June 28, 2007

The New China "Military Catch-All" Regulations: End-Use Restrictions on Certain Commercial Exports to China

Holland & Knight Alert
Jonathan M. Epstein

On June 19, 2007, the U.S. Department of Commerce Bureau of Industry and Security (BIS) implemented a new regulation that expands the types of commercial products requiring a license for export to the People’s Republic of China (PRC), but only when the U.S. exporter knows or has reason to know the product will be used for a “military end-use” in the PRC. Companies whose products are directly affected need to immediately take steps to comply with these new requirements. Other companies should also review their export procedures to the PRC as these regulations are merely one aspect of increased scrutiny by the U.S. government of technology exports to the PRC.

Do the New Restrictions Apply to Your Company’s Products or Customers?

Additional licensing restrictions apply if: (1) a product, software, or technology is identified in the expanded list of controlled items; and (2) the U.S. exporter knows or has reason to know that the item is going to a military end-use.

Is the Product, Software, or Technology on the New List of Controlled Items?

Listed Items

The list of products, software and technology are all items already identified on the Commerce Control List (CCL) of controlled dual-use goods. However, these are items that prior to issuance of this regulation could generally be exported without a license to any country and entity person, except embargoed countries and certain prohibited end-users/end-uses. These items include certain items in the following categories:

  • depleted uranium
  • carbon fiber and prepregs for use in composite structures
  • hydraulic fluids
  • bearings and bearing systems
  • computer-controlled machine tools and non-computer controlled machine tools used for generating optical quality surfaces
  • dimensional inspection or measuring equipment
  • oscilloscopes
  • flash X-ray machines and pulsed power systems
  • high performance computers (exceeding 0.5 Weighted TeraFLOPS) (this would not include most available desktop/laptops, but may include certain servers)
  • radio equipment that meets MILSPEC requirements or uses QAM
  • phased array antennas
  • lasers
  • optical sensing fibers
  • airborne communication and inertial navigation systems
  • underwater systems
  • aircraft
  • aero gas-turbine engines
  • microprocessors with certain performance criteria (these are already controlled for military end-use to a number of countries including China under existing regulations)

Are EAR99 Items Subject to These Regulations?

These regulations do not directly place any additional restrictions on commercial items that are not identified on the CCL and therefore classified as EAR99 for export purposes. However, even EAR99 items may be restricted if, for example, the U.S. exporter knows or has reason to know, the item will be used:

  • in certain nuclear activities
  • in a missile, space launch, or unmanned aerial vehicle program
  • in chemical or biological weapon production
  • by an entity identified on one of the many U.S. barred entity lists

Do You Have Knowledge That the Item Will Have a Military End-Use?

What Is a Military End-Use?

A military end-use is defined as follows:

  • the item will be incorporated into a piece of military equipment, software, or technology (e.g., into a communications systems specifically designed for a military application)
  • the item will be for the “use,” “development,” or “production” of military items, as these terms are defined by BIS (e.g., test and manufacturing equipment that will be used to produce/test military equipment)
  • for civil/demilitarized aircraft and aero gas-turbine engines, military end-use also means the “deployment” of such items (e.g., supplying such items where they will be assigned to PRC military units)

What Constitutes “Knowledge”?

Although the formal definition of “knowledge” is legalistic, as a practical matter you have knowledge if:

  • your company has actual knowledge of a military end-use
  • your company “should have known” of such military end-use
  • if your product is specifically identified by BIS as being intended entirely or in part for military end-use in the PRC
  • if a particular transaction or entity in the PRC is identified by BIS as being at risk

Expanded List of Items/Entities

In the regulations BIS indicated that they may notify individual companies or publish lists of items subject to additional restrictions. The implications of this are unclear, but it may mean BIS will indirectly require additional due diligence or license requirements for certain items that it believes are likely to be used by the PRC military. In addition, BIS recently expanded the criteria for designating companies on the “entity list” (which bars virtually all exports to that entity).

Can You Still Get a License?

If the product is on the list and will be exported for a military end-use, a company can apply for a license, but grants of such licenses are likely to be few and far between, and likely subject to a lengthy interagency review process.

No License Exceptions

Except for a limited exception for the export of certain items to the Chinese government, no license exceptions will be applicable where there is a military end-use.

Presumption of Denial

BIS has adopted a formal “presumption of denial” for any license applications for the export of all items controlled for national security, chemical, biological proliferation reasons, or where the item would make a direct and significant contribution to the PRC’s military capabilities, including but not limited to major weapon systems which include night vision equipment and the broad category of Command Control Communications Computer Intelligence Surveillance and Reconnaissance (C4ISR).

End-User Statement

An “end-user statement” will be required for any export that requires a license to China if it exceeds $50,000 in total value, except for certain controlled cameras and computers where the limit is $5,000. This end-use certificate is issued by MOFCOM, the Chinese Ministry of Commerce. Since this requirement was not coordinated with MOFCOM, it is unclear how easy it will be to obtain such certificates.

Validated End-User (VEU) Procedure

The one “carrot” in these regulations is a new provision that allows a Chinese company to receive advance screening as a “validated end-user.” If approved, that company could then receive items that would otherwise require a license to export to the PRC. In theory this could apply to any item (except missile/crime control items), provided the Chinese company intended to use the item for a bona fide civil purpose at that company’s facility, consume it during use, or transfer it subject to a BIS license.

Complying With the New Regulations

Any U.S. company exporting to the PRC needs to review its existing products and customers to determine whether it is affected by the new regulations, and what steps it needs to take to comply. The hardest part of compliance will be assessing what steps need to be taken to be reasonably assured the item is not going to a military end-use. Some measures to consider are the following:

Contractual Requirements/Customer Certification

A U.S. company should consider including end-use restrictions as a standard contractual provision and/or as part of a separate customer certification form.

Additional Due Diligence on New Customers

When supplying controlled products, companies should consider conducting some level of due diligence particularly given the wide definition of military end-use. For example:

  • for certain controlled manufacturing or test equipment it may be possible to ascertain whether the Chinese customer manufactures goods for the PRC military
  • while sales to companies owned or linked to the PRC military are not prohibited, this should be a red-flag triggering additional due diligence

Documenting Bona Fide Commercial Use on License Applications

It is not unlikely that the “presumption of denial” of licenses will, as a matter of practice, “bleed over” to applications for commercial uses in the PRC, requiring exporters to go to great lengths to demonstrate the bona fide commercial use of its Chinese customers.

Conclusion

Because the products, software and technology on the expanded list are not generally subject to export restrictions to most countries, these new regulations create an additional administrative burden on companies exporting to the PRC. In addition, underlying this new regulation is a policy goal of trying to prevent U.S. products and technology from being used to enhance the PRC military. In this light, virtually any sales to the PRC military or its wide-flung commercial enterprises are potentially suspect. It may be that BIS’ recent expansion of the criteria for designating entities on the entity list is a precursor to allow BIS to designate on this list certain Chinese entities closely associated with the PRC military.

While U.S. industry and Chinese news sources remain highly critical of these new restrictions, to its credit, BIS made significant efforts to engage U.S. exporters in formulating the regulation. As ambiguities are raised by those in the affected industries BIS is likely to provide additional interpretive guidance.

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