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LawFlash

China’s New Blocking Statutes – MNCs Beware!

January 14, 2021

China’s Ministry of Commerce (MOFCOM) published the Rules on Counteracting Unjustified Extraterritorial Application of Foreign Legislation and Other Measures (the Blocking Statutes) on January 9. The rules, which consist of only 16 articles, became effective upon publication.

The Blocking Statutes appear to be intended to deter multinational companies and their China subsidiaries from complying with foreign sanctions against Chinese persons through various measures. Such measures include, among others, prohibition orders issued by MOFCOM (Prohibition Orders) declaring the foreign sanctions unjustifiable and unenforceable, penalizing Chinese persons for violation of the Prohibition Orders, and allowing Chinese persons to sue the covered parties for damages. The Blocking Statutes also provide that the Chinese Government may take necessary “counter-measures” in response to “unjustified extra-territorial application of foreign legislation and other measures” (Article 12). Such countermeasures may include, among others, adding foreign entities or individuals to MOFCOM’s Unreliable Entity List and prohibiting the designated entities from engaging in China-related import or export activities.

The language in the Blocking Statutes is vague and general in nature and may be subject to discretionary interpretation by MOFCOM. Further, there has been no indication of whether MOFCOM will issue further guidance to allow multinational companies (MNCs) to better understand the scope of the Blocking Statutes restrictions. For now, MNCs are advised to carefully assess whether and how the Blocking States may impact their actions to comply with the applicable foreign sanctions and whether that compliance may subject them to any Prohibition Orders. Although much remains open to interpretation, identifying the available options to minimize legal risks in both China and other applicable jurisdictions would be advisable.

How Do the Blocking Statutes Work?

The primary foundation for the Blocking Statutes may be found in Articles 4, 5, and 6. According to Article 4 of the Blocking Statutes, the state will establish a joint committee “Working Mechanism” led by MOFCOM. The Working Mechanism will be composed of representatives from MOFCOM, the National Development and Reform Commission, and other relevant ministries. The Blocking Statutes do not contain details on the rules which will govern the Working Mechanism. The Working Mechanism will be responsible for determining whether “unjustified” extraterritorial application of foreign legislation and other measures (Foreign Sanctions) has occurred and, if it makes such a determination, it may authorize MOFCOM to issue a Prohibition Order, which will declare that the Foreign Sanctions “shall not be accepted, executed or observed.”

Under Article 5 of the Blocking Statutes, the Chinese persons who are subject to the Foreign Sanctions are legally obligated to truthfully report the matter to MOFCOM within 30 days, and if requested by the reporting Chinese persons, MOFCOM and its staff are obligated to keep such report confidential. The Blocking Statutes also do not prohibit the Working Mechanism from launching a review of any Foreign Sanctions on its own initiative.

Article 6 of the Blocking Statutes lists four factors that the Working Mechanism should consider when assessing whether the unjustified extraterritorial application of Foreign Sanctions exists, including: (i) whether international law or the basic principles of international relations are violated, (ii) the potential impact on China’s national sovereignty, security, and development interests, (iii) the potential impact on the legitimate rights and interests of the citizens, legal persons, or other organizations of China; and (iv) other factors that shall be taken into account. These four factors are consistent with China’s longstanding position toward the extraterritorial application of any unilateral Foreign Sanctions against Chinese persons, are highly subjective and are based on the interpretation of the Working Mechanism.

The Blocking Statutes do not impose a timeline within which MOFCOM must make a decision or issue a Prohibition Order upon the Working Mechanism’s confirmation.

What Foreign Sanctions Are Covered by the Blocking Statutes?

The Blocking Statutes apply to situations where the extraterritorial application of Foreign Sanctions “… unjustifiably prohibits or restricts the citizens, legal persons or other organizations of China (Chinese persons) from engaging in normal economic trade and related activities with a third State (or region) or its citizens, legal persons or other organizations” (Article 2).

The Blocking Statutes’ specific reference to “third State (region)” in the scope of application indicates the Chinese government’s focus on the so-called “secondary sanctions.” Secondary sanctions often refer to the enforcement of US sanctions targeting non-US persons doing business with sanctioned parties.. Indeed, the two Q&A articles published by MOFCOM (Q&As) following the release of the Blocking Statutes expressly confirm that the main target of the Blocking Statutes is to address the “secondary sanctions.” Under this interpretation, for example, US sanctions prohibiting EU member countries or EU persons from trading with Chinese persons would be covered by the Blocking Statutes. In contrast, the Blocking Statutes do not appear to cover sanctions by a foreign country that directly prohibits or restricts entities or individuals from its own country from trading with Chinese persons. For example, the Blocking Statutes do not appear to cover primary sanctions under OFAC regulations, which prohibit only US citizens or permanent residents from trading with SDN or MEU designees that are Chinese persons.

Which Parties Are Subject to the Prohibition Order?

Article 7 of the Blocking Statutes states that MOFCOM shall issue the Prohibition Order that the “unjustified” Foreign Sanctions “shall not be accepted, executed or observed,” without specifying who shall not accept, execute or observe the “unjustified” Foreign Sanctions. Nor do the Blocking Statutes specify whether the scope of the application shall include or exclude any foreign persons.

Given the vague language of Article 7, the Working Mechanism and MOFCOM may take the position that the Prohibition Orders should cover foreign persons, although questions remain on how and whether the Chinese government can extend the extraterritorial effect of the Blocking Statutes beyond its borders.

Once a Prohibition Order is issued by MOFCOM, the Blocking Statutes are silent on whether the Prohibition Order will be binding on all Chinese persons, including the China subsidiaries of MNCs, with respect to transactions which are governed by the Foreign Sanctions, but are unrelated to Chinese persons’ trade with a third country or its persons.

Exemptions to the Prohibition Order

Article 8 of the Blocking Statutes expressly allows Chinese persons to apply to MOFCOM for exemption from compliance with a Prohibition Order. This means that in cases where a Chinese person determines that it is in its best interest to comply with the Foreign Sanction, it may apply to MOFCOM for relief from the Prohibition Order. The Blocking Statutes do not expressly allow a foreign person to apply for an exemption.

Penalties for Violation of the Prohibition Order

Article 13 of the Blocking Statutes authorizes MOFCOM to impose certain penalties (such as warnings, an order to rectify within a specified period, or a fine according to the severity of circumstances) on the Chinese person for failure to comply with a Prohibition Order. There is no express authorization for MOFCOM to impose the same penalty on a foreign person. In its Q&As, MOFCOM states that the Chinese person would receive “necessary support,” including guidance and services, from the relevant departments and agencies of the Chinese government. Article 13, however, does not specify the levels of potential fines, if any, to be imposed.

Violation of the Prohibition Order and Judicial Remedies Available to the Infringed Chinese Persons

Article 9 of the Blocking Statutes provides that where a “party” (“当事人”) complies with the Foreign Sanctions within the scope of the Prohibition Order, and thus infringes upon the legitimate rights and interests of a “citizen, legal person, or other organization of China,” the latter may institute legal proceedings in a Chinese court and claim for compensation, absent the granting of an exemption in accordance with Article 8.

Further, if a Chinese person suffers from losses due to court decisions or awards rendered according to any Foreign Sanction covered by a Prohibition Order, the Chinese person may institute legal proceedings in a Chinese court, and claim for compensation by a relevant “party” who benefits from such court decisions or award. If the relevant “party” refuses to comply with the court judgment or ruling, the Chinese person may apply to the Chinese court for judicial enforcement.

Article 9, however, does not define the term “party,” and a Chinese court may take the position that “party” includes both Chinese and foreign persons who violate the Prohibition Orders. As a result, if an MNC or its China subsidiary takes action (such as terminating a commercial contract with the sanctioned Chinese person) to comply with Foreign Sanctions covered by a Prohibition Order, both the MNC and its China subsidiary could potentially face legal proceedings in China by the Chinese person that suffered damages resulting from such actions.

Enforcement Against Foreign Persons

China does not have treaties with most western countries (including the United States, Canada, United Kingdom, Germany, France, Australia, and Japan, etc.) to allow its court judgments to be enforced in such countries. It will be very difficult, therefore, to enforce a Chinese court judgment if a foreign party does not have assets – including receivables – in China.

Enforcement Against China Subsidiaries of Foreign Persons

The assets owned by the China subsidiary of a foreign person are legally separate from the foreign person, so the China subsidiary may not be subject to any judicial enforcement, unless in the litigation in China, the infringed Chinese persons can provide sufficient evidence to prove that there exists commingling of assets, fraudulent transfer, or other evidence such that the independent legal person status of the China subsidiary should be ignored and it should be held accountable for the liabilities of its foreign affiliate. In practice, however, the standards of piercing the corporate veil are very high in China, so the risk to the assets of the foreign party should be relatively low. These are all highly specific factual and legal questions that require a detailed analysis in order to assess the risk of loss or enforcement in these scenarios.

Looking Ahead

As the Blocking Statutes are newly released and their terms are vague and general in nature, it is difficult to predict how the Chinese government will enforce them. We expect that the Chinese government will issue more detailed implementing regulations to clarify the uncertainties and confusion highlighted above, as it typically does with similarly general regulations. However, no specific timeline for such implementing regulations has been announced.

If the Chinese government were to strictly and expansively enforce the new Blocking Statutes, many MNCs and their China subsidiaries may be forced to choose between compliance with foreign (especially US) sanctions and Chinese law. Should such a situation occur, MNCs are well-advised to carefully assess whether and how their actions to comply with the applicable sanctions may be captured by the Blocking Statutes, and consider their options to minimize their legal risks in both China and the other applicable jurisdiction(s). In that regard, we note that cases involving foreign blocking statutes concerning discovery issues have been frequently ignored by the US courts in applying the Supreme Court’s decision in Société Nationale Industrielle Aérospatiale v. U.S. District Court. It is also reasonable to anticipate that MNCs may cite the Blocking Statutes as their legal risk exposure in China, when applying with the US regulator for an exemption or license not to comply with an applicable US sanction.

Additionally, we note that the Blocking Statutes present similar approaches taken by other jurisdictions attempting to curb the impact of, for example, US secondary sanctions relating to Iran and Cuba. For example, under Council Regulation (EC) No 2271/96 of 22 November 1996 (EU Blocking Statutes), European companies are protected against the effects of the extraterritorial application of legislation adopted by a third country, and actions based thereon or resulting therefrom. Subsequently, the European Commission issued revisions to the list of foreign sanctions measures covered by the EU Blocking Statutes, covering most of the US Iran-related secondary sanctions. The latest revision, introduced on August 6, 2018, further covered primary sanctions prohibiting the re-export of any goods, technology, or services imported from the United States and are subject to US export control laws. Accordingly, borrowing a page from the European Union’s book, MNCs are advised to review opportunities and challenges raised by their operation in the European Union and be prepared for MOFCOM’s further implementation and identification of the specific sanction programs covered under the Blocking Statutes.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Asia Pacific
Lesli Ligorner (Beijing)
Charles Mo (Hong Kong)
Maurice Hoo (Hong Kong)
Todd Liao (Shanghai)
Motonori Araki (Tokyo)

United States
Carl Valenstein (Boston)
Giovanna Cinelli (Washington, DC)
Kenneth Nunnenkamp (Washington, DC)

Europe
Christina Renner (Brussels)
Michael Masling (Frankfurt)
Melanie Ryan (London)

Middle East
Mark Gilligan (Abu Dhabi)
James Kahika (Abu Dhabi)
Alishia Sullivan (Abu Dhabi)
Rebecca Kelly (Dubai)

Russia and CIS
Jon Hines (Moscow)