On June 29, 2020, the Commerce Department issued 32 Frequently Asked Questions (FAQs) concerning revision—effective as of the same date—to Part 744.21 of the Export Administration Regulations (EAR). As we discussed in a prior alert, the final rule promulgated in April 2020 significantly expanded existing licensing requirements for exports, reexports and transfers of certain goods, equipment, materials and software (Supp. No. 2 Items) to Chinese, Russian and/or Venezuelan military end users; broadened the definition of “military end use”; and extended the licensing requirements to additional categories of items and technologies. The Commerce Department’s 20 FAQs on the scope of the definition of “military end use” effectively deputize companies to identify high-risk end users through their due diligence and identification of relevant “red flags.”
Military End Users: A particularly challenging dimension of Part 744.21 for exporters of Supp. No. 2 Items is the definition of a “military end user,” which includes not only any country’s national armed services, national guard, national police and government intelligence services, but also “any person or entity whose actions or functions are intended to support” military end uses. This is not a new definition, as Q2 of the FAQs notes. However, the Commerce Department Bureau of Industry and Security (BIS) sought to provide additional guidance in light of the expanded scope of “military end use” and the broad impact of the new rule on exporters to Chinese customers and contractors, as compared to Russia and Venezuela.
In Q4, BIS states that a license is required for exports of Supp. No. 2 Items to a military end user “even if the item is destined for a non-military end use.” In Q8, BIS affirms that point but goes on to state that, “if the specific end user to receive the item is engaged exclusively in civilian work, it would not be a ‘military end user.’” Exporters are likely to find that there is a vast range of activity that falls short of “exclusively” civilian while not necessarily “intended to support ‘military end uses.’” Exporters may err on the side of caution because Q10 warns that “[t]here is no specific volume level [for military end use activities] that would trigger a license requirement.”
BIS offers to exporters that “[d]ue diligence is required” (Q9) and that its Know Your Customer Guidance “provides guidance on due diligence in knowing your customers” (Q15). The Know Your Customer Guidance provides steps for identifying and assessing “Red Flags” via Red Flag Indicators. These indicators may be helpful in identifying end users that are attempting to deceive an exporter. Accordingly, companies exporting Supp. No. 2 Items may consider increased training of logistics, finance, sales and other “frontline” personnel to ensure they are well-positioned and informed to identify these risk factors.
BIS provided additional guidance across several other areas, including:
Parents and Subsidiaries: In Q5 and Q7, BIS identifies the factors an exporter might consider in assessing whether a subsidiary or subordinate agency of a ministry of defense would be a “military end user.” In connection with a military hospital, an exporter’s due diligence would assess “the actual relation of the ‘military hospital’ to the country’s national armed services and the patient population served by the hospital, or whether it is an entity that develops, produces, maintains, or uses military items.” In Q9, BIS considers a situation where an exporter has knowledge that a parent or subsidiary of the end user is involved in “military end uses” and states that “[y]ou must exercise due diligence to determine whether the parent or subordinate entity’s military activities is relevant to the specific end user’s activities.”
Knowledge: BIS in Q9 emphasizes that the “knowledge” standard imposed on exporters “includes not only positive knowledge that the circumstances exist or are substantially certain to occur, but also an awareness of a high probability of its existence or future occurrence. Such awareness is inferred from evidence of the conscious disregard of facts known to a person and is also inferred from a person’s willful avoidance of facts.”
In the Know Your Customer Guidance, BIS states that exporters should not “cut off the flow of information that comes to your firm in the normal course of business.” Self-blinding is a key risk for companies in large part because an employee’s knowledge can be imputed to the employer. Accordingly, companies exporting Supp. No. 2 Items should ensure that their policies and internal controls are adequate to analyze any potentially relevant information they (and their employees) collect about their ultimate end users.
Military End Uses: The term “military end use” has been expanded to include the incorporation of an item into certain enumerated military items, as well as “any item that supports or contributes to the operation, installation, maintenance, repair, overhaul, or refurbishing, or the ‘development’ or ‘production’ of”” those items. In Q20, BIS affirms the expansiveness of this definition, stating that the reference to “any item that supports or contributes to” goes beyond being incorporated into a military item to also cover “direct facilitation, such as installation, inspection, or test equipment and related software and technology, of the operation, installation, etc.,” of a military item.
Licensing: BIS confirms in Q22 that export license requests under the new rule will be evaluated under a presumption of denial. But, in Q23, it helpfully clarifies that “the presumption can be overcome” by a demonstration of “exclusive civil end use, consistent with U.S. national security interests.” As an example, BIS suggests that “exporters with existing suppliers in China should submit license applications documenting the supply chain, i.e., what items are exported to the Chinese supplier and what the exporter received from the Chinese supplier.” This example addresses situations in which an end item is ultimately exported to (and perhaps consumed in) the United States, thereby mitigating the risk of a Chinese military end use. Exporters should consider how they might demonstrate to BIS that a particular export transaction does not undermine US national security interests even in other scenarios, especially where there may be a limited relationship between a Chinese customer and its “support” for military end uses.
As both the Trump Administration and Congress take an increasingly confrontational posture toward China, regulatory and congressional scrutiny—in addition to civil and criminal enforcement—may increase in the near term. The Commerce Department’s new FAQs highlight the need for exporters to carefully reevaluate their pre-transaction screening steps and personnel training in order to avoid violation of the expanded export licensing requirements, especially for “military end users” in China.