Qinghua Wang
Allbright, Shanghai
wangqinghua@allbrightlaw.com

Cheng Shi
Allbright, Shanghai
shicheng@allbrightlaw.com

Liuya Yuan
AllBright, Shanghai
liuyayuan@allbrightlaw.com

Considering various factors like geopolitical dynamics, economic imperatives and technological advancements, it is foreseeable that the trend of intensifying export controls and economic sanctions will persist in the near future. In response, entities must take proactive steps to navigate the adverse effects of these complex policies effectively. This includes establishing robust internal compliance systems, implementing compliance training programmes and enhancing contract drafting skills. By doing so, entities can mitigate the risks, ensure regulatory compliance and adapt to the evolving landscape of international trade regulations.

Building an internal compliance system

In practice, an internal compliance system concerning export controls and economic sanctions should at the very least include: senior management commitments; an internal control system; and a risk assessment system for import-export and trade activities.

Senior management commitments

Senior management commitments require the senior management of an enterprise to publicly support its compliance policies and procedures, provide sufficient resources (including personnel, expertise and financial support) for the compliance work in line with the business scope, target market and other factors affecting its overall risk profile, as well as support export compliance training and approve compliance manuals, ensuring that the compliance department has sufficient authority and autonomy to implement the compliance system and effectively control the risk of non-compliance.

When making commitments, enterprises should make sure that nothing in their compliance commitments or compliance management system documents conflicts with legal provisions.

Internal control system

An internal control system should meet the following requirements:

• it should have established a corresponding organisational structure and designated responsible personnel (including compliance officers and staff) to support the implementation of the compliance system concerning export controls and economic sanctions;
• the functions of each department should be clearly defined, including multi-department coordination among procurement, sales and legal compliance departments, as well as the supporting roles of IT and finance departments. For the procurement department, purchasable materials’ specifications, sources, origins, components and supplier assessments should be standardised. The sales department should pay attention to the end uses, customers and end users of its products or services. In regard to the legal compliance department, it should supervise and control the compliance risks;
• it should have established regular and specialised export compliance supervision and audit procedures. Enterprises should regularly assess the effectiveness of the export controls and sanctions compliance process and check whether the daily operations of the company complies with the compliance process. A compliance audit should be conducted by an audit team composed of compliance personnel with adequate authority, skills, expertise and resources. The audit team should enjoy full independence and flexibility to identify compliance deficiencies and potential risks;
• complete documents related to export controls and sanctions should be retained. Enterprises should file and retain relevant documents, including product and customer screening records, records of complete transaction processes, commercial contracts and confirmation letters, as well as application and approval documents for licences.[1] Based on the business of enterprises and in accordance with the laws and policies in various countries, enterprises should make what internal documents need to be stored and for how long[2], how to make copies of them and choose the most appropriate way to do so (either in paper or electronic form, etc); and
• a mechanism for investigating and handling instances of non-compliance and remedial measures should be established. Enterprises should take measures against non-compliance and to address risks that have occurred during the company’s daily operations or which have been found during an audit process, and should establish an internal and external reporting procedure for the suspicion of non-compliance, an international investigation procedure to find out whether non-compliance has occurred, as well as a punishment and correction procedure to deal with instances of non-compliance.

Risk assessment system for import–export and trade activities

The main objectives of a risk assessment in such a context include two aspects. On the one hand, the aim is to identify relevant factors that may trigger violations of export control regulations or sanctions in order to establish preventive measures. Risks of violations of export control regulations or sanctions may come from ‘customers, products, services, supply chains, intermediaries, counterparties, geographical location and measures of a transaction and the transaction itself, and existence of any connection with the U.S.’.[3] Instances of non-compliance can be found through identifying such risks by examining whether a company’s products or their components fall into the definition of controlled items, whether the customers are on any sanctions lists (such as the US Bureau of Industry and Security’s (BIS) Entity List), whether any transactions have taken place with customers in specific countries and the identity of the end customers of products, etc.

On the other hand, the aim of a risk assessment is to prevent conflicts between the laws of different countries. Heavy losses may occur if there is a conflict between the laws of different countries, therefore it is suggested that enterprises enhance their prior risk assessments for major foreign-related projects and develop emergency plans, including, but not limited to, withdrawal by negotiation procedures.

Internal and third-party compliance training programmes

An enterprise should provide training on compliance concerning export controls and economic sanctions on a regular basis to all relevant employees and personnel in line with its own risk profile. Internal compliance training can enhance employees’ coordination with the relevant compliance work and raise business personnel’s awareness of the importance of compliance in regard to relevant transactions. Enterprises should regularly review and revise the scope of such training and plans based on changes to the products, services, end uses, end users and export regulations, including the EAR (US Export Administration Regulations).

The screening of items is a core step in export control compliance. Item screening should be carried out regularly and occasional screenings should be carried out immediately after the relevant countries update their item lists.

Attention should be paid to the following four major issues in regard to the screening of items:

• what the items are. The Export Control Classification Number (ECCN) code should be applied in determining whether the item constitutes a controlled item. The sources of the materials, equipment, technology and software related to export controls, as well as the composition and proportion of controlled products, should be indicate;
• material sources and sales destination of the items. In terms of material sources, it is advised that materials and products with American components or originating from the US should be labelled in particular, in order identify their composition and the proportion of American components and indicate the sources, composition, control types and use of materials, equipment and technology subject to export controls. Export licensing procedures, processes and decision tables should be established for products requiring export licences from the US or other countries. In terms of the destination of sales, the commercial control list should be considered when determining whether an export licence is required;
• the identities of the suppliers, customers and end customers of the items. The key point is to identify whether those customers and suppliers are included on certain control lists;
• the end use of the items; and
• enterprises are advised to conduct the screening of materials and products based on databases of relevant laws and regulations and to examine whether the procurement, export and resale of items are subject to export controls and economic sanctions.

Establishing a screening system for trading partners

Trading partners are mainly suppliers and customers. It is suggested that enterprises conduct due diligence on their trading partners. Enterprises should conduct due diligence to collect as much relevant information as possible. The risks related to export controls and economic sanctions in regard to transactions concern customers, products, services, supply chains, intermediaries, counterparties, the geographical locations of transactions and the transactions themselves, etc.

Specifically, screening should be carried out based on the following steps:

• determining whether the items are subject to export restrictions and economic sanctions;
• creating files on suppliers and customers and examining whether suppliers, end customers, their actual controllers and other entities in a supply chain have any connection with sanctioned countries or entities and whether they are included on any control lists (such as China’s Unreliable Entity List and the US BIS Entity List, Denied Persons List, Unverified List, Military End-user List and SDN List subject to the 50 per cent rule) through the use of background checks. A special file should be created to manage suppliers and customers subject to export controls or sanctions; and
• it is recommended that companies continuously check on end users and the end use of their products or services, conduct basic due diligence on their customers, understand their ability to use materials and technology and whether their claimed end-user information is suspicious, as well as whether the end use is reasonable and whether they are based in a sanctioned country.

Establishing a dynamically updating monitoring mechanism

The policies and regulations established in the US, the European Union and other countries or groups of countries with respect to export controls and economic sanctions against foreign countries are updated and amended from time to time, therefore enterprises should establish an independent and real-time monitoring mechanism to enable a timely response to such updates and in regard to the implementation of preventive measures. Specifically, the following steps  should be carried out:

• establish a dynamic tracking mechanism for global export controls and sanctions. Enterprises should pay close attention to the changes to external laws and society, obtain information in regard to all aspects in a timely manner, understand the laws and regulations and law enforcement policies in various countries on aspects such as material classifications and licence applications, as well as actively seek compliance opinions from legal departments or external lawyers and engage them in assessing the risk levels of core businesses in different jurisdictions, so as to enable the flexible adjustment of compliance measures;
• tracking the latest developments in terms of their customers and suppliers dynamically. Enterprises should continuously track whether customers and suppliers are subject to export controls and sanctions imposed by the US and other countries, whether they have a connection with countries and entities subject to sanctions or export controls and their activities and whether their claimed end use is credible; and
• follow the legislative trends in all countries, with a particular focus on understanding the latest laws and regulations and law enforcement policies in China, the US and the EU.

Enhancing contract drafting skills

Identifying unconventional clauses in contracts

Enterprises should pay attention to the existence of any unconventional clauses during contract negotiations. Special attention should be paid to whether the products or materials provided are replaced with controlled items or whether the composition and proportion of products are changed, whether the transportation means and routes are reasonable, whether the transportation constitutes an export and re-export and whether payers, payees and their relevant accounts are in a normal state and whether the capital flow is normal, etc.

Drafting protective contract clauses

NECESSARY CLAUSES CONCERNING INFORMATION COLLECTION

Enterprises should add necessary clauses concerning the subject matter in contracts when drafting procurement and sales contracts. A procurement contract should contain the origin of the materials, US component details and export control information, and a sales contract should contain information such as the end use and location of the use of the materials.

USUAL WARRANTY AND COMMITMENT CLAUSES

An enterprise should require its counterparties to make provide warranties in contracts entered into with foreign counterparties, especially those contracts involving countries and regions sensitive to export controls and economic sanctions. Warranties should provide that:

• neither itself nor any entities under its direct or indirect control are subject to any export controls and sanctions;
• its operations are fully in compliance with relevant laws and regulations concerning export controls and economic sanctions; and
• in addition, it is suggested that a corresponding commitment clause is added, which provides that in the event of a violation of the aforesaid statements and warranties, the violating party should inform the other party immediately and take all necessary measures to prevent losses.

AN EARLY TERMINATION CLAUSE

It is suggested that enterprises add clauses that allow them to terminate contracts early.

On the one hand, enterprises can consider putting as one of the conditions for terminating the contract the circumstance that the relevant enterprises are affected by changes in policies, such as export controls and/or economic sanctions.

On the other hand, prior agreement on alternative or withdrawal plans at a time when the contract is affected by changes to policies on sanctions and export controls can reduce any adverse impacts.

EXEMPTION CLAUSES AND DISPUTE RESOLUTION CLAUSES

An exemption clause generally provides that in the event that a party fails to continue to perform its obligations due to export control restrictions or sanction orders, parties to any contracts or transactions impacted by the same sanctions are not entitled to claim damages from the party.

If there is no such exemption clause in the contract, the other parties to the contract affected by the sanction may be entitled to claim damages based on the contract. Particularly, when the country of a counterparty affected by sanctions is also sanctioned and the counterparty brings a lawsuit in that country, it is likely that the courts in that country will not consider the impact of the sanctions and rule in favour of the counterparty.

In addition, it is suggested that full attention should be paid to a dispute resolution clause and governing law clause in foreign contracts. For example, against the background of sanctions imposed by the US on Russia, if Chinese enterprises agree to apply Russian laws and settle disputes in Russia with a Russian counterparty, and there is no agreed exemption clause, they are likely to receive unfavourable litigation results.[4]

CONFLICT OF LAWS CLAUSES

Since the Anti-Foreign Sanction Law and Measures for Blocking Improper Extraterritorial Application of Foreign Laws and Measures both require organisations and individuals not to implement or assist in the implementation of discriminatory restrictive measures taken by foreign countries against Chinese citizens and organisations, conflicts of laws will occur.

In view of this potential conflicts of laws, it is suggested that enterprises review their existing contracts or templates of contracts under those laws and modify them by establishing a certain contractual mechanism, which provides that if counterparties are sanctioned within the contract period, the party has the right to unilaterally terminate the contract.

Notes