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Yong Zhou
JunHe, Beijing
zhouyong@junhe.com

 

At the beginning of 2021, the Ministry of Commerce (MOFCOM) issued the Rules on Counteracting Unjustified Extraterritorial Application of Foreign Legislation and Other Measures (PRC Blocking Rules). It immediately caused concern from all sides as soon as it was promulgated. This long-awaited China ‘Blocking Statute’ will have major effects on the compliance of Chinese companies and the subsidiaries of foreign companies in China, which are restricted by certain foreign sanction laws from engaging in economic and trade activities in third countries or with partners from third countries.

Many foreign countries and regions have already implemented similar measures. Taking the European Union as an example, Regulation No 2271/96 (the EU Blocking Statute)^[1] was enacted as early as 1996 to counter US unilateral sanctions. In 2018, the EU amended its Blocking Statute,^[2] immediately after former US President Trump declared US withdrawal from the Iran nuclear deal and decided to re-impose sanctions against Iran.

This article will focus on the interpretation of the institutional arrangements of the PRC Blocking Rules and provide a brief comparison with the EU Blocking Statute.

Key interpretation and comparison of the PRC Blocking Rules

The PRC Blocking Rules (MOFCOM Order No 1, 2021) was promulgated on 9 January with immediate effect. The PRC Blocking Rules consist of 16 articles and is concise. The interpretation of relevant articles and their comparison with relevant provisions in the EU Blocking Statute are explained below.

Legal authorisation

Article 1 of the PRC Blocking Rules states, ‘These Rules are formulated in accordance with the National Security Law of the People’s Republic of China and other relevant laws […]’, which does not specify the legal provisions from which the legislative authorisation originates. Taking the National Security Law as an example, most of which is laid out in very general articles, it is speculated that the following provisions may be relevant:

‘The State preserves and develops the fundamental interests of the overwhelming majority of the people, safeguards the security of the people, creates good conditions for survival and development and a stable working and living environment, and protects the life and property safety and other legitimate rights and interests of citizens.’ (Article 16)

‘The State Council shall, in accordance with the Constitution and laws, formulate administrative regulations on National Security, provide relevant administrative measures, and issue relevant decisions and orders [...]’ (Article 37)

‘Citizens and organisations shall perform the following obligations of safeguarding National Security: […] timely report clues of activities that endanger National Security; truthfully provide evidence of known activities that endanger National Security [...]’ (Article 77).

The PRC Blocking Rules were released by MOFCOM, although approved by the State Council, and shall be classified as departmental regulations. Whereas, the EU Blocking Statute is a law on the highest level (ie, a ‘Regulation’) in the EU with general applicability, which shall enter into force as a domestic law in all Member States immediately after its entry into force, requiring no other measures from the Member States’ domestic legislatures. Its legal authority is similar to ‘law’ in China, which holds more authority than administrative regulations and much more authority than departmental regulations. The PRC Blocking Rules occupies a comparatively low position in China’s legislative hierarchy. But its current position reflects a common legislative practice, coping with sensitive or complicated situations, that is, a rule being enacted in the form of departmental regulation first to test the waters, and then being enhanced into an administrative regulation when necessary or proper under later circumstances.

Scope of application

Article 2 of the PRC Blocking Rules defines the scope of application, that is, foreign legislation and other measures, in violation of international law and the basic principles of international relations, unjustifiably prohibit or restrict the citizens, legal persons or other organisations of China from engaging in normal economic and trade activities with a third state (or region) or its citizens, legal persons or other organisations, which is also known as the ‘secondary sanction’ under the US law. To be specific, a ‘primary sanction’ is to cut off the economic transactions of US enterprises and individuals with the sanctioned countries, which applies to US enterprises and individuals only, while the application scope of secondary sanction extends to enterprises and individuals in any third country. In a recent press conference, the person in charge of Department of Treaty and Law of MOFCOM stated that the enactment of PRC Blocking Rules drew on similar foreign legislative experience, while an expert stated that the scope of application was secondary sanctions. However, the text of this article seems not rule out the possibility that primary sanctions are also covered. The scope of application of the PRC Blocking Rules deserves further examination and discussion.

Significance of ‘violation of international law and the basic principles of international relations’ as criteria for defining application scope

It is our view that the PRC Blocking Rules mainly apply to circumstances under secondary sanctions, that is, the circumstances under which Chinese enterprises are banned or restricted from entering into transactions with enterprises of a third country. However, the extraterritorial application of foreign legislation and measures may occur in complicated situations and under multifaceted scenarios. As a criteria for application, the phase ‘violation of international law and the basic principles of international relations’ is principal and maintains room of flexibility, while results in ambiguity to certain extent.

The PRC Blocking Rules do not directly specify the objects to be blocked, instead, they establish a working mechanism for comprehensive assessment on ‘violation of international law and the basic principles of international relations’, and their application shall be determined based on the conclusion of such assessment. This method grants certain discretion to the authority in charge, and thus facilitates a wide coverage of the extraterritorial application of any foreign legislation and measures affecting domestic interests. It may save the PRC Blocking Rules from being frequently amended due to changes in international situations. According to Article 6 of the PRC Blocking Rules, when assessing and determining whether unjustified extraterritorial application of foreign legislation and other measures exists, ‘whether international law or the basic principles of international relations are violated’ is one of the key factors to be considered. As a general rule, compliance with their own national laws by a natural or legal person should not be deemed as ‘unjustified’.

In contrast, the EU Blocking Statute directly attaches the legislation and measures to be blocked as annexes and defined the scope of application in clear words. Adjustments of the scope of application would be done later through updating the annexes.

Whether non-Chinese enterprises are subject to the prohibition orders under the PRC Blocking Rules?

The author tends to give a negative answer to the question based on a reasonable interpretation of the captioned rules. ‘A prohibition order to the effect that, the relevant foreign legislation and other measures shall not be accepted, executed, or observed’ set out in Article 7, shall only govern Chinese citizens or legal persons; if foreign enterprises are also subject to the prohibition order, it would grant the PRC Blocking Rules itself the extraterritorial jurisdiction. In the author’s view, such self-granted extraterritorial jurisdiction should not be the intention of the legislators of the PRC Blocking Rules. In addition, articles 8 and 9 implicitly indicate that only Chinese citizens or legal persons are subject to the prohibition order, and that ‘a person’ refers only to Chinese citizens or legal persons:

‘A Chinese citizen, legal person or other organisation may apply to the authority for exemption from compliance with a prohibition order.’ (Article 8), and ‘[…] except where a person is granted exemption in accordance with Article 8 of these Rules.’ (Article 9).

It should be noted that foreign investment enterprises incorporated and registered in China are deemed as Chinese legal persons under the PRC laws and, therefore, will be subject to the PRC Blocking Rules.

Article 11 of the EU Blocking Statute specifically states that it applies to the EU residents and nationals of Member States, including the EU subsidiaries of US companies while excluding the Subsidiaries of EU companies in the US and branches of US companies in the EU.^[3]

Procedures

The procedures for applying the PRC Blocking Rules are shown as follows:

First, a Chinese citizen or legal person, who is banned or restricted by foreign legislation or other measures from engaging in normal economic, trade and related activities with a third country (or region) and its citizens or legal persons, shall report to the authority in charge within 30 days. It is our view that the requirement to report is unclear in certain aspects. For example, the number of Chinese companies, whose business had potentially been restricted by the US sanction law of Iran (which is publicly known), could number thousands. Do they all have the obligation of reporting to the authority within 30 days? It seems impractical and unnecessary.

Then, if the authority, on assessment, confirms that the existence of unjustified extraterritorial application of foreign legislation and other measures, it may issue a banning order to the effect that, the relevant foreign legislation and other measures shall not be accepted, implemented, or observed.

In addition to ‘whether there is any violation of international law or basic principles of international relations’ as mentioned above, the criteria to be considered in the assessment include ‘potential impact on China’s sovereignty, security and development interests’ and ‘potential impact on the legitimate rights and interests of Chinese citizens, legal persons or other organisations’.

Subsequently, if a Chinese citizen or legal person deems it necessary to abide by the relevant foreign legislation or measures (that is, there is special difficulty in abiding by the Chinese prohibition order), they may apply to the authority for exemption.

The procedural rules of the EU Blocking Statute are similar in providing the requirement to inform and the right to apply for exemption, while they also contain a significant discrepancy from the procedural rules of PRC Blocking Rules in the way that the former lack of assessment procedure to determine whether a target extraterritorial application of foreign legislation and other measures is unjustified or not. Since the EU Blocking Statute aims at named and specific foreign legislation, there is no need to go through such assessment procedure prior to its application.

Remedial measures

Judicial remedy

According to Article 9 of the PRC Blocking Rules, if a Chinese citizen or legal person (the ‘violator’) breaks the prohibition order and causes losses to other Chinese citizens or legal persons (the ‘claimant’), they may seek judicial remedy from the People’s Court and require the violator to compensate for losses, of course, unless the violator has obtained exemption from the prohibition order.

Does this judicial remedy clause create any new civil rights? In our opinion, it does not. First of all, a departmental regulation cannot grant any civil rights that do not already exist. Second, even before the enactment of the PRC Blocking Rules, the claimant was entitled to sue the violator who refuses to transact on the grounds of ‘breach of contract’ or ‘refusal to transact without justification’. Although foreign enterprises are not subject to the prohibition order, they may also be sued on the above-mentioned traditional civil law grounds if any Chinese citizen or legal person suffers losses due to their refusal to perform contracts on the pretext of their compliance with foreign sanctions laws.

Does the observance of foreign legislation by the violator fall within the scope of ‘justification’ or force majeure? This question reveals the importance of the judicial remedy clause of the PRC Blocking Rules, as the authority in charge shall have asserted the illegality of the refuse-to-transact act (and thereby issued a prohibition order) according to the criteria ‘whether international law or basic principles of international relations are violated’; and if such assertion requires court judgments at any levels, there would most likely be chaos. It can be said that the PRC Blocking Rules do not create any new civil rights, but it could promote the judicial remedy of existing civil rights in practice.

Similarly, Article 6 of the EU Blocking Statute also grants EU citizens or legal persons a private right of action, allowing them to sue for damages against the party who infringes their rights and interests and causes losses. It should also be noted that Article 9 (paragraph 2) of the PRC Blocking Rules ‘where a judgment or ruling made in accordance with the foreign legislation within the scope of the prohibition order causes losses to a citizen, legal person or other organisation of China, the latter may, in accordance with law, institute legal proceedings in a people’s court, and claim for compensation by the person who benefits from the said judgment or ruling’ has the potential of applying to more scenarios than claw-back under the EU Blocking Statute.

Other remedies

In addition to the judicial remedy, the PRC Blocking Rules also stipulates that where, in adherence to the prohibition order, any Chinese citizen, legal person or other organisation suffers significant losses resulting from non-compliance with the relevant foreign legislation or other measures, relevant government departments may provide necessary support on a case-by-case basis. However, this clause does not specify any supporting measures.

Summary

The PRC Blocking Rules are an important step in a series of countermeasures launched by the Chinese government in response to foreign sanctions, which includes three essential measures found in the current Blocking legislation of other major countries (prohibition of compliance, prohibition of recognition and claw-back). The Rules of Unreliable Entity List previously issued by MOFCOM in September 2020 targeted foreign entities (Article 2 of which stipulate that ‘foreign entities’ in these Regulations include foreign enterprises, other organisations or individuals), whereas the PRC Blocking Rules apply to Chinese citizens or legal persons. On how to counteract foreign sanctions, these two Rules may overlap. For example, a foreign entity interrupting transactions with a Chinese enterprise as a result of its compliance with an extraterritorial law may trigger the application of the unreliable entity list, while a Chinese enterprise may be subject to the prohibiting order under the PRC Blocking Rules because it complies with the same extraterritorial law.

Implications of the PRC Blocking Rules and our compliance suggestions

The promulgation and implementation of the PRC Blocking Rules will have far-reaching effects on both Chinese and foreign individuals, enterprises, and organisations involved in implementation of foreign sanctions against China. Should enterprises be more concerned about whether the introduction of the PRC Blocking Rules will present a compliance dilemma? The answer to this question is both yes and no. On one hand, the purpose of the PRC Blocking Rules is to state China’s position against the unjustified extraterritorial application of foreign legislation and measures, which will inevitably put the relevant enterprises between a rock and a hard place (facing sanctions imposed by the US v punishment imposed by China’s prohibition orders); but on the other, if the relevant enterprises believe that there may be special difficulties in complying with the prohibition orders (eg, the companies will suffer significant business losses), they may apply for exemption. We believe that the authority will, based on the actual circumstances, approve necessary exemption applications. Further elaboration will be made under the following circumstances:

Chinese citizens, legal persons or other organisations that are unjustifiably prohibited or restricted by foreign sanctions

The PRC Blocking Rules assert the illegality of the extraterritorial effect of foreign sanctions listed in the prohibition orders in China, which may, to some extent, alleviate the dilemma of foreign sanctions suffered by Chinese enterprises or individuals that are unjustifiably prohibited or restricted.

The PRC Blocking Rules also stipulate that Chinese citizens, legal persons or other organisations that suffer great losses as a result of their failure to abide by the relevant foreign legislation and measures may seek necessary support from relevant government departments. We understand that financial support may be one of the supports, but the Rules do not make any specification. We suggest that the authority may specify the form and strength of the supports with detailed rules to be promulgated later so that the enterprises can have reasonable expectations when making business decisions.

In addition, the judicial remedy clauses of the PRC Blocking Rules also set out the self-relief methods for Chinese enterprises or individuals whose rights are infringed: where the ‘person’ complies with the foreign legislation and measures within the scope of the prohibition orders, which lead to infringement of their legitimate rights and interests, Chinese citizens, legal persons or other organisations may file lawsuits with the people’s courts in accordance with relevant laws, requiring the ‘person’ to compensate for their losses.

Enterprises and individuals simultaneously subject to legal requirements imposed by foreign sanctions and bound by prohibition orders under the PRC Blocking Rules

For enterprises and individuals that are simultaneously subject to legal requirements imposed by foreign sanctions and bound by prohibition orders under the PRC Blocking Rules, such a dilemma may lead to huge compliance challenges. Taking the US for example, in addition to the US enterprises and individuals that need to comply with US sanctions provisions, the effectiveness of the US sanctions measures usually extend to the Chinese subsidiaries controlled by US enterprises and individuals. If the Chinese subsidiaries controlled by US enterprises and individuals fail to obtain the exemption from the prohibition order, it will fall into a rather tricky compliance situation.

We suggest that foreign enterprises and their Chinese subsidiaries, which have important commercial interests in China and whose products and services have been or are likely to be included in foreign government list of prohibited transactions with certain Chinese enterprises, shall take the initiative to assess the risks and prepare a plan based on the results of the risk assessment:

• assess the possibility that foreign governments may increase, strengthen, relax or remove the relevant sanctions;

• assess the possibility of obtaining the exemption from sanctions imposed by the foreign government;

• assess the possibility of including the relevant sanction measures in the prohibition order under the PRC Blocking Rules;

• assess the possibility of obtaining the prohibition order exemption from the Chinese government; and

• determine the measures which need to be taken to control risk exposures if they cannot be exempted from sanctions imposed by the foreign governments as well as the prohibition orders imposed by the Chinese government.

Among the risk-controlling measures, we suggest paying extra attention to the following:

(1) For business involving foreign sanctions and Chinese prohibition orders, it may be necessary to establish a risk firewall between the foreign parent company and its Chinese subsidiaries or between the Chinese parent company and its foreign subsidiaries.

A multinational company usually maintains a considerable degree of control over the operations of its foreign subsidiaries. For the business potentially aimed by both foreign sanctions and Chinese prohibition orders, such a control by the parent company may simultaneously expose both the parent company and the subsidiary company to significant compliance risks. Taking into full consideration the specific provisions of foreign sanctions and Chinese prohibition orders, as well as the nature of the enterprise’s business, it may worth exploring the possibility of segregating the parent company from its subsidiaries in terms of decision-making in relevant business, for the purpose of building a risk firewall so as to reduce the compliance risks of the parent company and its subsidiaries to a certain extent.

(2) If the risk firewall is unable or insufficient to control risks, it may be necessary to consider an alternative coping mechanism at a higher level.

For particularly sensitive products and services, or some particularly sensitive enterprises and individuals, the risk firewall is likely to be insufficient to control their compliance risks. In that case, an alternative coping mechanism may have to be considered at a higher level. For example, the business model may need to be adjusted, whereby some businesses that were originally undertaken by a Chinese subsidiary or a foreign subsidiary may be undertaken by a company in a third country.

(3) Carefully consider the sanction clauses in the contract.

Many economic contracts currently have incorporated ‘sanctions clauses’ on the request of the foreign party, that is, the compliance clause requiring a Chinese party to comply with the sanction laws of other countries (such as the US). We believe that once a foreign sanction is subject to the prohibition order under the PRC Blocking Rules, the said compliance clause may be held illegal and invalid in China. Furthermore, and the compliance clause itself may be used as evidence of violating the prohibition orders under the PRC Blocking Rules, thus the Chinese party could be exposed to the punishment imposed by the Chinese government and/or the litigation claims from other Chinese companies and individuals. We suggest that the enterprises concerned should carefully consider the wording of ‘compliance’ clauses in their contracts (eg, excluding the application of measures covered by prohibition orders of PRC Blocking Rules) and actively take measures to avoid or mitigate relevant risks (eg, applying for an exemption from the authority).

Observations

Extraterritorial jurisdiction is an extended application of a country’s laws or an extended judicial and administrative jurisdiction beyond its borders. Extraterritorial jurisdiction related provisions can be found more or less in the legislative documents of many countries, and some court judgments may give effect to extraterritorial jurisdiction. However, the US is unique in the world in expanding its legal jurisdiction, which is, of course, based on its economic and financial hegemony in the world following the Second World War. The issue of US extraterritorial jurisdiction, represented by unilateral sanctions, has been a controversial topic for a long time in the field of international law. In practice, it often arouses strong reaction from other countries and even affects international relations. The PRC Blocking Rules came out in the context of such environment and due to the changes in Sino-US economic, trade and political relations, which we believe may bring new challenges to the operation and investment of Chinese enterprises and foreign investment enterprises in China.

 

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