22 March 2021
On November 12, 2020, the then President Trump issued Executive Order No. 13959 (" Executive Order "). The executive order is the basis of the sanctions plan for Chinese military-related enterprises implemented by the Office of Overseas Assets Control (" OFAC ") of the U.S. Department of the Treasury . After a certain period of time, the sanctions plan will ban Americans. Purchase or hold publicly traded securities or derivatives of such securities of Chinese military-related enterprises. As we reported in the previous legal newsletter , OFAC issued a guidance on December 28, 2020, stating that it will adopt a broad interpretation of Administrative Order No. 13959. We have also reported here that on January 13, 2021, the then President Trump issued Executive Order No. 13974 in the last few days of his term, supplementing Executive Order No. 13959, requiring Americans to The company sold all its securities within 365 days after it was designated as a military-related enterprise. On January 14, 2021, the US Department of Defense designated Xiaomi and eight other Chinese companies as military-related enterprises in accordance with Executive Order 13959. Given that the ban on investment in military-related companies took effect 60 days after military-related companies were designated, the investment ban on Xiaomi was originally scheduled to take effect on March 15, 2021. But Xiaomi and three shareholders who collectively own three-quarters of the company’s voting rights filed a lawsuit, seeking an emergency injunction in the Federal District Court of Washington, DC. The plaintiff claimed that Xiaomi was wrongly designated as a military-related enterprise.
2. The decision of the U.S. District Court to approve the injunction
On March 12, 2021, the Federal District Court approved Xiaomi's application for a temporary injunction order and issued a 26-page and powerfully worded opinion statement explaining its decision.
The court focused on whether Xiaomi could successfully challenge the decision of the U.S. Department of Defense to designate it as a military-related enterprise, and determined that Xiaomi has the right to obtain a temporary injunction order based on three reasons:
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First, the court held that the Ministry of National Defense’s interpretation of the designation of Xiaomi as a military-related enterprise was insufficient. The court pointed out that when the Ministry of National Defense added Xiaomi and eight other companies to the list of military-related companies on January 14, 2021, the Ministry of National Defense did not provide any explanation for this move. During the proceedings, the Ministry of Defense provided a two-page internal document. The document concluded that “Xiaomi meets the standards [ designated as a military-related enterprise ] ” because (1) Xiaomi’s CEO was once rated as an “outstanding builder of socialism with Chinese characteristics” by the Ministry of Industry and Information Technology of China. The Ministry of Industry and Information Technology of China is considered to be an organization that "helps China manage dual-use", and (2) Xiaomi ’s five-year plan to invest in 5G telecommunications capabilities and artificial intelligence (" AI ") involves "modern military Technology necessary for action". However, the court held that this document of the Ministry of National Defense did not contain any reasoning to prove that there is a reasonable connection between the two facts and the conclusion that “Xiaomi meets the standards [ designated as military-related enterprises ] ”.
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Second, the court held that Xiaomi did not meet the standards of being designated as a military-related enterprise in the National Defense Authorization Law of the 1999 Fiscal Year (" National Defense Authorization Law "). Section 1237 ( "National Defense Authorization Act of 1237 article ") provisions related to military enterprises include any individual who meets the following criteria:
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"(1) Owned or controlled by [Chinese People’s Liberation Army] or a certain department of the [Chinese] government, or affiliated to [Chinese People’s Liberation Army] or a certain department of the [Chinese] government, or owned by an entity affiliated with [China] National Defense Industrial Base Or control; and (2) engage in commercial services, manufacturing, production or export".
(See National Defense Authorization Act, Article 1237(b)(4)(B).) The US Department of Defense has no objection that Xiaomi is not "owned or controlled" by any banned Chinese entity, but argues that Xiaomi is "affiliated with the Chinese military And defense agencies". The relevant evidence presented by the Ministry of Defense did not convince the court. The court held that Xiaomi is "a listed company that produces civilian commercial products, controlled by its independent board of directors and controlling shareholders, and is not actually controlled by or related to other persons owned or controlled by the Chinese government or its armed forces."
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Third, the court held that the US Department of Defense designated Xiaomi as a military-related enterprise lacking "substantial evidence." The court reasoned that although the 5G and artificial intelligence technology invested by Xiaomi may be used for military purposes in addition to consumer electronics products, this fact is not sufficient to support the conclusion that Xiaomi is a military-related enterprise. Another basis of the US Department of Defense is that Xiaomi stated in its 2019 annual report that its founder and CEO had been awarded the title of "Excellent Builder of Socialism with Chinese Characteristics" by the Chinese government, but this did not convince the court. The court accepted Xiaomi’s evidence that the award was awarded to private entrepreneurs in recognition of their contribution to China’s economic development. Since 2004, more than 500 entrepreneurs have won the award. The Ministry’s link is “untenable” because the winners are not directly selected by the Ministry.
The court further pointed out that it is appropriate to approve the injunction, because if Xiaomi is not removed from the list of military-related enterprises, Xiaomi is likely to suffer irreparable reputation damage and serious and irreparable economic losses.
In addition, the court also pointed out that the U.S. Department of Defense “cannot determine any technology transferred from Xiaomi to the Chinese government” and questioned the importance of the military-related enterprise designation procedure for safeguarding the national security of the United States, because the procedure “has been consistently used for nearly two decades. It was not used until the Trump administration was activated to designate a large number of military-related enterprises in the last few days."
On March 14, 2021, OFAC issued new guidance before the sanctions will take effect , stating that in view of related lawsuits, the injunction in Executive Order No. 13959 “will not apply to Xiaomi until the court makes further instructions”.
3. Conclusion
The most direct effect of the temporary injunction is that before the court finalizes the identity of Xiaomi’s military-related enterprises, US investors and market participants who buy and sell Xiaomi securities can maintain the status quo and continue to buy and hold Xiaomi securities.
More broadly, we predict that this decision will lead to more lawsuits against regulatory actions involving sanctions and export controls during Trump's administration. Historically, most of the challenges to sanctions and related measures have been unsuccessful, because US laws and regulations have given the government great respect on issues related to national security. According to Article 889 of the National Defense Authorization Act of 2019, government departments and companies in the US government supply chain are prohibited from using equipment produced by Huawei (and other designated companies). Huawei recently defended against the sanctions, but was unsuccessful. However, before Xiaomi’s injunction was approved, other court injunctions recently stopped the Trump administration’s attempts to prevent Chinese technology companies from entering the US market. In September, October, and December 2020, the federal courts in California, Pennsylvania, and Washington, D.C., respectively banned portions of President Trump's Executive Order No. 13942 and No. 13943 . These administrative orders try to prohibit Americans from using Douyin and WeChat because they fear that the Chinese government will obtain sensitive data on American users. In the Douyin and WeChat cases, the court issued an injunction on the grounds that these trade restrictions exceeded the president's legal authority.
Although we anticipate more similar lawsuits, we do not believe that the injunction obtained by Xiaomi indicates that other companies designated as military-related enterprises, or more generally other entities sanctioned by the US government, can successfully obtain relevant Injunction. As mentioned above, the reason why the court is willing to approve the temporary injunction applied by Xiaomi is based on the specific circumstances of Xiaomi and the specific facts in the process of the US Department of Defense designating Xiaomi as a military-related enterprise. For other designated military-related enterprises, judicial procedures may have different results, depending on the reasons for the Ministry of National Defense designating these companies as military-related enterprises and/or the nature of the relationship between these companies and the Chinese government. We also expect that, given the relatively sound procedures for the sanctions list designated by the U.S. Department of the Treasury, any company that has been listed by OFAC on its "non-specified national CCP military-related companies list" in addition to military-related companies may be included in the U.S. government file. Find additional evidence to support it.
But the reality is that more companies will be encouraged by this decision. In fact, Luokung Technologies filed a lawsuit in the Federal District Court of Washington, DC earlier this month, challenging its designation as a military-related enterprise, and subsequently applied for an emergency injunction. We expect that the outcome of these lawsuits will cause the Biden administration to issue more guiding explanations on relevant sanctions and export controls.
For further information, please contact:
B. Chen Zhu, Partner, Deacons
chenzhu@mofo.com
