25 January 2021
On 9 January 9 2021, the PRC Ministry of Commerce (MOFCOM) released with immediate effect its 2021 No. 1 order, Rules on Counteracting Unjustified Extra-territorial Application of Foreign Legislation and Other Measures (《阻断外国法律与措施不当域外适用办法》in Chinese, and which we'll refer to here as the "Blocking Rules").
As the name of the new rules suggests, they aim at providing legal remedies to those Chinese companies (for example, Huawei) that suffer from the extra-territorial application of a foreign country’s laws and other administrative measures (ie the so-called "long arm laws” now applied by the US globally). However, the Blocking Rules have much more complicated implications that go beyond the Sino-US context – they could impact European companies, too.
References to the PRC National Security Law in the Blocking Rules reveal their strong political flavour. It's clear that they are an attempt to push back against perceived abuse of weaponised legalisation by the US. However, the Block Rules have also have potentially unforeseen consequences for European companies, as well.
According to Article 2 of the Blocking Rules, they will apply:
"…where the extra-territorial application of foreign legislation and other measures [eg American long arm laws and secondary sanctions], in violation of international law and the basic principles of international relations, unjustifiably prohibits or restricts the citizens, legal persons or other organisations of China from engaging in normal economic, trade and related activities with a third State (or region) or its citizens, legal persons or other organisations [eg European companies]."
Article 9 of the Blocking Rules further stipulates that a Chinese entity that suffers from foreign long arm laws, such as those of the US, may seek judicial remedies in front of Chinese court against the party. This would apply to European companies that comply with long arm laws or other measures against which the Chinese government already issued injunctions.
Under the Blocking Rules, European companies (as third State companies) will face a dilemma.
On the one hand, they will need to comply with US sanction measures involving or implying a Chinese entity due to their business in the US or other connections with US laws; on the other, they'll face potential legal action from Chinese companies under the Blocking Rules. Although Article 8 of the Blocking Rules provides for certain exemptions, such exemptions can only be initiated by Chinese companies and individuals. Therefore, a "choose side" scenario will inevitably arise.
Currently, it's not very clear whether an application for the exemption under Article 8 can also be initiated by the China subsidiaries of European companies including their Chinese employees. Technically speaking, China subsidiaries and Chinese staff qualify as "Chinese citizens, legal persons or other organisations" as mentioned by Article 8. But considering the strong political undercurrent of the Blocking Rules, whether this interpretation will be upheld remains to be seen.
A dedicated working mechanism (Working Mechanism) composed of various national level ministries will be formed to implement the Blocking Rules. The mechanism will be led by the MOFCOM in coordination with the National Development and Reform Commission (NDRC) and other relevant departments of the State Council.
This approach is like the working mechanism established earlier in September 2020 to implement the Unreliable Entity List (UEL) in response to the sanction measures taken by the US. Similarities to the UEL scheme can also be found in the criteria used by the Working Mechanism to assess whether there are any unjustified extra-territorial applications of foreign long arm laws and sanction measures, including (among other factors):
An assessment by the Working Mechanism will be initiated by a Chinese citizen, legal person or other organisation that claims to be unfairly impacted by foreign legislation and other measures when conducting normal business with business counterparty from a third State or region, such as a European company.
The Blocking Rules don't just define an assessment initiation as a right of the concerned Chinese party. Instead, it's an obligation of the concerned Chinese party to report a case to the MOFCOM within 30 days; failure to do so could result in administrative penalties like receiving warning, being ordered to correct, and/or incurring a fine. This could potentially mean that any long arm application of US laws and sanction measures targeting Chinese parties is supposed to subsequently trigger an assessment.
Where unjustified application is established upon assessment, the MOFCOM will issue an injunction not to recognise, enforce or abide by the relevant foreign legislation and other measures. Such an injunction may be avoided if:
The Blocking Rules will have an impact on European companies, but this shouldn't be misunderstood as an indication that they were formulated. During a recent press conference, a MOFCOM spokesman asserted that the Blocking Rules were not targeting any specific country or transaction. However, by factoring in the current geopolitical climate, you could reasonably assume that these rules were designed with the US in mind, to counteract the perceived unjust influence caused by the long arm application of its laws and sanction measures.
Significant issues still need to be clarified under the Blocking Rules, regardless of their underlying intent. For instance, the Blocking Rules focus on unjustified application of foreign laws and sanction measures upon a Chinese citizen, legal person or other entity (Chinese party) "when they conduct normal economic and trading activities" with a third party country/region, such as Europe, including its citizen, legal persons or other entities (foreign party). You could question whether the China subsidiaries of a European company qualify as a Chinese party, and vice versa – whether the European subsidiary of a China based company qualifies as a foreign party under the Blocking Rules.
Either way, European companies with close business ties with both China and the US will be affected by the Blocking Rules. These companies should start to assess the potential impact of the rules on their business – especially those in high-end machinery and other high-tech related businesses, as particular attention will be paid to sectors where Europe has strength and strong demand from China.
Necessary restructuring of business set-up and supply chain management – as well as revisiting routine contractual provisions like export control and compliance clauses – will become strongly recommended to avoid any unnecessary risk. That said, the Blocking Rules also provide European companies, including their China subsidiaries, with a strong legal basis and argument to push back on unjustified long arm requests targeting their important Chinese customers.
The Blocking Rules are an unprecedented move for China, but one that may not be too unfamiliar to European companies. Notably, the EU previously expanded the annexes of the so-called Blocking Regulation (Regulation (EC) No 2271/96), which entered into force on 29 November 1996, to include the US Iran sanctions with Delegated Regulation (EU) 2018/1100 of 7 August 2018 (EU Blocking Regulation).
The EU Blocking Regulation also states that US decisions based on US extraterritorial acts against Iran listed in the annex to the Blocking Regulation cannot be enforced in the EU (Art. 4). Furthermore, the EU Blocking Regulation has already prohibited EU companies from complying with demands or prohibitions based on the US "secondary sanctions" against Iran listed in the Annex to the Blocking Regulation (Art. 5) for two years.
Regarding the intended defensive function of the EU Blocking Regulation against the extraterritorial extension of US sanctions law, it's particularly problematic that US sanctions against EU companies that violate US "secondary sanctions" can have direct effects even without enforcement of the sanction decision by an EU Member State authority. For example, EU companies that violate "secondary sanctions" can be placed on a US sanctions list, which would mean that US individuals and businesses are no longer allowed to do business with them. This result in complete exclusion from the US market, as well as considerable impediments to participation in the US-dominated international financial system.
In addition to the EU Blocking Regulation, a Special Purpose Vehicle (SPV) was established in the EU to enable European companies to process payments for Iranian transactions outside the usual US dollar-dominated financial channels. Although there are also still various uncertainties at the European level in the application of the EU Blocking Regulation, drawing upon European experience of operating under the it could help us to better understand and analyse issues associated with the Blocking Rules.
If you'd like to discuss any of the issues raised in this article in more detail, please reach out to a local member of our Competition, EU & Trade team.