the definition of military end use included items intended for incorporation into, or designed for the “use,” “development,” or “production” of, certain military items; the rule has been broadened now to include “any item that supports or contributes to the operation, installation, maintenance, repair, overhaul, refurbishing, ‘development,’ or ‘production,’ of military items.”

The rule also adds 17 export control classification numbers (“ECCNs”) and expands the scope of 3 ECCNs listed in Supplement 2 to Part 744, which require a specific license when exported to military end users or for military end uses in China, Russia and Venezuela. These ECCNs cover materials processing, electronics, telecommunications, information security, sensors and lasers, and propulsion commodities; however, Supplement 2 does not include items designated as EAR99. This expansion of the rule creates an affirmative obligation for heightened customer due diligence for items that previously would not have required a license (such as mass market encryption software). As BIS stated in its explanatory notes for the rulemaking: “This expansion will require increased diligence with respect to the evaluation of end users in China, particularly in view of China’s widespread civil-military integration.”5

Moreover, this rule amends the reporting requirement for all exports items listed on the CCL to China, Russia and Venezuela – not only those concerning military end uses or end users. Effective June 29, 2020, Electronic Export Information (“EEI”) must be submitted through the Automated Export System (“AES”) for such exports to these counties.6 The EEI, including the correct ECCN, is required regardless of value and even in instances where the export to China, Russia or Venezuela does not require a license (or use of a license exception). The new rule does not create a new AES reporting requirement for EAR99 exports. Expanded EEI reporting requirements for China, Russia and Venezuela benefits the government by enabling it to collect detailed information about transactions that otherwise do not require authorization.

Proposed Rule for Additional Permissive Reexports

Finally, BIS is proposing to eliminate a provision of License Exception Additional Permissive Reexports (“APR”)7 applicable to China, Russia and Venezuela.

The provision at issue allows for a number of reexports of certain U.S.-origin commodities from a country in Country Group A:18 or Hong Kong to countries in Country Group D:19 (which includes China, Russia and Venezuela). Under the current rules, provided the reexport is approved by the Country Group A:1 country, it is authorized by License Exception APR.10

However, the proposed rule intends to eliminate this exemption for two reasons. First, elimination grants “better visibility into transactions of national security or foreign policy interest to the United States” because reexporters will be required to obtain specific licenses from BIS. Second, the proposed rule announces that the U.S. government is no longer in alignment with its close allies in identifying national security threats posed by China, Russia, Venezuela and other counties in Country Group D:1.

“BIS proposes to remove a provision of License Exception APR due to variations in how the United States and its partners, including partners located in Country Group A:1, perceive the threat caused by the increasing integration of civilian and military technology development in countries of concern.”11

Comments on the proposed rule are due on June 29, 2020. Companies that routinely rely on License Exemption APR should consider submitting formal written comments or risk the possibility of losing the ability to utilize License Exception APR.

Potential Developments on the Horizon

These rule changes relating to military end use and end user restrictions are part of a long-term trajectory in U.S. national security policy towards China, Russia and Venezuela. We expect this trend to continue, especially with respect to China. BIS is reported to be considering several options to address its concerns about China and parties subject to export bans on the BIS Entity List.12 One option is the reduction of the U.S. content requirements for foreign-made items subject to U.S. jurisdiction under the De Minimis Rule.13 A second option is the expansion of the Foreign Direct Product Rule14 to assert U.S. jurisdiction over more foreign-made products based on U.S. technology. While the U.S. government has not yet made any formal announcements about its intent to pursue these additional options, these latest developments may be a precursor to further restrictions.

Conclusion

These amendments to the U.S. export regulations, with a focus on China, Russia and Venezuela, increase compliance obligations and expectations for customer due diligence for companies that routinely conduct business with those countries. The two new rules go into effect on June 29, 2020, with comments on the proposed rule due that same day. During the next two months, companies should evaluate their supply chains to determine licensing needs, inform their customers of the new licensing requirements, implement processes to apply for licenses (as needed) and update their procedures for EEI reporting. With the new licensing requirements, U.S. companies will have longer lead times and they will need to adjust to this new competitive environment. Those companies that prepare in advance of implementation will be best positioned to ensure compliance while minimizing business disruptions.

Footnotes

1) 85 Fed. Reg. 23470 (Apr. 28, 2020).
2) Country Group D:1 includes: Armenia, Azerbaijan, Belarus, Cambodia, China, Georgia, Iraq, Kazakhstan, North Korea, Kyrgyzstan, Laos, Libya, Macau, Moldova, Mongolia, Russia, Tajikistan, Turkmenistan, Ukraine, Uzbekistan, Venezuela, Vietnam and Yemen.
3) 85 Fed. Reg. 23459 (Apr. 28, 2020).
4) 15 C.F.R. § 744.21.
5) 85 Fed. Reg. 23460 (Apr. 28, 2020).
6) Prior to this rule, exports under $2,500 did not require filing of the EEI if no license was required. The new rule does not apply to exports under License Exception Governments and International Organizations (“GOV”).
7) 85 Fed. Reg. 23496 (Apr. 28, 2020).
8) Country Group A:1 includes: Argentina, Australia, Austria, Belgium, Bulgaria, Canada, Croatia, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, India, Ireland, Italy, Japan, South Korea, Latvia, Lithuania, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Romania, Slovakia, Slovenia, South Africa, Spain, Sweden, Switzerland, Turkey, and the United Kingdom.
9) See, footnote 2.
10) See, 15 C.F.R. § 740.16(a).
11) 85 Fed. Reg. 23496 (Apr. 28, 2020).
12) See, Reuters, Trump administration moves toward blocking more sales to Huawei: sources (Jan 14, 2020), available at https://www.reuters.com/article/us-usa-huawei/trump-administration-moves-toward-blocking-more-sales-to-huawei-sources-idUSKBN1ZD2VD
13) Under the De Minimis Rule, BIS considers foreign-made items that include at least 25% U.S.-origin controlled content to be subject to U.S. jurisdiction (10% for embargoed destinations). See, 15 C.F.R. § 734.4.
14) Application of the Foreign Direct Product Rule subjects foreign-made products that meet national security control criteria, derived from U.S.-origin technology that also subject to national security controls, to U.S. export control jurisdiction without regard to any U.S.-origin content. See, 15 C.F.R. § 736.2(b)(3).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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