International Law Advisory - New Export Control Rule for Exports to China Released by Commerce Department

On June 18, 2006, the Department of Commerce's Bureau of Industry and Security (BIS) released its final rule revising the export and reexport controls for the People's Republic of China (PRC).  BIS adopted the bulk of its proposed rule (see International Law Advisory, dated July 5, 2006), including a licensing policy of denial for certain items that would enhance China's military capabilities, a new "military end-use" rule for items in 31 different Export Control Classification Numbers (ECCNs), a Validated End-User authorization process, and end-user statement requirements.  BIS, however, did make a few changes in response to comments submitted by the public. The rule became effective on June 19, 2007, but items that are en route to a port of export that would become subject to license requirements under the new rules will retain their previous eligibility so long as they are exported before July 19, 2007.

Presumption of Denial for "Direct and Significant Contribution to the PRC's Military Capabilities"

The final rule adopted by BIS incorporates a presumption of denial for items controlled for reasons of national security, biological and chemical weapon proliferation, nuclear nonproliferation and missile technology, if those items would make a "direct and significant contribution to the PRC's military capabilities."  (15 C.F.R. s. 742.4(b)(7))  The "direct and significant contribution" standard is narrower than the "material contribution" standard that BIS originally proposed, and follows BIS's past approach to application reviews.  While BIS agreed with commenters on the standard that should be applied during its review, BIS has decided to apply this review standard to all PRC military capabilities, rather than a select list of activities.    

Control of Items Destined for "Military End-Use"

BIS also adopted its proposed rule to require a license for certain items identified in Supplement No. 2 to Part 744 when those items are exported to China and the exporter has knowledge that those items are destined for a "military end-use."  (15 C.F.R. s. 744.21)  The new rule will impose a greater licensing burden on some exporters because the list includes items that would not otherwise require a license under the Export Administration Regulations (EAR).  BIS clarified the definition of "military end-use" in response to comments to mean: "incorporation" into items on the U.S. Munitions List (USML), items on the International Munitions List (IML), items listed under ECCNs ending in "A018" on the Commerce Control List (CCL); or for the '"use", "development," or "production'" of items described on the USML, the IML, or items listed under ECCNs ending in "A018" on the CCL.  "Military end-use" also means "deployment" of items classified under ECCN 9A991 as set forth in Supplement No. 2 to Part 744.  (15 C.F.R. s. 744.21(f))  The new section also defines certain words used in this new section, such as "use" and "development."  BIS noted in response to comments that the knowledge standard adopted in this section is the same standard defined in Section 772.1.  (See 15 C.F.R. s. 744.21(a))  Under the final rule, applications to export "military end-use" items will be "reviewed on a case-by-case basis to determine whether the export, reexport, or transfer would make a material contribution to the military capabilities of the PRC and would result in advancing the country's military activities contrary to the national security interests of the United States."  (15 C.F.R. s. 744.21(e) (emphasis added))

As opposed to the original proposed rule, BIS reduced the list of items to which the "military end-use" control would apply.  In the proposed rule, BIS identified 47 ECCNs that would be subject to this new control regime.  However, in response to comments, BIS evaluated each of the 47 ECCNs to determine (1) the military applicability of the item; (2) the relative foreign availability of the item; and (3) the level of U.S. commercial exports of the item to the PRC.  Following its review, BIS reduced the list to 31 full and partial ECCNs covering approximately 20 product and technology categories.  For example, BIS removed items containing low-level encryption classified under ECCNs 5A992 and 5D992.

Validated End-User Authorization

The final rule incorporates a new Validated End-User (VEU) authorization, which allows U.S. exporters to transfer eligible items to approved end-users in eligible destinations without a license.  (15 C.F.R. s. 748.15)  Under the new program, either a Chinese company, a U.S. exporter, or a non-U.S. re-exporter on behalf of its Chinese customer may file an advisory opinion request, identifying the items that will be exported or transferred to the VEU candidate.  Supplement No. 8 to Part 748 describes the information that must be included in the advisory opinion request, including the following:

• An overview of the VEU candidate's structure and ownership and an overview of any business activity or corporate relationship with government or military organizations;
  
• A list of the items the VEU candidate will receive and their intended end-uses;
• The destination where the items will be reexported in the event the VEU candidate intends to reexport them;
• A description of the VEU candidate's record-keeping system and how it will ensure compliance with the VEU requirements; and 
• A statement signed by an authorized employee of the VEU candidate certifying that it (i) understands that use or diversion of the items it receives under VEU authority contrary to the EAR is prohibited; (ii) understands and will abide by all VEU end-use restrictions, including the requirement that items received under VEU authority will be used only for civil end uses; (iii) will comply with VEU recordkeeping requirements; and (iv) agrees to allow on-site compliance reviews by U.S. Government officials. 
  

Advisory opinion requests will be submitted to the newly created End-User Review Committee (ERC).  The ERC is made up of representatives from the Departments of State, Defense, Energy, and Commerce.  In evaluating applications, the ERC will consider a range of information, including the VEU candidate's record of exclusive civil end-use activities; its compliance with U.S. export controls; the need for an on-site review by U.S. Government officials prior to approval; the VEU candidate's ability to comply with the VEU requirements; its agreement to continuing on-site reviews; and its relationship with U.S. and foreign companies.  The ERC also will consider the export controls and adherence to multilateral export control regimes demonstrated by the VEU candidate's government.  The ERC will complete its review within 30 days after a complete application is circulated to the ERC agencies.

Authorized VEUs may not receive items controlled for missile technology or crime control reasons.   Items received pursuant to the authorization must be used only for civil end-uses and may not be used for uses described in Part 744 of the EAR (e.g. nuclear end-uses, chemical or biological weapons end-uses).  VEUs also must make their records related to the items received under the VEU authorization available to U.S. Government officials upon request.

Prior to an initial export of eligible items to a VEU, exporters/reexporters must obtain certifications from the VEU regarding end-use and compliance with the VEU requirements.  Exporters must submit annual reports to BIS identifying each VEU to whom the exporter transferred eligible items and the quantity and value of those items.

During the comment period, some commenters raised concerns that companies that did not receive VEU authorization would effectively be "black listed" because U.S. exporters would be unwilling to apply for a license to export to those companies.  BIS responded to this concern by adding language to Section 748.15 stating: "If a request for VEU authorization for a particular end-user is not granted, . . . such a result does not render the end-user ineligible for license approvals from BIS."

End-User Statements

In its proposed rule, BIS had intended to expand the end-user statement (EUS) requirement to all items destined for the PRC that require a license and exceed a total value of $5,000.  In order to minimize the impact of the expanded requirement on exporters, the PRC government, and itself, BIS increased the threshold to a total value of $50,000 for most items requiring a license.  (15 C.F.R. s. 748.10)  BIS did not apply the new increased threshold to items classified under ECCN 6A003 or subject to Section 748.10(b)(3) of the EAR, which requires EUSs for any computers that require a license to be exported to the PRC regardless of dollar value.

Conclusion

The new China export control rule presents a number of challenges and opportunities for U.S. exporters and non-U.S. reexporters.  First, for a host of items controlled for nuclear proliferation, national security, missile technology or chemical and biological weapons reasons, the new rule may signal a more penetrating and extensive review of end-users and end-uses when these items are the subject of export license applications for the PRC.  Exporters may need to anticipate somewhat longer licensing times, greater scrutiny, and an increase in license denials or conditions on approvals.  Second, the new "military end-use" rule will likely take some time to understand in its operation and effect.  While the knowledge standard has not changed, exporters and reexporters may need to expend more time and effort in their due diligence to confirm no actual military end-use for the items now subject to this rule.  At the same time, an exporter or reexporter that has adopted a robust set of due diligence and "KYC/KYE" procedures, and follows BIS's red flag guidance, should be able to rely on those procedures to discharge its responsibilities under this new rule. 

As for the VEU program, exporters, reexporters and Chinese end-users should where possible take advantage of the new opportunity to eliminate licensing requirements by adopting U.S.-compliant export control procedures.  While the VEU candidate must agree to U.S. Government audits and exporters/reexporters must file annual reports with BIS, if appropriate procedures are put into place and adequately staffed, these requirements can be managed.  Note two important limitations to the VEU program.  First, items controlled for missile technology or crime control reasons cannot receive license-free treatment under the VEU program.  Second, a Chinese entity that has considerable business or connections to Chinese military projects or end-users may find it difficult to qualify for the program,   even if it has significant and bona fide civilian end-uses.

If you have inquiries on the new rule or any questions about the operation of the new VEU program or military end-use licensing requirements, please contact Ed Krauland at (202)429-8083, or Petra Vorwig at (202)429-6417.