China’s Ministry of Commerce (MOFCOM) announced on May 31, 2019, that China will introduce an “Unreliable Entity List” regime under which foreign entities or individuals which boycott or cut off supplies to Chinese companies for noncommercial purposes, causing serious damage to Chinese companies, may be listed as "Unreliable Entities" subject to legal action.
In a number of interviews in mid-June and early July, MOFCOM officials and spokespersons stated that the “Unreliable Entity List” regime is undergoing required internal review with detailed rules/measures soon to be promulgated.
This new regime was announced after the US government added Huawei Technologies on its “Entity List.” The new regime is widely believed to be one of China’s countermeasures against foreign export control enforcement actions targeting Chinese companies, in particular US sanctions against Huawei. According to MOFCOM, four standards will be considered together when determining whether a foreign entity or individual should be listed as an “Unreliable Entity,” including (i) where there it is boycotting, cutting off supplies to Chinese companies or taken other specific discriminatory actions against Chinese companies; (ii) whether these actions are taken for noncommercial purposes, in violation of market rules or in breach of contractual obligations; (iii) whether these actions cause material damage to the legitimate interests of Chinese companies and relevant industrial sectors; and (iv) whether these actions constitute a threat or potential threat to China's national security.
The “Unreliable Entity List” regime will be established pursuant to the Foreign Trade Law, Anti-Monopoly Law and National Security Law. Such statutory authority includes:
Art. 7 of the Foreign Trade Law, which provides in general terms that if a foreign country or region adopts prohibitive, restrictive or similar measures on a discriminatory basis against China in trade, China may take corresponding counteractions against such country or region.
The Anti-Monopoly Law focuses on penalizing monopoly conduct eliminating or reducing competition, including monopoly agreements, abuse of market dominance and monopoly through concentration of business undertakings. Art. 17 in particular prohibits abuse of market dominance by such means as refusal to trade or imposition of discriminatory conditions or prices.
Art. 59 of the National Security Law provides that the State, in order to prevent and mitigate national security risks, shall establish a national security review and supervision system and conduct national security reviews on foreign investment, specific articles, key technologies, products and services relating to network information technologies, infrastructure construction products and other important transactions and activities that impact or may potentially impact national security.
In addition to the three laws specifically referenced as the legal basis for the new regime, we note that Art. 40 of the new Foreign Investment Law which enters into effect on January 1, 2020, also provides that China may take corresponding countermeasures against a foreign country or region if such foreign country or regime takes discriminatory measures against China, prohibiting or restricting investments.
We note that both Art. 7 of the Foreign Trade Law and Art. 40 of the Foreign Investment Law are directed against foreign governments, not specific companies. Therefore, a foreign company which complies with its own government's rules to restrict trade or investment with China may be treated as an “unreliable entity.”
With respect to enforcement actions, even pending adoption of the detailed measures, foreign entities who are informally named as “Unreliable Entities” may face such market access sanctions as bans or restrictions on trade, investment, regulatory permits and licenses. Chinese business counterparts to foreign entities on the list will likely be ordered to cease business dealings with such foreign entities.
The sanctions may apply to both the underlying foreign entity and its affiliates and subsidiaries, including its subsidiaries in China. As stated by MOFCOM, foreign individuals may also be listed as “Unreliable Entities” which may include officers of foreign entities.
Before a foreign entity is listed as an “Unreliable Entity”, relevant procedures under the Administrative Licensing Law will need to be followed. This means that a foreign entity will have the right to participate in hearings to rebut the allegations and have its views heard before a decision is made. MOFCOM stated that a foreign entity may also be removed from the list after corrective measures are taken. In terms of sequence, it is likely that the rules and measures on the “Unreliable Entity List” regime will first be promulgated before the actual list comes out.
While it is unclear at this point which Chinese government agency will take the lead in enforcing the new regime, we would expect that MOFCOM will play a leading role. MOFCOM established a new “Bureau of Industry, Security, Import and Export Control” (BISIEC) in 2015 that has been relatively quiescent until now. BISIEC’s roles and responsibilities are to some extent similar to those of the Bureau of Industry and Security (BIS) in the US Department of Commerce, which, among others, administers the BIS “Entity List.” BISIEC’s key responsibilities include, among others, research and establishment of an import/export security review system involving national security and trade restrictions, tightening of the administration of import and export control systems, encouragement of relaxation of control on technologies exported to China, and establishment of bilateral export control and high technology communication mechanisms.
We understand that BISIEC has focused in part on export controls on “dual use” items (items that can be used for both civilian and military purposes) and also plays an important role in formulating China’s Export Control Law, which may restrict exports of Chinese origin products or technologies to specified foreign entities. Unlike the Export Control Law, the measures on the “Unreliable Entity List” are likely to take the form of administrative regulations rather than a statute.
The US and China have agreed to hold their 12th round of trade negotiations in Shanghai beginning July 30. Whether and how this new round of trade negotiations will affect the formulation of the “Unreliable Entity List” regime remains to be seen. However, China is likely to adopt the “Unreliable Entity List” regime regardless of the outcome of the negotiations.