The so-called China Blocking Rules, effective on January 9, 2021 and issued by China MOFCOM through its No. 1 Order of 2021, are departmental rules, but with the huge potential impact on Chinese companies complying with foreign economic sanctions and foreign blacklisting measures.
The full name of China Blocking Rules is The Rules on Blocking Unjustified Extra-territorial Application of Foreign Legislation and Measures (hereinafter the “Blocking Rules”). [1]Though MOFCOM can interpret its departmental rules, it seems reluctant to do so thus far. Interestingly, upon release of the Blocking Rules, comments by a scholar were publicized on the same rules[2], which did not provide any meaningful information. Soon after, an official interview was released by MOFCOM[3], and again it offered no further clarification of the same rules. It seems MOFCOM needs to retain some flexibility. Obviously, the Blocking Rules need time to develop itself against the changing landscape of international trade regulation environment. The extent of enforcing the Blocking Rules may in a large part depend on whether the Chinese government can find a compromise with the Biden Administration.
Why are the Blocking Rules issued so early in 2021?
Given the constantly mounting economic sanction pressure from the United States against Chinese companies, China is under a severe political pressure to plant every possible defense and counter measures. As China did not have any rules of law that can protect the interests of Chinese companies who transact or intend to transact with their counterparts in countries subject to US economic sanctions (for instance, Iran), China at a minimum and as a political gesture must have something in place similar to the Blocking Statute of European Union, as soon as possible.
Under the Blocking Rules, Chinese companies normally mean companies established under the laws of PRC, no matter who may be the shareholders of such companies.
What are the problems that the Blocking Rules intend to resolve?
The Blocking Rules possibly consider resolving the following difficulties afflicted on the part of Chinese companies:
1. Chinese companies are prohibited under the law of United States from engaging in certain commodity or service transactions relevant to a country or nationals of such country subject to OFAC sanctions, whether it is a primary or secondary sanction (“US Blocked Transactions”);
2. Chinese companies are prohibited or restricted under the law of United States to transfer or re-export a given item controlled by EAR (“US Re-export Restrictions”);
3. Those Chinese companies blacklisted by OFAC or BIS on their SDN or Entity List, for instance, suffer stoppage of supply of goods or services from their counterparts (“Stoppage of Supplies to Blacklisted Parties”).If a foreign statutory law applies to a company in China, it may be viewed under the Blocking Rules as having an extra-territorial effect, and the Blocking Rules intend to block such foreign statutory laws and mandatory decisions from being applied, observed and enforced in China.
What are the measures planted under the Blocking Rules?
The Blocking Rules adopt the following measures to protect Chinese companies from being affected by the foreign statutory laws and mandatory decisions:
1. A reporting mechanism
As under Article 5 of the Blocking Rules, it is my view that Chinese companies are not supposed to report existence of every foreign law not in their favor, but must report the instances they encountered of normal business or trade activities with a counterparty in a third country (the “Foreign Party”), which are prohibited or restricted by a foreign law or foreign mandatory measures. It seems that the obligation of Chinese companies to report the instances of prohibition or restriction under a foreign law can be triggered mostly upon satisfaction of the following conditions on the part of the Chinese company:
(a) There is a business case where a meaningful business model exits;
(b) A reasonably detailed transaction is in place or contemplated with a given Foreign Party.
Though any Chinese company can report the negative impact of a foreign law, it is another matter whether the company is held liable for not discharging the reporting obligation. If a business case or a reasonably detailed contemplated transaction cannot be proved, it is difficult for MOFCOM to ascertain that the company has a serious business case to report so that it is administratively unreasonable to impose administrative sanctions against such company for not so reporting.
In the event a business case with a specific contemplated transaction is indeed impacted by a foreign law or a foreign mandatory decision, the Chinese company is to report such impact. However, the Blocking Rules fail to identify the specific penalties, which will be prescribed by MOFCOM. Pending such prescription, it seems the Chinese company failing to report will not be sanctioned by the penalties, but only subject to the warning, and rectification of the failure within a given timeframe only (Article 13).The reporting mechanism is significant to MOFCOM. It may rely on the data of reports to assess the impact of a given foreign law or measures and determine which foreign law to block.
2. The scheme of blocking foreign laws
An inter-departmental working mechanism led by MOFCOM will determine which foreign law to be blocked. The elements considered in such determination are as follows:
(a) Violation of international law and the basic principles of international relations
Under this heading, the Working Mechanism will examine the international law basis and/or the sufficiency in factual evidence for the jurisdiction of or measures taken under a given foreign law. For instance, the Working Mechanism will determine whether inclusion of a Chinese company into the Entity List of BIS is based on a due process and sufficient factual evidence for the alleged inclusion reasons.
(b) Potential impact on China’s national sovereignty, security and development interests
This element involves the overall national security assessment based on the reported and other data.
(c) Potential impact on the legitimate rights and interests of the citizens, legal persons or other organizations of China
This is a consideration of the negative impact on the specific transactions, actual or contemplated.
(d) Other factors that shall be taken into account
This may include consideration of response to the same foreign law or measures from other countries (e.g., EU) or the difficulty of implementing the blocking measures.
If the Working Mechanism determines that a foreign law or decision is not justified over its extra-territorial jurisdiction, MOFCOM will publicize an order of injunction not to recognize, enforce or comply with the blocked foreign law or measures (“Blocked Foreign Law”). As recognition and enforcement of a foreign law is a matter of Chinese courts, the legal risks for Chinese companies lie in their compliance, if any, with such Blocked Foreign Law.
3. Prohibition from compliance with the Blocked Foreign Law
A Chinese company is not supposed to comply with the Blocked Foreign Law, unless it has been granted an exemption not to follow the order of injunction. The grant of exemption is a discretionary power by MOFCOM, which can be positive or negative but must be made within 30 days or promptly if it is an urgent case.
It is always difficult and problematic to determine what behavior of the Chinese company can constitute compliance with the Blocked Foreign Law. Given the objective of protecting the lawful rights and interests of Chinese companies (Article 1), all Chinese companies still retain the freedom in signing or not signing a transaction agreement with a counterparty. Accordingly, no transaction with a Foreign Party or another Chinese party on the Entity List of BIS per se does not mean the compliance with the Blocked Foreign Law. The Blocking Rules do not force a Chinese company to transact with certain country or certain party.
However, if a Chinese company terminates a negotiation or agreement with a Foreign Party pursuant to a Blocked Foreign Law, or with a Chinese party who has violated a Blocked Foreign Law and thus has been listed on the BIS Entity List or OFAC SDN list or other blacklists, the Chinese company may be held in violation of the order of injunction not to follow the Blocked Foreign Law, thus may incur the administrative consequences of a warning and an order to rectify its failure to follow the order of injunction and/or certain amount fines if the fines are specified in the future.
“An order to rectify” means the Chinese company has to proceed with the negotiation or transaction with the other party. If the Chinese company refuses to rectify, the company would face administrative fines as well as claim of damages by the counterparty, foreign or domestic, in courts in China.
4. Judicial remedies through Chinese courts
(a) Legal action for damages against a Chinese party
Under Article 9.1, a Chinese company may according to law seek legal action at a Chinese court for the damages it suffers from the compliance with Blocked Foreign Law by a counter “party”. Such party is unofficially construed as a Chinese party only.
Given the qualification “accordingly to law”, it seems that Article 9.1 does not by itself confer on the Chinese plaintiff an independent cause of action.
The Blocking Rules only nullifies in effect the Blocked Foreign Law so that the Chinese party cannot rely as a legal defense on compliance with the Blocked Foreign Law. Rather, it is a violation of the Blocking Rules. However, whether the plaintiff can establish a valid claim for damages depends upon its ability to prove such damages as well as causation between the illegal compliance and such damages according to the law of tort under the Chinese Civil Code.
(b) Legal action for compensation against a foreign company
Assuming there is a judgment (most likely a foreign court judgement in practice) against a Chinese party based on the Blocked Foreign Law and a Chinese party suffers loss occasioned by the judgement, this Chinese party may lodge a lawsuit against the counterparty benefiting from the foreign court judgement (Article 9.2).According to an unofficial oral construction by MOFCOM, such benefiting counterparty potentially liable under the compensation proceedings in China can be Chinese or foreign companies.
What do the Blocking Rules mean to foreign companies?
1. Subsidiaries in China
The Chinese subsidiaries of foreign companies will face twofold legal risks under the Blocking Rules.
(a) The obligation to report the impact of a foreign law or measures
Such obligation would likely arise when a meaningful business case and a reasonably detailed transaction are in place or contemplated with a given Foreign Party. In practice, the Chinese subsidiary has to monitor whether there is a meaningful business case and specific actual or contemplated transactions with a Foreign Party unilaterally sanctioned by a foreign country.
(b) Risks of compliance with a Blocked Foreign Law
It is not clear what constitutes such a compliance. In practice, the issue depends upon whether the Chinese subsidiary can adduce sufficient commercial justification for discontinuing or terminating any business with a Foreign Party or a Chinese party on the BIS Entity List, for instance, so that such discontinuing or terminating decision is not coerced by the Blocked Foreign Law. In this connection and with such sufficient commercial justification, a unilateral termination right under a given agreement can be a useful tool.
If compliance with a Blocked Foreign Law is deemed existing by MOFCOM, the Chinese subsidiary will be ordered to take rectification measures to continue the discontinued business. Such order may be difficult to follow, and the Chinese subsidiary will be exposed to certain amount as fines.
The same subsidiary may also be sued in a Chinese court for its compliance with Blocked Foreign Law. If the subsidiary discontinues the business with some Chinese companies on the BIS Entity List or other foreign unilateral blacklists and the inclusion of these companies into such list is based on the Blocked Foreign Law, the Chinese subsidiary will be liable to the Chinese plaintiff.
2. Foreign companies
Foreign companies generally are not subject to the Blocking Rules. However, if a foreign company wins or benefits from a foreign lawsuit against a Chinese party based on a Blocked Foreign Law, the foreign company will face a lawsuit in China by the Chinese party for compensation of losses. The Chinese court may enforce its judgement against the equity interest held by such foreign party in its subsidiary in China or the assets in China owned by such foreign party, unless the same party is insulated from such enforcement by holding no shares in any Chinese companies and owning no assets in China.
Please note that foreign companies may be included into the Unreliable Entity List for its stoppage of supplies to Chinese companies on BIS Entity List or other foreign unilateral blacklists, in which case its business and trade with China will be substantially affected.
Preliminary Conclusions
It remains to be seen whether the Blocking Rules will indeed substantially resolve the difficulties Chinese companies are facing with the US Blocked Transactions or the US Re-export Restrictions, or the Stoppage of Supplies.
If MOFCOM intensifies enforcement of the Blocking Rules, like the Rules of Unreliable Entity List[4] where foreign companies may be forced to choose sides with the United States or China, the Blocking Rules may also force the foreign subsidiaries in China and ultimately their parent companies to take sides as between the United States and China, and the global market and technology will be segregated into two blocks, one is US block, another is non-US block.
The question is how many foreign companies and their subsidiaries will choose the side of China or the United States. If a Chinese subsidiary has to continue business with a Chinese party on the BIS Entity List, for instance, its foreign parent company and its foreign affiliates may need to cut the trade and technology transaction links to the Chinese subsidiary if such transaction has a US element, simply for the fear of further sanctions by BIS against the same foreign parent company and affiliates. In such a case, the Chinese subsidiary’s business will be jeopardized even if it is more than willing to observe the Blocking Rules, and how can the Chinese company on the Entity List benefit anything from such a case and what is the point of enforcing the Blocking Rules against such a Chinese subsidiary of a foreign company who has no choice but to follow the US sanctions?
Given that there is no sign of compromising the economic sanctions and export control measures after European Union adopts its Blocking Statute, the United States may likely follow the same pattern even with the advent of the Blocking Rules of China. Strategically the only way a foreign company and its subsidiaries in China can avoid risks of confronting US or China regulations would be to find a supply chain without any commodity, technology, software and labor of the US origin. If that supply chain immune from the bite by any US origin elements can be developed, the foreign company and its subsidiaries will be able to emancipate themselves from the constraints of US economic sanctions and the Blocking Rules of China.
The potential market and technology segregation as mentioned above will be the most sensitive issue that MOFCOM must consider carefully and seriously in enforcing the Blocking Rules and the Rules of Unreliable Entity List. Please note that China has not yet determined which foreign law is to be blocked. This can be viewed as an element of prudence of MOFCOM in enacting the Blocking Rules.
[1] The official English version of the Blocking Rules is available at: http://english.mofcom.gov.cn/article/policyrelease/announcement/202101/20210103029708.shtml
[2] Safeguarding legitimate interests and international trade order: experts taking questions on the Rules on Counteracting Unjustified Extra-territorial Application of Foreign Legislation and Other Measures, January 11 2021, available at: http://english.mofcom.gov.cn/article/newsrelease/significantnews/202101/20210103031442.shtml
[3] Head of MOFCOM's Department of Treaty and Law Answered Questions from the Press on the Rules on Counteracting Unjustified Extra-territorial Application of Foreign Legislation and Other Measures, January 12 2021, available at: http://english.mofcom.gov.cn/article/newsrelease/policyreleasing/202101/20210103031441.shtml
[4] MOFCOM Order No. 4 of 2020, Rules on the Unreliable Entity List, available at: http://english.mofcom.gov.cn/article/policyrelease/announcement/202009/20200903002580.shtml
