Key Takeaways

• The U.S. Department of Defense (“DoD”) updated its list of “Chinese military companies” operating “directly or indirectly” in the United States on January 31, 2024, adding 17 new entities and removing three. The list was first published in June 2021 and had not been updated since October 2022.
• The list is known as the “Section 1260H List” as it is statutorily required under Section 1260H of the National Defense Authorization Act (“NDAA”) for Fiscal Year (“FY”) 2021.
• Currently, an entity’s presence on the list has no legal ramifications, but as a result of the NDAA for FY 2024 (which became law in December 2023), in coming years DoD will be prohibited from procuring goods or services directly or indirectly from entities on the list, with potentially significant consequences for the supply chain due diligence requirements of DoD contractors.

This OnPoint addresses updates to the Defense Department's Section 1260H List of "Chinese Military Companies" and new developments on the legal implications of being listed.

Context

National security concerns regarding China, and in particular its military-industrial complex, have been growing for several years in both the Legislative and Executive Branches. The creation of the Section 1260H List is just one of several ways in which the U.S. government has taken action. In 2020, as the NDAA for FY 2021 was making its way towards passage in Congress, President Trump issued Executive Order (“E.O.”) 13959, which established the Communist Chinese Military Companies (“CCMC”) sanctions program. The CCMC sanctions program prohibited U.S. persons from transacting in publicly traded securities of certain Chinese companies that DoD identified and the Treasury Department’s Office of Foreign Assets Control (“OFAC”) listed on its CCMC List.

Shortly after taking office in 2021, President Biden issued E.O. 14032, which revised and superseded E.O. 13959. Among other things, Biden’s E.O. renamed the CCMC List as the “Non-SDN Chinese Military-Industrial Complex Companies List” (“NS-CMIC List”), expanded the designation criteria to include Chinese companies involved in surveillance technology, and placed designation authority with the Treasury Secretary. E.O. 14032 continued the prohibition on U.S. persons transacting in publicly traded securities of listed companies.

Executive agencies under both presidents continue to take action regarding exports to and imports from China: Chinese entities are appearing in increasing numbers on the Commerce Department’s Entity List and Military End User List, which restrict U.S. goods and technology from being exported to listed entities, and on the Department of Homeland Security’s Uyghur Forced Labor Prevention Act Entity List, which restricts goods produced by listed entities from being imported into the United States.

Congress remains vigilant to the perceived threat to U.S. national security from China and its military-industrial complex. Two days before DoD published its updated Section 1260H List for 2024, on January 29, 2024, seven Republican senators sent an open letter to the Secretary of Defense requesting a briefing on why the Department had not updated the list in 2023, and requesting an update on the process for determining how the Department develops, updates, and publishes the list.

Section 1260H List Criteria

The authors of Section 1260H of the NDAA for FY 2021 (“Section 1260H”) had similar concerns in mind. Section 1260H, which became law as part of the NDAA during the transition period from Trump to Biden, requires the Secretary of Defense to “identify each entity the Secretary determines… is operating directly or indirectly in the United States… that is a Chinese military company.” “Chinese military companies” are defined to include entities engaged in providing commercial services, manufacturing, producing, or exporting that are (i) owned, controlled, or beneficially owned by, or acting on behalf of, the People’s Liberation Army or any other organization under the Chinese Communist Party’s Central Military Commission; or (ii) identified as a military-civil fusion contributor to the Chinese defense industrial base. “Military-civil fusion contributor” is defined to include:

1. Entities knowingly receiving assistance from the Government of China or the Chinese Communist Party through science and technology efforts initiated under the Chinese military industrial planning apparatus.
2. Entities affiliated with the Chinese Ministry of Industry and Information Technology, including research partnerships and projects.
3. Entities receiving assistance, operational direction or policy guidance from the State Administration for Science, Technology and Industry for National Defense.
4. Any entities or subsidiaries defined as a ‘‘defense enterprise’’ by the State Council of the People’s Republic of China.
5. Entities residing in or affiliated with a military-civil fusion enterprise zone or receiving assistance from the Government of China through such enterprise zone.
6. Entities awarded with receipt of military production licenses by the Government of China, such as a Weapons and Equipment Research and Production Unit Classified Qualification Permit, Weapons and Equipment Research and Production Certificate, Weapons and Equipment Quality Management System Certificate, or Equipment Manufacturing Unit Qualification.
7. Entities that advertise on national, provincial, and non-governmental military equipment procurement platforms in the People’s Republic of China.
8. Any other entities the Secretary determines is appropriate.

New Developments for the Section 1260H List

As a result of the most recent DoD update, there are now 46 entities (plus their subsidiaries) on the Section 1260H List. While no legal consequences flow at present from the addition of a company to the 1260H List, that will soon change.

Congress recently imposed such consequences (albeit with delayed effect) in Section 805 of the NDAA for FY 2024, which became law on December 22, 2023. The first key provision will prohibit the DoD from entering into, renewing, or extending a contract for the procurement of goods, services, or technology with an entity on the Section 1260H List; this provision will take effect on June 30, 2026. The second key provision will prohibit DoD from entering into, renewing, or extending a contract for the procurement of goods or services that include goods or services produced or developed by an entity on the Section 1260H List; this provision will take effect on June 30, 2027.

Contracts entered into before the relevant effective dates are exempt from the prohibitions, even if they are renewed or extended after those dates. Further, the provisions do not apply to “components,” defined broadly to mean items supplied to the federal government as part of an end product or of another component, or to procurement of goods, services, or technology that provide a service that connects to the facilities of a third party (such as backhaul, roaming, or interconnection).

As DoD spends hundreds of billions of dollars on procurement each year, the impact of these new prohibitions could be significant, both for listed Chinese companies and for U.S. (and other) companies who procure products from them in the course of supplying to DoD. Heightened supply chain due diligence will be required.

Congress currently is considering other steps that might be taken with respect to Chinese companies that are seen to pose a threat to U.S. national security. Such potential measures include imposing full OFAC blocking sanctions on entities listed on the Section 1260H List, effectively cutting off these companies (and companies in which they own a 50% or greater interest) from the U.S. economy.

Dechert regularly represents companies and individuals facing the implications of U.S. national security policies, laws, and regulations, including those targeting China. We will continue to monitor this space as the Section 1260H List and other such measures are updated.