Xiaomi Corporation (Xiaomi), one of the world’s largest smartphone manufacturers, won a preliminary injunction from the DC District Court on March 12, 2021 that enjoined the US government from enforcing a Trump-era rule that prohibits US persons from purchasing or possessing Xiaomi’s publicly traded securities. The ban applied to Xiaomi by virtue of its listing as a Communist Chinese military company (CCMC) by the US Department of Defense (DoD) pursuant to Section 1237 of the National Defense Authorization Act of FY 1999 (Section 1237) – a determination made by DoD despite the fact that Xiaomi is a Cayman Islands incorporated company, not owned by the Government of China, whose shares are publicly traded on the Hong Kong Exchange.
Fundamentally, the District Court found that there was a high probability of success on the merits of Xiaomi’s claim that its designation as a CCMC, in the relevant facts and circumstances, was arbitrary, capricious and not in accordance with law because it was not based on reasoned decision-making and did not meet Section’s 1237 substantive criteria. The Court made this ruling despite the traditional judicial deference afforded the executive branch’s national security decisions.
Thus, the implication of the Court’s ruling is that other Chinese companies named as CCMCs, especially those that are not directly government-owned, can potentially challenge their inclusion on the DoD list and, therefore, the applicability of the Trump trading ban to transactions involving their publicly traded securities. Moreover, recognizing the prospect of such potential claims, DoD may think twice about designating companies as CMMCs that are not government-owned and cannot be demonstrated to be subject to control by the People’s Liberation Army.
The DoD list of “Communist Chinese military companies” and related public trading ban
By way of context, as reported in our November 13, 2020 Legal Alert, last year DoD designated a number of Chinese companies under the authority of Section 1237, more than 20 years after Section 1237 was enacted. Section 1237 defines a CCMC to include a company that is “owned or controlled by” or “affiliated with” the People’s Liberation Army (PLA) or a ministry of the Chinese government or “owned or controlled by” an entity affiliated with the Chinese defense industrial base.
Thereafter, on November 12, 2020, then-President Trump issued Executive Order 13959 (the Order) prohibiting US persons from transacting in publicly traded securities of the DoD listed companies, or any other company determined to be a CCMC or any derivatives of such securities. The Office of Foreign Assets Control (OFAC) of the US Department of the Treasury, which is responsible for implementing the ban, has to date listed 45 companies as CCMCs and is in the process of identifying and adding the names of CCMC subsidiaries. Similar to its recent actions to restrict exports of US semiconductor technology to China, the US targeting of Xiaomi, which manufactures smartphones, televisions and laptop computers, is emblematic of US efforts to deprive China of US technology and investment in support of China’s development of 5G telecommunication capabilities.
The District Court ruling
In granting preliminary injunctive relief, the Court found that Xiaomi had shown a high likelihood of success on the merits of its claims made under the Administrative Procedure Act (APA) and that, without relief, it would suffer irreparable harm in the form of serious reputational and unrecoverable economic injuries.
Citing a decision document relied upon by the DoD in designating Xiaomi as a CCMC (the DoD Memo), the Court found that the DoD had not engaged in the “reasoned decision-making” required by the APA. Rather, according to the Court, the DoD Memo misquoted the criteria for designation of a company under Section 1237 and only cited to two facts from the company’s annual report as a basis for its decision – i.e., the fact that Xiaomi’s CEO had been recognized by PRC’s Ministry of Industry and Information Technology, and the report’s description of Xiaomi’s five-year plan to invest in fifth generation telecommunications (5G) technologies and artificial intelligence, which are considered “critical technologies essential to modern military operations.” The Court found that, even considering these two pieces of evidence together, there was “plainly a lack of substantial evidence” to support Xiaomi’s designation.
In addition, the Court found that Xiaomi does not meet the statutory criteria for designation under Section 1237 and that, therefore, DoD acted outside its statutory authority in designating Xiaomi. In this regard, Section 1237 requires DoD to publish and keep up-to-date a list of companies that are “owned or controlled by, or affiliated with, the [PLA] or a ministry of the government of the [PRC] or that [are] owned or controlled by an entity affiliated with the defense industrial base of the [PRC],” and are “engaged in providing commercial services, manufacturing, producing or exporting.”
While stipulating that Xiaomi is not “owned or controlled” by any of the proscribed Chinese entities delineated in Section 1237, DoD nevertheless argued that Xiaomi is “affiliated” with the Chinese military and defense establishment if it is found to have a “common purpose,” “shared characteristics” or if it is “closely associated with another typically in a dependent and subordinate position.”
In short, the Court rejected the agency’s broader definition of “affiliated” in favor of a definition based on common ownership and control. The Court, therefore, concluded that Xiaomi is not an “affiliate” of any of the proscribed entities identified in Section 1237.
On the question of irreparable injury, the Court found that the reputational damage caused by the designation, in conjunction with the “very serious unrecoverable financial harm” that Xiaomi had already begun to experience, weighed in favor of granting a preliminary injunction. The Court observed that it was “almost unquestionable” that the designation had damaged Xiaomi’s reputational standing with corporate customers and business partners. Further, the Court noted that since the designation was announced, Xiaomi’s stock price had dropped by 9.5%, resulting in a loss of approximately $10 billion in market capitalization, while peer companies’ share prices increased.
Will the ruling stand?
The issuance of a preliminary injunction means that the Court has concluded that Xiaomi is likely to succeed on the merits of the case. The US government may file an interlocutory appeal to the DC Court of Appeals to vacate the injunction. The US government may also decide to seek a stay of the injunction pending appeal.
Whether the Biden Administration will take these steps and defend the Trump Administration’s designation remains to be seen. If, however, appellate actions are unsuccessful, the US government may still challenge the imposition of a permanent injunction, but would likely have an uphill battle in doing so.
Will the ruling be extended to other sanctioned parties, including other listed CCMC companies?
While the Court’s ruling does offer an avenue of potential relief to certain parties named as CMMCs, the availability of this “avenue” may be limited in nature and only available to named companies that have limited or no Chinese government ownership.
Specifically, in finding that Xiaomi’s CCMC designation was likely made in violation of the APA, the Court relied heavily on its finding that Xiaomi is not “owned or controlled by,” or “affiliated” with the PLA, or the Chinese government or “owned or controlled by” an entity “affiliated” with China’s “defense industrial base.” In this regard, Xiaomi is an outlier on the CCMC list because it is one of the few companies on the list that is not state-owned. In fact, of the 45 companies listed as CCMCs to date, 39 are at least partially state-owned and, therefore, on that basis, could potentially be considered to be under common ownership with the People’s Liberation Army.
Nevertheless, the ruling is interesting because, typically, US government agency decisions are granted a great degree of deference in issues affecting national security. Determinations made under the president’s national security authorities are rarely subject to judicial review. Based on the Court’s description of the extremely brief explanation for DoD’s decision to designate Xiaomi, no doubt other targets of Trump-era sanction actions could question, and may consider challenges to, whether their sanction designations were sufficiently substantiated and made on a reasoned basis.