DUE DILIGENCE CONSIDERATIONS WHEN EXPORTING TO CHINA
by Keil J. Ritterpusch
Senior Compliance Associate
Jenny A. Hahn
The current climate between the U.S. Government and China related to export controlled commodities is quite hostile and is not likely to change in the near term, even with a new U.S. President in place. The U.S. Government, concerned with national security threats, human rights abuses, military modernization, theft of U.S. technology, and theft of U.S. personal information by Chinese actors, has gone on the offensive from an export regulatory perspective to attempt to prevent parties supportive of the Chinese Government and Chinese military from acquiring US-origin products, including, in some cases, products that are EAR99.
The U.S. Government, acting through the U.S. Department of Commerce's Bureau of Industry & Security ("BIS"), has recently added a large number of Chinese companies, including companies that are predominantly involved with commercial enterprises, to the Entity List under the Export Administration Regulations ("EAR"). By being added to the Entity List, any export from the U.S. to a listed party is subject to an export license requirement under the EAR, with a presumption of denial applicable in most cases. Listed parties cannot receive U.S. exports indirectly either, such as by buying through intermediary parties. These intermediary parties know that it is not lawful for U.S. exporters to engage in transactions involving ultimate end use by parties on the Entity List. Thus, in many cases, they disguise the intended end-use, end-users, and parties to the export transactions.
Beyond the expansion of the Entity List, BIS has taken steps to expand the EAR's Foreign Direct Product Rule at EAR Section 736.2(b)(3) to specifically target Chinese telecommunications giant, Huawei Technologies Group Co. Ltd. ("Huawei") and affiliates in China and worldwide. The EAR's Foreign Direct Product Rule was expanded so that foreign origin products built in plants with U.S.-origin equipment and technology that are exported from abroad or re-exported to Huawei and affiliates are subject to the EAR and prohibited without a license from BIS.
In addition to the broad prohibitions that have been placed on numerous Chinese companies, preventing them from receiving exports of any commodity from the United States, a large number of Chinese companies and organizations have recently been identified under the EAR as Military End Users ("MEUs"). The action to formally identify companies as MEUs, in China, as well as Russia and Venezuela, follows their identification by the U.S. Department of Defense as parties with strong ties to military end-users and military end-uses. By adding entities as MEUs under the EAR, U.S. exporters are officially on notice that any export transaction involving these entities where an item on the EAR's Commerce Control List ("CCL") -- meaning any item with an Export Control Classification Number ("ECCN") requires an export license approved by BIS.
Given the extensive expansion of export restrictions involving China (as well as Russia and Venezuela), it is more important than ever for parties exporting from the United States to carefully identify the parties to their export transactions and the export classifications of products being exported. Even items that are EAR99 or are otherwise No License Required ("NLR") to most worldwide destinations now require licensing for export to certain end-users and for certain end uses in China. Thus, exporters must take formalized steps to document their export due diligence for transactions involving China, as well as Hong Kong and Macau (which are now treated as part of China by the U.S. Government).
BIS has published "Know Your Customer Guidance and Red Flags" as a supplement to the Ten Prohibitions listed in EAR Part 736. The guidance explains the appropriate due diligence required for U.S. export transactions and provides context as to how to sufficiently establish "knowledge" of the particulars of export transactions, including the proper identification of parties, end uses, and end-users. The General Prohibitions cover a gamut of export-related matters but generally prohibit exporters and re-exporters from engaging in export transactions involving prohibited end uses and prohibited end-users. In order to comply with the EAR's General Prohibitions, exporters and re-exporters must establish "reasonable " knowledge regarding the parties to their export transactions and the ultimate end-use and end-users of the exports.
The industry standard for validating this information is through the End User Statement ("EUS")/End User Certification ("EUC"). Without a EUS/EUC, an exporter is arguably self-blinding with respect to compliance with the EAR General Prohibitions, as well as overall export compliance with EAR requirements. Companies that fail to establish sufficient "knowledge" of the details of export transactions can be hit with substantial fines when export transactions result in end uses or end users that are prohibited.
What is Reasonable Due Diligence?
An array of documentation can be used by exporters and re-exporters to validate the parties, end uses, and end users involved with export transactions. The following are tools that should be used by exporters and re-exporters in varying degrees as part of the due diligence to validate export transactions.
- End-Use and End-User Statements
- Denied Party Screening
- Internet research validating the parties to the export transaction
- Business licenses and other documents validating the bona fides of the parties, should information regarding the entities to the transaction not be easily discovered through internet searches.
Of these tools for performing due diligence, the most important, by far, is the End User Statement/End-Use Certification. In our opinion, this document should be obtained for all export transactions. After receipt of the EUS/EUC, the U.S. exporter should perform Denied Party Screening on the names of the parties to the export transactions, including the purchaser, intermediate consignees, ultimate consignee, and end-user, doing "fuzzy" searches of company names and variations on the company name. In addition, the Denied Party Screening should search for companies at the same or similar addresses. Widely scoped Denied Party Screening is crucial to the overall due diligence, as it demonstrates to the U.S. Government that the exporters (and re-exporters) took steps to validate that the parties to the transaction are not prohibited from receiving U.S. exports.
Following the Denied Party Screening, we recommend that exporters and re-exporters perform an internet search to ensure that the parties named on the EUS/EUC exist and are in a business with a connection to the product to be exported. Should information on the parties not be able to be readily found on the internet, the exporter or re-exporter should contemplate getting a more detailed EUS/EUC and having it signed both by their customer and the ultimate consignee/end-user. Even in cases where a multi-party signed EUS/EUC is received. It may be necessary to receive copies of business formation documents if the exporter or re-exporter cannot find information on a party to the export transaction after an internet search, particularly the stated end-user/ultimate consignee.
What Flags Should a Prospective Exporter Look For?
Exporters and re-exporters are responsible under the EAR for engaging in lawful export transactions and not engaging in export transactions where they "know" or have "reason to know" that the export transaction may involve an unauthorized party, end-use, or end-user. When evaluating the due diligence collected in relation to prospective export transactions, exporters and re-exporters should highlight any facts where there is missing information or where answers to questions about the parties, end-use, and end-users do not "add up."
For example, if a party receives a completed EUS/EUC that lists a distributor as an end-user, the entire export transaction is a red flag since details regarding the true end-use and end-user are not being provided. Similarly, if a party receives a completed EUS/EUC that lists various parties, including the purchaser, ultimate consignee, and end-users, that cannot be validated through an internet search, there is a red flag to the export transaction, and additional due diligence should be performed.
Liability In the Event that a Party to An Export Transaction Provides Incorrect Information?
Entities in China that have been placed on the Entity List or designated as MEUs still need to receive components to manufacture their products. Companies like Huawei and Semiconductor Manufacturing International Corporation ("SMIC") have not slowed their production of products for the commercial marketplace or for the Chinese Government. As a result, we fully expect that "front" companies will be formed solely for the purpose of diverting goods to companies like Huawei and SMIC in contravention of the EAR. Exporters and re-exporters cannot afford to completely stop exporting to China and Hong Kong (and other destinations) solely because there are a possibility that their shipments will be diverted for unauthorized end uses or unauthorized end users.
To mitigate the risks associated with diversions downstream in export transactions, exporters and re-exporters need to be able to rely on certifications made by legitimate parties to export transactions. There is no requirement to perform post-delivery validation of export transactions involving products that are EAR99 or controlled by the EAR for Anti-Terrorism ("AT) reasons alone. However, exporters and re-exporters need to be able to validate before shipment that the parties to export transactions are legitimate legal entities and that other red flags are overcome.
Therefore, a critical burden on exporters and re-exporters is to ensure that the parties who sign EUS/EUC for prospective export transactions are legitimate legal entities. Once the EUS/EUC is received and the bona fides of the parties have been established and export classifications validated, exporters and re-exporters can export/re-export freely, whether under an export license, under a license exception, or as NLR, if applicable. If an exporter or re-exporter learns after the fact that there has been a diversion, the matter should be reported to BIS, and steps taken internally to document concerns with the pertinent parties to the export transaction resulted in diversion should be undertaken to avoid any recurrence of the diversion.
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**FD Associates notes that there are financial sanctions applicable to other parties to export transactions that do not relate to the EAR but rather are implemented under U.S. Department of Treasury regulations. This article does not address such requirements, but parties engaged in export transactions with a nexus with the United States should consult the U.S. Department of Treasury regulations and website to validate that other parties to export transactions, including freight forwarders, banks, and issuers of credit, are not debarred from engaging in transactions involving U.S. jurisdiction.
China’s Largest Semiconductor Chip Manufacturer, SMIC, and Commercial Drone Manufacturer, DJI, Among Nearly 60 Chinese Companies Added to the U.S. Department of Commerce’s Entity List
By Keil J. Ritterpusch, Senior Compliance Associate
On December 18, 2020, the U.S. Department of Commerce’s Bureau of Industry Security (“BIS”) announced the addition of 77 foreign entities, including 59 in the People’s Republic of China (“PRC”), to the Entity List, published in Part 744 of the Export Administration Regulations (“EAR”), 15 C.F.R. Part 740. The formal addition of the companies to the Entity List will be made official with publication in the Federal Register on December 22, 2020. A copy of the Federal Register notice made available for public inspection can be found at https://public-inspection.federalregister.gov/2020-28031.pdf.
Any company – U.S. or foreign – must obtain an export license from BIS for the export of any hardware, software, or technology subject to the EAR to any party named on the Entity List. In some cases, there is a presumption of denial for exports. The specific cases where there is a presumption of denial are specified in the Entity List published in Part 744 of the EAR. In virtually all cases, a license is required to export even items falling under EAR99 control if a company is listed on the Entity List.
Among the 77 entities added to the Entity List, there are two companies that are particularly notable: China’s top semiconductor chip manufacturer Semiconductor Manufacturing International Corp (“SMIC”) and affiliates, and Chinese commercial drone manufacturer and retailer DJI.
In the case of exports to SMIC, there is a presumption of denial for exports of items subject to the EAR that are “uniquely required for the production of semiconductors at advanced technology nodes (10 nanometers and below, including extreme ultraviolet technology). All other exports, including EAR99 items, require a license and will be reviewed on a case-by-case basis.
For exports to DJI, there is a presumption of denial for all exports of hardware, software, and technology subject to the EAR, except that the export of items necessary for detecting, identifying, and treating the infectious disease will be reviewed and approvable on a case-by-case basis. Three other of the 77 added entities include a similar allowance for the case-by-case review of exports of items used for detecting, identifying, and treating infectious diseases.
In announcing the expansion of the Entity List, Secretary of Commerce Wilbur Ross said: “We will not allow advanced U.S. technology to help build the military of an increasingly belligerent adversary.” Secretary Ross further advised: “Between SMIC’s relationships of concern with the military-industrial complex, China’s aggressive application of military-civil fusion mandates, and state-directed subsidies, SMIC perfectly illustrates the risks of China’s leverage of U.S. technology to support its military modernization.”
U.S. Secretary of State Mike Pompeo added a further comment to the additions to the Entity List, stating that “Today’s actions mark yet another sign of our resolve to use all countermeasures available” to prevent Chinese companies and institutions “from exploiting U.S. goods and technologies for malign purposes.”
While the U.S. remains dominant in the chip industry, its market lead has shrunk as companies in Taiwan and South Korea has rapidly ramped up production. SMIC trails Taiwan Semiconductor Manufacturing Co, the industry’s market leader, in its development of the most advanced chips. It has sought to build out foundries for the manufacture of computer chips that can compete with those of TSMC.
Adding SMIC, the Shanghai-based state-owned chip maker, to the Entity List limits the company’s ability to buy key components from U.S. and foreign suppliers that are subject to U.S. export restrictions, making it difficult for SMIC to build advanced chipsets. SMIC was also among the Chinese companies on a separate list announced by the U.S. Department of Defense earlier in December that will bar American investors from investing in these firms because of their alleged ties with the Chinese military. Under that policy, U.S. investors will have to sell their investments in SMIC by late in 2021, essentially cutting the Chinese firm off from U.S. capital.
Chinese drone giant DJI was added for enabling high-tech surveillance of the Chinese people in China, which a Commerce Department spokesperson referred to as a “human rights abuse.”
In addition to adding SMIC and DJI, several Chinese construction companies, including China Communications Construction Co., were added as a result of their purported assistance in the militarization of disputed territory in the South China Sea. Several Chinese universities were also added to the Entity List as a result of U.S. Government findings that the universities had aided the Chinese military in the acquisition of sensitive information to the national security of the United States. Among the universities added were the Beijing Institute of Technology, Beijing University of Posts and Telecommunications, the Nanjing University of Science and Technology, and Nanjing University of Aeronautics and Astronautics.
The complete list of entities added to the Entity List is as follows:
- Dimitar Milanov Dimitrov;
- Mariana Marinova Gargova;
- Milan Dimitrov; and
- Multi Technology Integration Group EOOD (MTIG).
- AGCU Scientech;
- Beijing Institute of Technology;
- Beijing University of Posts and Telecommunications (BUPT);
- China Communications Construction Company Ltd.;
- China National Scientific Instruments and Materials (CNSIM);
- China State Shipbuilding Corporation, Limited (CSSC) 7th Research Academy;
- China State Shipbuilding Corporation, Limited (CSSC) 12th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 701st Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 702nd Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 703rd Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 704th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 705th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 707th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 709th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 710th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 711th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 712th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 713th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 714th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 715th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 716th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 717th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 718th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 719th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 723rd Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 724th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 725th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 726th Research Institute;
- China State Shipbuilding Corporation, Limited (CSSC) 750th Test Center;
- China State Shipbuilding Corporation, Limited (CSSC) 760th Research Institute;
- Chongqing Chuandong Shipbuilding Industry Co Ltd.;
- Chong Zhou;
- CSSC Huangpu Wenchong Shipbuilding Co., Ltd.;
- Guangxin Shipbuilding and Heavy Industry Co., Ltd.;
- Guangzhou Taicheng Shipbuilding Industry Co., Ltd.;
- Huisui Zhang;
- Jiangsu Hengxiang Science and Education Equipment Co., Ltd.;
- Jinping Chen;
- Kuang-Chi Group;
- Nanjing Asset Management Co., Ltd.;
- Nanjing University of Aeronautics and Astronautics;
- Nanjing University of Science and Technology;
- Ningbo Semiconductor International Corporation (NSI);
- ROFS Microsystems;
- Semiconductor Manufacturing International (Beijing) Corporation;
- Semiconductor Manufacturing International Corporation (SMIC);
- Semiconductor Manufacturing International (Shenzhen) Corporation;
- Semiconductor Manufacturing International (Tianjin) Corporation;
- Semiconductor Manufacturing South China Corporation;
- SJ Semiconductor;
- SMIC Holdings Limited;
- SMIC Northern Integrated Circuit Manufacturing (Beijing) Co., Ltd.;
- SMIC Semiconductor Manufacturing (Shanghai) Co., Ltd.
- Tianjin Micro Nano Manufacturing (MNMT);
- Tianjin University;
- Tongfang NucTech Technology Ltd.
- Wei Pang; and
- Zhao Gang.
- France Tech Services; and
- Satori Corporation.
- Maintenance Services International (MSI) GmbH; and
- MRS GmbH.
- SMIC Hong Kong International Company Limited.
- Zigma Aviation.
- Feroz Ahmed Akbar; and
- Sparx Air Ltd.
- Geo Research, and
- Link Lines (Pvt.) Limited.
- Cosmos Complect;
- Ilias Kharesovich Sabirov; and
- OOO Sovtest Comp.
UNITED ARAB EMIRATES
- Satori Corporation; and
- Sky Float Aviation FZE.