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Legal Analysis of China’s “Unreliable Entities List”

2019.06.18 ZHOU, Yong (Z.)QIN, Yu (Bill)、LUO, Shijing

Recently, the Ministry of Commerce of the People's Republic of China (MOFCOM) announced that, according to relevant laws and regulations, China will establish an “Unreliable Entities List”. The Unreliable Entities List (also referred to as “the List”) will target foreign legal persons, other organizations or individuals who block or cut supplies, or adopt other discriminatory measures against Chinese entities for non-commercial purposes, causing substantial damage to related industries in China or constituting a threat or potential threat to national security.1 The List is currently undergoing the necessary procedures and further details will be announced in the near future.


I. Legal basis


According to a MOFCOM spokesman, the Unreliable Entities List is based on the Foreign Trade Law of the People's Republic of China, the Anti-Monopoly Law of the People’s Republic of China, the National Security Law of the People’s Republic of China, and other relevant laws and regulations. MFOCOM does not specify the specific provisions on which it is based. We have identified the following articles which we believe to be of relevance to the establishment of the List:


i. Article 7, Foreign Trade Law


Article 7 provides that “For any country or region that takes discriminatory banning, restriction or other acts against the People's Republic of China in terms of trade, the People's Republic of China shall be entitled to adopt, in accordance with the actual circumstances, corresponding measures against them.”


Analysis: This Article is an enabling clause. Accordingly, China may adopt “corresponding measures”, but what the specific corresponding measures will be is as yet unclear.


ii. Article 17, Anti-Monopoly Law


Article 17 provides that “Business operators with a dominant market position are prohibited from committing any of the following acts of abusing the dominant market position: … (3) refusing to transact with trading counterparts without a valid reason; (4) restricting trading counterparts to transact only with the business operator or only with designated business operators without a valid reason…”


Analysis:


a. Dominant market position


The precondition for the application of Article 17 of the Anti-Monopoly Law is that the business operation has a dominant market position. According to the Anti-Monopoly Law, determination of whether a business holds a dominant market position shall be based on the following factors:


(1) The market share of the business operator in the relevant market and the status of competition in the relevant market;


(2) The ability of the business operator to control the sale market or the procurement market for raw materials;


(3) The financial strength and technological conditions of the business operator;


(4) The extent of reliance by other entities on transactions with the business operator;


(5) The level of ease or difficulty of entry by other business operators into the relevant market; and


(6) Any other related factors.


According to Article 18 of the Anti-Monopoly Law, if a business operator holds the statutory market share in the relevant market, it shall be deemed to be holding dominant market position. In simple terms, a market dominant position means that the business operator has the ability to control the relevant market. According to Article 17 of the Anti-Monopoly Law, entities included in the Unreliable Entities List must be market-dominant, and entities without market dominant position cannot be included in the List under this Article.


b. Valid reason


The Anti-Monopoly Law does not prohibit business operators from having a dominant market position. Only when the operator "abuses" the dominant position are its actions regulated. We note that sections 3 and 4 of Article 17 both emphasize “without a valid reason”. So what might be the valid reason here?


On 15 May, President Trump issued an executive order and declared a national emergency. Following the issue of the executive order and the addition of Huawei to the Bureau of Industry and Security (BIS) Entity List, some US entities may be required to bring to a halt their dealings with or cut supplies to Huawei in order to comply with the US domestic executive order. This raises the question of whether adherence to US domestic executive orders constitutes a valid reason?


In determination of a valid reason, the legitimacy of the consequences of the act need to be considered, and specifically their legitimacy in the aspects of efficiency, fairness and competition. If a foreign entity itself takes the initiative to adopt discriminatory measures such as a restricting or halting supplies, then its act is generally unlikely to be justified, so that the valid reason defense as described will not be able to be invoked. Rather, there is a need to consider the circumstances in which foreign entities are “compelled” to implement such discriminatory measures, in order to comply with domestic laws or executive orders. While the Anti-Monopoly Law does not regard fault as a key determinant of an act or responsibility, a distinction can be drawn between whether the action is based on the entity’s own initiative or is passive. Generally speaking, in terms of the abuse of a market dominant position, passive actions are perceived as less damaging to market competition than active ones.2


However, if the domestic law/executive order does not constitute a valid reason, the foreign entity will face a dilemma. Choice A: Comply with the national executive order and be added to China’s Unreliable Entities List. Choice B: Disregard the national executive order, continue trading with China entities, and consequently face domestic punishment. Clearly, neither choice is appealing meaning the List may place foreign entities in a difficult and unreasonable situation.


In our opinion, if it does comply with a domestic order, a foreign entity should not be punished since its action could be argued to be justifiable. Provided the action is justifiable, it would be self-contradictory and legally inconsistent if MOFOCOM still added the entity to the Unreliable Entities List. However, if all entities act in accordance with Trump’s executive order and these entities are thus excluded from the Unreliable Entities List, this will defeat the Chinese government’s reason for introducing such a list, which is as a specific response within the context of the current trade war. Simultaneously, any acts that are carried out in accordance with national law/administrative orders, even if they are “forced”, will not necessarily have legitimacy.


Therefore, we believe that when judging whether a domestic law/executive order can constitute a valid reason, the determination should be based on the specific facts. If a foreign entity passively implements discriminatory measures within the limits required by the domestic law/executive order, it may be a valid reason. However, if the conduct carried out by a foreign entity exceeds the level required by the domestic law/executive order, it is clearly not a valid reason.


Article 19 and Article 59, National Security Law


Article 19 provides that “The State shall safeguard national basic economic system and socialist market economic order, improve systems and mechanisms to prevent and resolve economic security risks and protect the security of key sectors and key areas, key industries, key infrastructure and key construction projects as well as other significant economic benefits related to the lifeline of national economy.”


Article 59 provides that “The State shall establish a review and regulation system and mechanism for State security, and shall carry out State security review of foreign investment, specific items and key technologies and network information technology products and services that affect or may affect State security, projects relating to State security matters and other material matters and events in order to effectively prevent and resolve State security risks.”


Analysis: These two are general provisions for establishing a mechanism to guarantee China's economic order, market and national security and it is not clear how they will impact upon the implementation of the Unreliable Entities List.


II. Four criteria to determine who will be on the List


According to MOFCOM, four criteria will be considered when determining the foreign legal persons, organizations or individuals to be included in the List:3


i. Whether the foreign entity’s conduct is for non-commercial purposes, contrary to market rules and the spirit of a contract;


ii. Whether the foreign entity imposes a blockade, cuts supplies or adopts other discriminatory measures against Chinese entities;


iii. Whether the foreign entity causes substantial damage to Chinese enterprises or related industries;


iv. Whether the foreign entity constitutes a threat or potential threat to China's national security.


To avoid being included in the Unreliable Entities List, the first consideration would be to mount a defense based upon any of the above four criteria. If a foreign entity is included in the List based on the criteria, then the foreign entity should consider whether it can invoke any of the aforementioned as valid reasons for their defense. For example, if a foreign entity claims that its conduct is in accordance with the domestic law/administrative order, its conduct can therefore not be identified as being for commercial purposes and it can offer this as a justification in its defense. However, if the foreign entity’s act is deemed to be based on commercial purposes, that valid reason may not be applicable.


The above four criteria are not independent of each other and should be considered together. So far, there have been no specific guidelines issued to evaluate these four criteria. In practice, it is difficult to establish a common standard, particularly when determining whether an activity constitutes a threat to national security. For example, while the US’s Export Administration Regulations (EAR) provides an illustrative list of activities that could be considered contrary to US national security or foreign policy interests, the list is not exhaustive, and any ruling will be highly dependent on the facts of individual cases. Therefore in terms of determining whether an entity should be added to the Unreliable Entities List will requires investigation and review on a case-by-case basis, with the relevant department being entitled to employ a degree of discretion.


III. Potential measures and remedies under the Unreliable Entities List


While specific provisions relating to the Unreliable Entities List have not as yet been introduced, we anticipate they may include the following possible measures and remedies.


i. License requirement


For entities added to the Unreliable Entities List, China may impose a license requirement, without which the activities of such entities, such as export, re-export and transfer, may be prohibited. The US entity list system already has similar provisions.


ii. A credit investigation system


The Unreliable Entities List may function as a credit investigation platform, and any foreign entity that was not able to satisfy the requirements of such system would be labeled as “unreliable”, raising difficulties for any Chinese business that was considering doing business with them. Such a measure would potentially even impact upon affiliates of such an entity within China. To this effect, the Director of the Bureau of Industry, Security, Import and Export Control within MOFCOM has reminded Chinese entities to be vigilant and to minimize risks when dealing with foreign entities on the Unreliable Entities List.


iii. Impact on a foreign entity’s Chinese affiliates


If an entity included in the Unreliable Entities List has any affiliate companies in China, these affiliates may also be affected. For example, such affiliates may be subject to fines, to limits on bank lending, and their industrial and commercial annual inspections could be impacted. However, to impose such penalties on domestic affiliate companies, will require clarification of the legal basis.


The law provides for the setting of different types of administrative penalty. Any penalty that restricts personal freedom can only be created by law. Besides this, administrative penalties may be created by administrative rules and regulations. Administrative penalties, with the exception again of restriction of freedom of person and the cancellation of an enterprise’s business license, may be created in local regulations. Rules enacted by departments under the State Council and local governments may impose disciplinary warnings and fines.


At present, it is not clear what form the Unreliable Entities List will take once published, but whatever it may be, any administrative penalties require the authority of a higher law. The US entity list system has been stipulated by the EAR, and the EAR takes its authority from the 2018 Export Control Reform Act, which allows it to block activities contrary to US national security and foreign policy. Based on our earlier analysis of the legal basis of such system, there is no specific provision for such penalties in the Chinese law, only a general authorization clause. Without such basis to impose administrative penalties, any affiliated domestic entity may have the basis to file an administrative lawsuit or to apply for administrative reconsideration.


iv. Right to object/Exemption


In setting up the Unreliable Entities List system, in order to ensure the system is not unreasonable or inflexible, we expect it should include provisions for affected parties to be given the right to object and to apply for removal from the List. Indeed, the MOFCOM’s Director of the Department of Treaty and Law, Wang Hejun, has suggested that entities on the Unreliable Entities List and their relevant parties will be given certain rights of defense to oppose the decision. Such rights of defense will likely be similar to those stipulated in the US EAR.


v. Administrative reconsideration/litigation as remedy


If incorporating an entity into the Unreliable Entities List is an administrative act, will it still be subject to administrative reconsideration or litigation? Can relevant parties resort to administrative reconsideration or litigation to obtain relief?


Administrative reconsideration directly examines specific administrative acts, with the review taking into account various administrative acts of general application. For inclusion of an entity in the Unreliable Entities List, first, is the activity specifically targeted and legal? Also, is it a unilateral act, and in accordance with the statutory power, that aims to derogate from the entity’s right or to create additional obligations for the entity (such as the requirement for to be licensed.) If so, it constitutes a specific administrative act and thus if a foreign entity is added to the Unreliable Entities List, it will have the right to apply for administrative reconsideration.


According to Section 8, Article 12 of the Administrative Procedure Law, if it is thought that an administrative organ has abused its administrative power to preclude or restrict competition, then citizens, legal persons or other organizations may initiate an administrative lawsuit. At the same time, the decision to include an entity in the unreliable entities should be actionable as a specific administrative act. Article 13 of the Administrative Procedure Law provides a negative enumeration of the scope of administrative litigation. The first three sections are not related to the acts discussed here. As for Section 4, given that no specific measures are provided, it is not clear whether administrative organs would be entitled to the final determination on the decision whether to include an entity in the Unreliable Entities List.


In addition, according to Article 14 of the Law on Administrative Reconsideration, if there is unwillingness to accept specific administrative actions taken by a department under the State Council, the applicant can apply to the said departments for administrative reconsideration. When refusing to accept a decision made after administrative reconsideration, the applicant may bring an administrative lawsuit before a People's Court, or apply to the State Council for arbitration, which shall give a final ruling on the issue and no further litigation proceedings can be filed.


In summary, the act of adding an entity to the Unreliable Entities List is theoretically remediable through administrative reconsideration or administrative litigation. But even provided with such relief, companies should consider the feasibility of taking such action. Taking the US entity list as an example, from a legal perspective, if it is considered that the actions of the US Department of Commerce (DOC) have been arbitrary, capricious, or an abuse of discretion, the entities included in the entity list and their relevant parties are entitled to sue the DOC, in accordance with the US Administrative Procedure Act. However, even with the right to appeal, entities that have been included in the entity list rarely file such lawsuits, because the DOC has ultimate discretion in determining whether an entity should be included in the list of entities, making it very difficult to challenge the rationale of its decision. Given the high degree of discretion of the Ministry with responsibility for China's Unreliable Entities List, seeking relief through administrative reconsideration or litigation may not be an effective strategy.


vi. The Unreliable Entities List may have similar effect to the EU Blocking Statute


A blocking statute is used to counteract the application of extraterritorial sanctions on domestic firms. In the case of the European Union, if the economic or financial interests of EU companies are directly or indirectly affected by US-Cuban sanctions laws or actions, the Blocking Statute prohibits EU companies from complying directly or indirectly with the US extraterritorial sanctions laws. It also sets an exemption system. When EU companies believe that non-compliance with US extraterritorial sanctions laws will seriously damage their interests or EU interests, they can submit applications to the European Commission for special authorization to comply with these extraterritorial laws.


China's Unreliable Entities List system may in practice have similar effects to the EU’s Blocking Statute. If a country’s sanctions laws prohibit its domestic companies from transacting with certain Chinese companies, they may be added to the Unreliable Entities List, which could be damaging to their interests. The risk of being added to the List may encourage these companies to apply for exemption from the sanctions in order to be able to continue their transactions with Chinese companies. However, it is not certain whether or not their home country would approve such a reason and grant an exemption.


If the Unreliable Entities List plays a similar role to a blocking statute, that is, as a legal challenge to extraterritorial sanctions, it may ultimately work to promote further trade negotiations between the two sides.


IV. The relationship between the Unreliable Entities List and the 2017 Draft Export Control Law


In 2017, MOFCOM issued the Draft Export Control Law (the “Draft Law”) for public comment. The Draft Law represents China’s first ever comprehensive legislation on export controls. It addresses items including new export qualification requirements, such as “reexport” and “deemed export”, licensing and control requirements, as well as embargoes, blacklists and other retaliatory measures. According to the State Council's 2019 legislative work plan, the Draft Law is due to be submitted to the Standing Committee of the National People's Congress for deliberation.4


There are various possible options for how the Unreliable Entities List and the Draft Law might interact with each other:


i. The Unreliable Entities List links in with export controls


As mentioned above, since the US entity list is stipulated under the EAR, China's Unreliable Entities Lists may also be connected to the Export Control Law if it draws on the US entity list system. Simultaneously, if China establishes its Unreliable Entities List in order to function as an export control system, it should be included in the Draft Law. MOFCOM’s Director of the Bureau of Industry, Security, Import and Export Control has further commented on the Unreliable Entities List, suggesting that the issuing of the List may relate to export control.


Since the Draft Law does not have provisions regarding the Unreliable Entities List, it may need to further develop a section to include such a list. There are two likely options: First, make detailed provisions for the establishment, implementation, supervision, etc. of the Unreliable Entities List. Second, make general provisions and authorize the specific implementation rules to be prescribed by the State Council and other relevant departments. Alternatively, it may be more appropriate to act as interface with the Unreliable Entities List system in order to minimize any legislative conflict. Whatever approach is taking, both the Unreliable Entities List and the Export Control Law, when finalized, will be significant milestones in the development of China’s international trade framework.


ii. The Unreliable Entities List does not link in with export controls


As mentioned earlier, the Unreliable Entities List may also serve as a credit investigation system. If it is indeed set up as a credit investigation system, it is more likely to play a "blacklist" role, and foreign entities included in it may face restrictions in terms of their access to loans, business registration, etc. In this case, the Unreliable Entities List would be unrelated to export control and would thus not be included in the Export Control Law.


V. Implications


As MOFCOM has stated, “In order to maintain international economic and trading rules and multilateral trading system, oppose unilateralism and trade protectionism, safeguard China’s national security, social public interest and enterprises’ legitimate interests, the Chinese government has decided to establish an ‘Unreliable Entities List’.”


Despite the fact that no individual country is specifically mentioned in MOFCOM’s speech, given the context of the ongoing trade war, and the recent Sino-US confrontation, it can be inferred that the Unreliable Entities List is being introduced at this point a countermeasure to another country’s recent actions, with its very first target being the United States. However, the final aim of this List should not be as a counterattack, nor should this become the basis for continuing Sino-US trade. In the current somewhat fractious dealings between the China and the United States, it is vital that any longer-term rules should be developed in a considered and peaceful manner in order assist with the resolution of the issues. Using countermeasures may work as short-term bargaining chips in the immediate negotiation process, but should never be considered as an element in a longer-term strategy.


While specific measures have not as yet been introduced, foreign entities can, for the meantime, refer to the BIS entity list in order to prepare themselves for trade compliance when the Unreliable Entities List is ultimately introduced. It is recommended that foreign companies should continue to pay close attention to any follow-up measures and policies. Additionally, according to media reports, the National Development and Reform Commission (NDRC) has taken a lead in organizing research and in establishing a national technological security management list system in accordance with the National Security Law and other relevant laws and regulations, in order to more effectively forestall and to defuse national security risks. Specific measures will be introduced in the near future. We will continue to track any follow-up developments of such NDRC list. 



1. http://www.mofcom.gov.cn/xwfbh/20190531.shtml

2. XIAO Jiangping, "Valid Reason” in Determination of Abuse of Market Dominant Position, Studies in Law and Business, 2009.

3. http://finance.cnr.cn/jjgd/20190601/t20190601_524635349.shtml?ivk_sa=1023197a&ivk_sa_s=130827

4. http://www.gov.cn/zhengce/content/2019-05/11/content_5390676.htm?trs=1

5. https://news.cgtn.com/news/3d3d774d3067544d35457a6333566d54/index.html

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