Home Army Technology New Rules Restrict U.S. Exports to China, Targeting Chinese Military End Uses and End Users – JD Supra

New Rules Restrict U.S. Exports to China, Targeting Chinese Military End Uses and End Users – JD Supra

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[co-author: Brian Wong]

A new rule issued by the Department of Commerce’s Bureau of Industry and Security (BIS) will significantly expand restrictions on U.S. exports of a variety of products, software, and technology to China, including materials processing, electronics, telecommunications, encryption and information security, semiconductors, sensors and lasers, and aircraft and propulsion items.

BIS’s action was prompted by U.S. concern about China’s “civil-military integration” and its acquisition of U.S. technology through civilian supply chains, or under civilian-use pretenses, for use in development of Chinese military and surveillance capabilities, and the inadequacy of prior U.S. efforts to restrict exports to only civilian Chinese customers.

Reflecting a significant shift in U.S. policy, the new rule revises an existing regulation to cover additional export items in a wider range of end uses (including Chinese military end uses), adds a licensing requirement for Chinese military end users, and subjects export license applications regarding such products and technologies to a “presumption of denial.” The new rule, which becomes effective on June 29, 2020, will impact U.S. companies exporting to China, Chinese companies that depend on U.S. supply chains, and a variety of cross-border joint ventures, partnerships, and similar collaborations, cutting across a broad range of industries.

At the same time, BIS issued a second rule that eliminates a license exception (License Exception Civil End Users (CIV)) for exports to China, Russia, Venezuela, and other so-called Country Group D:1 countries, a change that will affect exports and “deemed exports” (the release of U.S. technology and source code to foreign nationals in the United States).

Accompanying the issuance of these two new rules, BIS also gave notice of a proposed rule that would eliminate another license exception (License Exception Additional Permissive Reexports (APR)), under which it previously has been possible to reexport many items subject to the Export Administration Regulations (EAR) from Group A:1 countries to Group D:1 countries – including China – without an otherwise-required export license.

Viewed against the backdrop of the Trump Administration’s campaign to stem the loss of U.S. technology to China and concern over U.S. exports enhancing China’s military and surveillance capabilities, companies should anticipate strict enforcement of these new export restrictions. U.S. exporters need to carefully consider whether any of their export items or technologies, including licensed technologies, are covered by the new rules and, if so, ensure they have conducted thorough due diligence on their Chinese customers.

1. New Export Requirements for China, Russia, and Venezuela Military End Uses and End Users

BIS’s amended rule expands the military end use and military end user license requirements for China, Russia, and Venezuela (covered countries), adds military end users in China to the military end user restriction previously applicable to Russia and Venezuela, expands the definition of military end use/end user, and broadens the list of covered export items. The rule practically will eliminate exports of covered hardware, software and technology for Chinese military end use or to military end users, and will require all U.S. exporters to thoroughly vet their Chinese trade partners, particularly given the sometimes opaque relationship between Chinese civilian companies and the Chinese military.

Broadened Definition of “Military End Use”

The rule expands the definition of military end use. The current rule applies to items listed in Supplement No. 2 to Part 744 (covered items) exported, reexported, or transferred (in-country) (collectively “export”) to covered countries for “incorporation into a military item1 . . . or for the “use,” “development,” or “production” of military items.”2

“Use” is currently defined as “operation, installation (including on-site installation), maintenance (checking), repair, overhaul and refurbishing” (emphasis added).

The new rule defines military end use as:

[I]ncorporation into a military item . . . or any item that supports or contributes to the operation, installation, maintenance, repair, overhaul, refurbishing, “development,” or “production,” of military items (emphasis added).

There are two significant changes in the new definition. BIS changed “and” to “or” in the definition of “use,” stating that “any one of the six elements, standing alone, is sufficient” to constitute a “use.” The existing term “use” requires all six elements to be present to constitute a “use.” This change is a substantial expansion of the licensing requirement because, in many instances, all six elements are not present, in which case no license has been needed under the current rule.

In addition, adding the phrase “or any item that supports or contributes to” further expands the licensing requirement; and, as those terms are not defined, there is uncertainty as to how broadly to apply the rule. Exporters must increase their due diligence review of the end use of their products, and determine what constitutes an acceptable demonstration of end use.

Assessing end use must be done in the context of the rule requirement that exports of covered items may not be made absent a license if the exporter has “knowledge” that the item is intended, either “entirely or in part,” for a military end use or a military end user in the covered countries. “Knowledge” is defined in the EAR to include not only “positive knowledge that the circumstance exists or is substantially certain to occur, but also an awareness of a high probability of its existence or future occurrence,” i.e., “reason to know.”

Existing License Requirement Extended to “Military End Users” in China

The new rule adds military end users in China to the requirement that previously applied to military end users in Russia and Venezuela. All such military end users require a license for the covered items listed in Supplement No. 2 to Part 744. The definition of military end users remains the same: the national armed services (army, navy, marine, air force, or coast guard), as well as the national guard and national police, government intelligence or reconnaissance organizations, or any person or entity whose actions or functions are intended to support military end uses” (emphasis added). Exporters are subject to the same standard of “knowledge” discussed above regarding whether an item is intended, “entirely or in part,” for a military end user in the covered countries.

The combination of these provisions will present substantial due diligence challenges for a broad range of exporters. In the text accompanying the rule, BIS stated that this expansion “will require increased diligence with respect to the evaluation of end users in China, particularly in view of China’s widespread civil-military integration.” Given the often labyrinthal Chinese company ownership structures and interrelationships, combined with the “entirely or in part” usage standard of the rule, exporters and legal counsel are already requesting additional BIS guidance on these new requirements.

Even if such guidance is forthcoming, it may not arrive in time, and it is reasonable to expect that BIS will not provide a safe harbor listing of due diligence activities sufficient to meet exporters’ compliance responsibilities. U.S. companies exporting any of the covered items to China, Russia, or Venezuela should reevaluate their due diligence procedures to determine whether additional inquiry is needed.

New Covered Items Added to Supplement No. 2 to Part 744

Items subject to the military end use and end user restrictions are limited to the products, software, and technology specifically listed in Supplement No. 2 to Part 744. These span a number of industrial sectors, and include materials processing, electronics, telecommunications, information security, sensors and lasers, and propulsion. The new rule adds a number of additional Export Control Classification Numbers (ECCNs) to those presently included in Supplement No. 2: 2A290, 2A291, 2B999, 2D290, 3A991, 3A992, 3A999, 3B991, 3B992, 3C992, 3D991, 5B991, 5A992, 5D992, 6A991, 6A996, and 9B990.

Additionally, the rule expands the range of items under ECCNs 3A992, 8A992, and 9A991 included in Supplement No. 2 to part 744. Newly added items include, for example:

  • Certain types of electronic devices and components (such as integrated circuits and energy storage items);
  • A broad range of equipment for the manufacture, inspection or testing of electronic parts, components, materials, accessories and technology, including some semiconductor production items, mass market encryption commodities and information security software;
  • Marine or terrestrial acoustic equipment;
  • Magnetometers and superconductive electromagnetic sensors; and
  • Vibration test equipment.

Presumption of Denial Imposed on License Applications

The new rule changes the standard of review for license applications from a case-by-case evaluation to a policy of presumption of denial, which means it will be very unlikely that any such licenses will be granted. BIS volunteered that, while it anticipates that the new rule will increase the number of license applications submitted, it expects a “continuing likelihood of denials.”

New AES Filing Requirement Added for Exports to China, Russia, and Venezuela

Under the new rule, exporters to China, Russia, and Venezuela must submit Electronic Export Information (EEI) in the Automated Export System (AES) for all items on the Commerce Control List and provide the applicable ECCN (with minor exceptions under License Exception GOV). The existing rule does not require AES filings for shipments valued at $2,500 or less and when the export items are controlled only for anti-terrorism (AT) and a license is not required for exports to China, Russia, and Venezuela. Exporters who do not currently classify export items under an ECCN when unnecessary under the current rule must now determine the applicable ECCN(s) for entry into the EEI for exports to China, Russia, and Venezuela. Determining those ECCNs could be a substantial burden for some exporters.

2. Removal of License Exception Civil End Users (CIV)

The second rule, also effective June 29, 2020, eliminates License Exception Civil End Users (CIV). Currently, License Exception CIV allows exports of items subject to National Security (NS) controls and identified in the Commerce Control List as subject to CIV to civil end users for civil end uses in China and the rest of Country Group D:1, except North Korea. BIS stated that it is removing License Exception CIV “due to the increasing integration of civilian and military technology development in these countries of concern,” which makes it “difficult for industry to know or determine whether the end use and end users . . . will not be or are not intended for military uses or military end users” – a policy statement directed at China. Affected items include, for example, electronics, computers and telecommunications products under ECCNs 3A001.a.3, 3A001.a.7, 3A001.a.11, 4A003.g, and 5A001 (and 5A001 sub-categories).

Exporters who relied on License Exception CIV must now obtain export licenses and, significantly, deemed export licenses for the release of U.S. technology and source code subject to NS controls to foreign nationals in the United States. The elimination of this license exception will affect the export of semiconductors, semiconductor production equipment, materials for semiconductor production, computers, telecommunication equipment, bearings, optical equipment and materials, acoustic systems, radar equipment, marine systems, and civil aircraft engine production equipment.

This rule change could affect many U.S.-China joint ventures and research and development projects, and participants in such activities should check if they currently are relying on License Exception CIV for deemed exports of NS-controlled technology or source code in the United States. U.S. exporters should similarly check for any exports of NS-controlled items under CIV. A savings clause applies to exports that were or are in process by June 29. 2020, and that are exported by July 27, 2020. Exporters who will require export or deemed export licenses should file license applications early because BIS processing times are likely to be delayed due to the pandemic.

3. Proposed Modification of License Exception Additional Permissive Reexports (APR)

BIS also has proposed to modify License Exception Additional Permissive Reexports (APR). The objective is to implement the policy goals behind the two new rules discussed above by applying them to reexports3 of U.S. items from countries that may not apply controls to those reexports that are as restrictive as those that the United States applies.

Presently, the APR exception allows the reexport of NS-controlled items from Country Group A:1 countries or Hong Kong to destinations including Country Group D:1 countries, so long as the reexport is consistent with an export authorization from the country of reexport, and the item is not subject to other reasons for control under the EAR, including missile technology and nuclear nonproliferation controls. The proposed rule would modify the APR provision to eliminate Country Group D:1 as a category of eligible destination. Comments are due by June 29, 2020.

These new rules significantly broaden, and make more complex, the restrictions applicable to export of goods, technology and software to China, particularly in the case of exports that involve potential military end uses and/or end users. Given heightened U.S. sensitivity to China’s civil/military integration and the loss of U.S. technology to China, the broad “knowledge” standard applicable to U.S. exporters, and the stiff penalties for violations of U.S. export laws, careful regulatory analysis and due diligence by U.S. companies doing business in China are essential.

FOOTNOTES

1 Both the current and revised rules define defense articles as items under the U.S. Munitions List or Wassenaar Arrangement Munitions List, and as items classified under “600 series” or “A018” Export Control Classification Numbers (ECCNs). Both versions also include as military end use the deployment of items classified under ECCN 9A991, as set forth in Supplement No. 2 to part 744.

2 This Alert follows the Export Administration Regulations convention of using double quotation marks in the Commerce Control List to indicate terms that are defined in 15 C.F.R. part 772 (Definitions of Terms), or to indicate where a definition is provided within an ECCN. We have retained such double quotation marks to indicate defined terms even where single quotation marks would normally be used.

3 Reexports are transfers of items subject to the EAR from one foreign country to another foreign country, or releases of technology or source code subject to the EAR to a foreign person of a country other than the foreign country where the release or transfer takes place (a deemed reexport).

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