China Lawyers

For more than a decade, China has blocked American tech companies from fully participating in China’s Internet boom. If you know China’s Internet-related laws for foreign companies and you have represented foreign companies trying to proft from China’s Internet, you know that in most cases, the reality for foreign companies has been much worse even than the laws. To put it bluntly, the way China treats foreign companies is what has prevented companies like Google, Facebook, Uber, Amazon, and even Apple (FAANG) from succeeding wildly in China. Those who believe it a coincidence that these five companies have done so well worldwide as compared to China either unintentionally or deliberately do not understand how China has treated these companies. Or, as the New York Times accurately put its in As Huawei Loses Google, the U.S.-China Tech Cold War Gets Its Iron Curtain:

The digital Iron Curtain has been long in the making. From its earliest days dealing with the internet, the Chinese government has squelched content it didn’t like. Today, the Chinese internet at first glance doesn’t look much like the one the rest of the world uses. It has different platforms, ideals and business strategies, all tended carefully by censors.

And just as the way China has treated foreign tech companies should come as no surprise to those who regularly do business with China, U.S. retaliation for that treatment has not come as a surprise to many in China:

Others in China point to the country’s own barriers against competitors as a strategy that was going to provoke retaliation sooner or later. At some point, the United States was bound to use reciprocity in dealing with a closed Chinese internet market. One popular blog post explained that reciprocity has been translated into “mutual benefit” in Chinese, which explains why many in China didn’t understand that the idea could be used in retaliation.

Another popular blog post drives the point even more clearly.

“You’ve been opposing the U.S. for many years,” said the headline. “You should be long prepared that the U.S. will oppose you one day.”

A large part (so far) of U.S. tech retaliation has been against Huawei, “a Chinese multinational telecommunications equipment and consumer electronics manufacturer, headquartered in Shenzhen, Guangdong, China …. founded by a former People’s Liberation Army officer.” See Wikipedia. The U.S. is acting against China in two ways. The first is a ban on sales of technical products to Huawei, with the threat that this ban will be extended to other Chinese companies. The second is a ban on purchases of telecom products from Chinese companies, with Huawei as the probable initial target. I discussed the sales ban yesterday in The Huawei Sales Ban: Brrrrr. In this post I consider the purchase ban.

The purchase ban was implemented by an Executive Order issued on May 15, 2019, entitled Executive Order on Securing the Information and Communications Technology and Services Supply Chain. In the Order, President Trump declares a national emergency to counter “foreign adversaries” threatening the U.S. telecom sector by selling certain telecommunications products to persons located in the United States. Under powers granted under the International Emergency Economic Powers Act (IEEPA), President Trump ordered the United States Department of Commerce to issue rules to prohibit the import of offending products into the United States.

The U.S. administration has been working to impose a ban on imports of telecom products from China’s Huawei and this Order is generally seen as the final implementation of that plan. This Order goes well beyond just prohibiting the U.S. government and its agencies from buying Huawei telecom products; it will impose a general ban on purchasing such products by any U.S. person/entity. It is an absolute, nationwide ban.

The Order itself does not refer to Huawei specifically. It refers only to “foreign adversaries” and it gives the Department of Commerce 150 days to publish the foreign adversaries list. We can though assume for now that at a very minimum Huawei will be on that list.

This then means, for example, that rural U.S. telecoms that rely on inexpensive Huawei telecom equipment will be forced to find an alternative supplier. The media is reporting (and I believe rightly) that the result of this ban will a major blow for rural American telecom companies, since no alternative supplier that meets their needs has been identified.

There is much that is not clear about this Order. The uncertainty is at least party due to the fact that this appears to be the first use of the IEEPA national security sanction involving the sale of a commercial product. The 30 Existing IEEPA national security sanctions are listed by the Department of the Treasury on its Sanctions Programs list here and a quick review of those sanctions shows they fall into the more traditional notion of what constitutes a foreign based national emergency. Prohibiting the purchase of Huawei products does not fit easily into the tradition of sanctions under the IEPPA program. This means how this sanction will be applied is uncertain.

The next thing apparent from reviewing the sanctions list is that no country in Asia other than North Korea had previously been placed on it. If, as expected, various Chinese companies, including Huawei get placed on this list, China will be joining pariah regimes such as Russia, Iran, North Korea and South Sudan. This will significantly alter the U.S. relationship with China from business adversaries to political adversaries. This is a major event and it should be seen that way in the United States, particularly since it is not clear there is a general consensus in the United States for placing China in this category.

The following additional open issues are more technical but also significant:

1. The Order requires the Department of Commerce to designate the specific foreign adversaries that will be subject to the U.S. purchase ban. As stated in the Order, a foreign adversary can be a nation state, a company or an individual. It is almost certain Huawei will be listed as a foreign adversary. What is not known is whether other Chinese companies such as ZTE will also make the list. Will the entire PRC be placed on the list? Will entities and countries outside China be placed on the list? At this time we just do not know.

2. The order states its goal is to protect the United States in the following sectors:

— Information and communications technology

— Critical infrastructure

— Digital economy

— National security

As I have noted above, this list goes far beyond any previous uses of the IEEPA. The list moves from the classical definitions of national security to purely economic spheres such as the digital economy. Whatever anyone thinks of that broadened scope, the fact is the U.S. has no experience with this type of regulation coming from an executive order. For that reason, we do not know what its immediate impact will be or its impact in the future. Will the U.S. government eventually convert all economic conflicts with foreign competitors into national emergencies?

3. Though the Order is couched in terms of telecom equipment, its definition of impacted technology is very broad:

(c) the term “information and communications technology or services” means any hardware, software, or other product or service primarily intended to fulfill or enable the function of information or data processing, storage, retrieval, or communication by electronic means, including transmission, storage, and display.

This definition can apply to virtually any modern electronic product. Obviously, it applies to the telecom switches sold by Huawei to the rural telecoms in the U.S., but it also applies to Huawei smartphones. More significantly, it can be read to apply the Internet of Things (IoT) devices that are incorporated in the huge variety of “smart products” currently being imported from China and the rest of the world. Much of the work I and the other China lawyers at my firm have been doing for the last five years has involved IoT devices.

Consider the IoT issue. Say the U.S. designates China as a whole to be a foreign adversary. And say the U.S. follows the clear language of the definition to include IoT devices as products that fall under the purchase ban. Designating of IoT devices as a security threat would not be far fetched. Bruce Shneier outlined the threat from IoT in his recent book Click Here to Kill Everybody. The State of California has recognized this threat by promulgating IoT security rules. Yesterday, the U.S. Department of Security warned of Chinese made drones of secretly gathering up and sending back sensitive military information to China. See DHS warns of ‘strong concerns’ that Chinese-made drones are stealing data. Our China lawyers have done probably at least a half a dozen transactions involving Chinese drones and I mention this to show the extent of the impact this ban might have.

A vast number of products imported from China contain an IoT component. A huge number of the electronic devices imported from China implement a feature that allows it to be controlled by a smartphone or laptop. If the Order is enforced in a completely consistent way and IF the entire country of China is designated as a foreign adversary, a huge list of electronic products imported from China will be banned from sale to the United States. Even if this will not be the immediate impact of the Order, the threat remains that the Order could be expanded at any time to have this impact.

Note also that there is no way to avoid this result. The ban follows the component. It will not work to move production to a neutral country and then have the component shipped from China and incorporated into a product made in that third country. The ban follows the specific IoT (telecom) component. In a world of interlocking supply chains, determining the source of each and every critical component for each and every electronic product produced from each and every country in the world will be overwhelming.

The end result of this Order is uncertainty and risk. Initially, the risk comes from direct purchases of telecom products from China. But as the process works out, the risk may infect the entire world trading system. The final result is hard to predict. What we can say, however, is what we have been saying for nearly a year: relations between China and the United States are on a straight-line decline with no end in sight.