ZTE Trade Controls Denial Order – Four Crucial Points

Orrick, Herrington & Sutcliffe LLP

On April 15, 2018, the U.S. Commerce Department's Bureau of Industry and Security ("BIS") imposed a "denial order" against Zhongxing Telecommunications Equipment Corporation ("ZTE Corporation") and ZTE Kangxun Telecommunications Ltd. ("ZTE Kangxun"; collectively, "ZTE") under the Export Administration Regulations ("EAR"). The denial order springs from a March 2017 settlement of alleged export control and economic sanctions violations, including a criminal plea, relating to alleged transactions involving Iran and North Korea. The denial order broadly forbids supply to ZTE of goods, software and technology that originated in the United States or are otherwise subject to U.S. export control jurisdiction. The denial order is scheduled to last for seven years. But given the extraordinary business disruption caused by the denial order, there is pressure for BIS to suspend or limit the order based on new ZTE commitments to the U.S. government.

Crucial Points

 Building on our alert about ZTE's March 2017 settlement:

  1. Extraterritorial Trade Control Enforcement: The ZTE settlement, in particular, the April 15 denial order, demonstrates the U.S. government's seriousness about enforcing U.S. sanctions and export controls ("U.S. Trade Controls") extraterritorially against non-U.S. companies acting outside the United States. In ZTE's case, the U.S. authorities applied U.S. Trade Controls to transactions abroad based on the fact that the traded goods, software or technology involved were either created in the United States or contained an over-de minimis level of content that was created in the United States. The Trump Administration views U.S. Trade Controls enforcement as an important element of its policy of blocking movement of critical technology to China and elsewhere.
  2. U.S. Access as Leverage: The ZTE denial order highlights the U.S. government's leverage over major U.S. and non-U.S. companies. The ZTE settlement provided for nearly US$1 billion or more in payments to the U.S. government. Even a monetary penalty at this level, however, commonly pales in comparison to a broad sanction like the ZTE denial order. Blocking access to supplies of U.S. goods, software and technical assistance is often crippling for a major multinational company.
  3. Impact on U.S. Companies: The ZTE denial order, which broadly blocks U.S. sales to ZTE, demonstrates that the U.S. government is prepared to let U.S. companies absorb severe collateral damage that a sanction like the ZTE order can cause. Notably, BIS imposed the order on a Sunday (April 15) without warning, and the order went into effect immediately without providing U.S. companies with a grace period to wind down business with ZTE. Without a grace period, there is much uncertainty about the lengths to which companies must go to terminate shipments. In addition, the ability to receive payment from ZTE in compliance with the denial order for pre-April 15 transactions is especially complicated. United States companies will want to consider whether major international customers are in compliance with U.S. Trade Controls.
  4. Additional Similar Sanctions Threatened: There is little reason to expect the ZTE denial order to be unique. In fact, recent reports indicate that Huawei, China's largest telecommunications company, is also under criminal investigation for possible U.S. Trade Controls violations relating to business with Iran.

Discussion

The ZTE group is China's second-largest maker of telecommunications equipment and the fourth-largest telecommunications manufacturer in the world. It relies heavily on U.S. equipment, software and technology to develop and produce its telecommunications products.

In March 2017, ZTE settled criminal and civil proceedings involving charges that centered on allegations that ZTE supplied electronic products to Iran and North Korea in violation of U.S. Trade Controls. U.S. government agencies emphasized that ZTE, among other things, allegedly bought export-controlled U.S.-origin components, incorporated them into ZTE network infrastructure products and supplied these products to Iran, and then took elaborate steps to hide these activities from U.S. authorities.

As part of the 2017 settlement, in addition to financial penalties of at least US$892 million and as much as US$1.19 billion, ZTE agreed to an independent monitor of its operations, a program of compliance auditing and maintenance of compliance program arrangements. Crucially, ZTE also agreed to a seven-year suspended denial order that could be activated based on a violation of the settlement agreement with BIS or if ZTE committed additional violations of the EAR. The denial order was activated by BIS on April 15, 2018, after BIS determined that ZTE made false statements about employee disciplinary actions both during settlement negotiations and after entrance into the settlement agreement. BIS apparently discovered that ZTE made allegedly false statements to the U.S. government only after BIS requested information and documentation showing that employee discipline had been implemented.

The denial order prohibits ZTE and, when acting for or on ZTE's behalf, its successors, assigns, directors, officers, employees, representatives or agents from directly or indirectly participating in transactions involving any goods, software or technology that are subject to U.S. jurisdiction under the EAR as described in the order.

Further, the denial order forbids anyone – wherever they are located and whether or not they are U.S. persons – to:

  • Export or re-export any item subject to the EAR to or on behalf of ZTE;
  • Facilitate the acquisition or attempted acquisition by ZTE of the ownership, possession or control of any item subject to the EAR that has been or will be exported from the United States, including financing or other support activities related to a transaction whereby ZTE acquires or attempts to acquire such ownership, possession or control;
  • Acquire or facilitate the acquisition or attempted acquisition from ZTE of any item subject to the EAR that has been exported from the United States;
  • Obtain from ZTE in the United States any item subject to the EAR with knowledge or reason to know that the item will be, or is intended to be, exported from the United States; or
  • Engage in any transaction to (i) service any item subject to the EAR that has been or will be exported from the United States and which is owned, possessed or controlled by ZTE, or (ii) service any item, of whatever origin, that is owned, possessed or controlled by ZTE if such service involves the use of any item subject to the EAR that has been or will be exported from the United States.

The denial order does not apply directly to subsidiaries or other affiliates of ZTE that are not acting for or on behalf of ZTE. In addition, it does not prohibit dealings with ZTE that have no connection to an item subject to the EAR. Transactions involving purely financial or investment matters with ZTE may not be prohibited. But companies should be aware that the U.S. government, including the U.S. Treasury Department's Office of Foreign Assets Control, could impose further sanctions on ZTE.

Under these circumstances, non-U.S. companies' development and promotion of effective U.S. Trade Controls compliance safeguards are plainly worthwhile if they prevent a fraction of the adverse implications of the ZTE settlement.

It is possible that the U.S. Department of Commerce will issue further guidance on implementation of the denial order.

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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