Commerce Department Issues New Regulation for Exports to China

Exports to China Face Higher Scrutiny
Export Controls in the Spotlight at Justice Department


If your company exports items to China, has China-based operations, or engages in technology licensing, manufacturing, or distribution agreements with entities in China, the June 19, 2007 final rule published by the Commerce Department’s Bureau of Industry and Security (“BIS”) may significantly increase your company’s due diligence and compliance burdens. Most importantly, the regulation imposes new licensing requirements on exports, reexports, and transfers of designated goods and related technology if the exporter has knowledge that the items are destined for military end-use in China. In addition, the regulation expands requirements for mandatory support documentation for certain exports subject to license requirements for China. It also establishes a new Validated End-User authorization that would allow transfers of eligible items to approved entities in China without a license.

New License Requirements: Most notably, the BIS regulation imposes a new licensing requirement for commodities, software and technology controlled on the Commerce Control List under 31 specific Export Control Classification Numbers (“ECCNs”) that otherwise do not require a license for export to China. The designated ECCNs control items spanning a variety of industries, including: certain telecommunications and radio equipment; high performance computers (exceeding 0.5 weighted teraflops); program validation software; certain types of lasers and optical sensing fibers; certain oscilloscopes; certain bearings and machine tools; flash x-ray machines and components of pulsed power systems; certain underwater systems; certain avionics production and test equipment; commercial aircraft and aero gas turbine engines; and related software and technology.

The licensing requirement would be triggered if, at the time of export, the exporter has knowledge, or is informed, that the item is destined for a military end-use in China. The term “military end-use” is broad and covers, among other things, incorporation into, development, production, or use of items controlled on the U.S. Munitions List and certain other specified activities. The definition of “knowledge” set forth in the Export Administration Regulations, which includes both positive knowledge and circumstances approximating “reason to know,” would apply in this context.

Expanded End-User Statement Requirements: The final rule also includes an expanded requirement to obtain End-User Statements (“EUS”) from China’s Ministry of Commerce for exports of all commodities that require a license to China for any reason and are valued at over $50,000. An EUS identifies the end-user and end-use of the licensable item and must be submitted with a license application for export to China subject to this requirement. Although exports of software and technology are exempt from the EUS requirement, the regulation, which until now applied only to exports controlled for national security reasons, significantly expands this requirement for commodities. Companies should also ensure that their efforts to secure the required documentation do not run afoul of the restrictions under the Foreign Corrupt Practices Act.

Validated End-Users: The final rule establishes a new authorization for exports of eligible items to certain validated end-users (“VEUs”) in China without licenses. Entities could be certified as VEUs upon submission to BIS of an advisory-opinion request that includes, among other things, a list of the items to be exported to the candidate VEU, a description of intended end-uses, and overview of the entity’s ownership structure, business activities, and any relationship with either government or military organizations. To be approved as a VEU, the entity would have to agree to comply with the VEU recordkeeping requirements and, notably, permit on-site inspections by U.S. government officials.

While the BIS rule purports to reach a balance between facilitating U.S. exports to legitimate civil end-users in China and preventing transfers that would enhance military capability of China, the compliance burdens likely will be heavy for companies whose transactions are impacted by the new controls. Since many commercial enterprises in China have ties to the government, including the military, screening on a transaction-specific basis against the “military end-use” prohibition could be challenging and, at a minimum, resource-intensive. Nonetheless, in light of the strict liability standard for export controls violations and tough enforcement climate, companies must ensure that their internal controls are sufficiently robust to safeguard against violations. At the same time, U.S. exporters, foreign reexporters of U.S.-origin items, and their affiliates, customers or business partners in China should carefully assess whether the VEU status would benefit their transactions and business relationships, notwithstanding the onerous approval process and post-approval compliance responsibilities.

Justice Department Appoints National Export Control Coordinator

The Justice Department has recently created the post of National Export Control Coordinator within the Department’s National Security Division to improve the investigation and prosecution of unlawful exports of U.S. goods and technology. Steven W. Pelak, who had most recently served as an Assistant U.S. Attorney and Senior Litigation Counsel in the National Security Section of the U.S. Attorney’s Office for the District of Columbia, was appointed to the post. In his new post, Mr. Pelak will also be responsible for coordination between the Justice Department and multiple federal agencies tasked with the enforcement of U.S. export controls.

This development underscores the continued U.S. government focus on heightened enforcement and tougher penalties for export control violations. Because the U.S. government views export controls as vital tools to protect national security, the last several years witnessed a consistent increase in government resources focused on export enforcement. In the past, export enforcement actions typically settled administratively. In recent years, however, the government significantly stepped up criminal prosecution of export control violations, collecting millions of dollars in criminal fines and imposing prison terms. Increasingly, criminal prosecutions are targeting not only companies but also company executives for their roles in export control violations. In addition to this upward trend in enforcement, recent amendments to the International Emergency Economic Powers Act raised penalties from $11,000 to $50,000 per violation in administrative cases and from a maximum of 10 years to maximum of 20 years imprisonment in criminal cases. In short, expect more export enforcement, including criminal prosecutions, and tougher penalties in the near future.

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