On January 9, China’s Ministry of Commerce (MOFCOM) issued Rules on Counteracting Unjustified Extraterritorial Application of Foreign Legislation and Other Measures (the Blocking Rules) (in English; in Chinese). The Blocking Rules are designed to counteract the extraterritorial application of foreign laws that, in China’s view, infringe on the rights interests of China, its nationals, and its companies. In concrete terms, the Blocking Rules: (1) allow a MOFCOM-led working group to prohibit Chinese individuals and entities from complying with designated foreign (i.e. non-Chinese) laws, including potentially U.S. secondary sanctions; and (2) introduce domestic Chinese countermeasures against these laws. To date, no foreign laws have been identified by the working group for blocking, but that may just be a matter of time. As described more fully below, the Blocking Rules have potentially weighty consequences for any multinational or US business that is subject to both Chinese and non-Chinese legal regimes or that does business with Chinese counterparties.
The Bigger Picture
China’s Blocking Rules follow significant actions by the US government targeting Chinese businesses. In recent months, the Trump Administration has issued executive orders banning transactions with certain Chinese software companies and prohibiting US investors from owning or trading shares of companies that the US Government has determined to be controlled by the Chinese military (see our takeaways). In December, Congress also passed the Holding Foreign Companies Accountable Act, which tightens auditing rules on US-listed foreign businesses and specifically requires disclosure concerning companies’ links to the Chinese Communist Party.
The Blocking Rules do not single out specific countries or areas of trade, but their timing and content identify them as the next in a series of legal countermeasures that China has rolled out to protect Chinese companies from restrictive measures imposed by foreign countries, particularly the United States. We have previously discussed the “Unreliable Entities List” that China promulgated in September 2020 to restrict or ban certain blacklisted companies or individuals from trading with China, and written about China’s establishment of a unified Export Control Law in October 2020.
Overview of the Blocking Rules
In last week’s alert, we covered the content of the Blocking Rules in detail. Given their potential impact, it is worthwhile to highlight the implications for multinational and US companies. The terms of the Blocking Rules are broad and give Chinese authorities broad discretion to identify and prohibit compliance with extraterritorial laws that they believe unjustifiably prohibit Chinese citizens, legal persons, or organizations (Chinese parties) from normal economic, trade, and related activities. The Blocking Rules also institute a new obligation that Chinese parties report to MOFCOM within 30 days if a non-Chinese law prohibits or restricts their normal economic, trade, and related activities. This obligation, which has already taken effect, exists whether or not compliance with that extraterritorial law is prohibited.
The imposition of an order prohibiting compliance with an extraterritorial law (Blocking Order) would trigger a waterfall of countermeasures with potentially significant consequences for multinational and US businesses. The Blocking Rules permit Chinese parties to apply for an exemption from complying with a Blocking Order, but it remains to be seen whether non-Chinese parties will have a comparable option to avoid penalties.
What Multinational and US Businesses Need to Know
- Litigation Exposure in Chinese courts. Chinese parties injured by a company’s compliance with a blocked foreign law or foreign judgment from which the company benefitted can now seek compensation from that company in Chinese courts, meaning that companies potentially stand to suffer financial harm from mere compliance with US laws. The Blocking Rules do not provide details as to the damages that could be imposed or the elements for such a claim.
- Exposure through Subsidiaries. The Blocking Rules do not expressly grant the MOFCOM-led working group (referred to as a Working Mechanism) power to impose administrative penalties on non-Chinese parties, but it appears that multinational businesses may have exposure to penalties through their Chinese subsidiaries. The Blocking Rules allow the Working Mechanism to issue a warning, a rectification order, and/or an unspecified fine on a Chinese party that fails to comply with a Blocking Order or the Blocking Rules’ new reporting obligation.
- Eroding Competitive Edge. The Blocking Rules empower some Chinese government departments to provide “necessary support” to Chinese parties suffering “significant harm” from noncompliance with a blocked foreign law and empower the Chinese government as a whole to take other necessary countermeasures in response to circumstances and needs, which remain undefined. Competitors may have enjoyed an advantage over Chinese companies that suffered the commercial consequences of sanctions, export controls, and other restrictive measures imposed by the United States and other countries. This advantage may now start to erode, as litigation avenues and opportunities for material state support become available to Chinese parties affected by foreign laws. Chinese parties may now stand on more even footing in negotiations with multinational and US business partners as parties compare risk profiles for leverage in negotiations.
- Unpredictability. The Blocking Rules are new law. They have not yet been applied, and their broad terms remain largely undefined. It is unclear whether China will make aggressive use of them, or whether the rules are to serve primarily as a deterrent or political statement. By virtue of their design—to blunt or altogether negate the domestic impact of designated foreign laws—the Blocking Rules potentially set up a collision course between legal systems that companies will be hard-pressed to navigate. Businesses and employees may be whipsawed between irreconcilable, competing demands. Companies may be at the mercy of politics as well, to the extent that increasing bilateral tensions spur additional measures and countermeasures.
What Should Multinational and US Companies Do?
In line with our previous alert, multinational and US businesses should take the following initial steps to reduce their risk profile under the Blocking Rules:
- Risk Assessment. Assess current or future decisions to terminate or modify business dealings in order to comply with laws prohibiting or restricting dealings with Chinese parties, and assess the risk of such law being subject to a future Blocking Order in China.
- Risk Comparison. Carefully consider what is strictly required and weigh the risks associated with breaching an extraterritorial law (particularly US sanctions and export control laws in the current geopolitical climate) against the risks arising from enforcement of China’s Blocking Rules. In some cases, the consequences of non-compliance can be severe and, in the case of US law, involve criminal liability, but in other cases the consequences may be more modest. The extent of a business’s liability under the Blocking Rules is far less clear: companies may be subject to unspecified fines and other enforcement actions and ramifications through their Chinese subsidiaries, and are directly subject to compensatory suits from injured Chinese parties. This calculus should also take into account the nature and scope of the company’s business and internal policies, protocols and business plans.
- Diplomatic Documentation. Where a company terminates or modifies business dealings with a Chinese party, it should be mindful about how the decision is justified and documented internally, including if there is a non-sanctions related business justification, and also take care in how the decision is communicated externally with the Chinese party. Both can serve as evidence in a future Chinese lawsuit challenging the company’s justification for terminating or modifying business dealings, or in a US enforcement action.
- Monitor Developments. Companies should monitor the rapidly evolving legal and enforcement landscape and should be responsive to new precedent and other information (particularly in relation to US sanctions and China’s enforcement of the Blocking Rules). Moreover, Chinese subsidiaries will be obligated to report any impact from the extraterritorial application of non-Chinese laws.