United States Proposes Major Changes in Export Controls for China

July 19, 2006

The U.S. Department of Commerce recently proposed changes in export rules for the People’s Republic of China (the “PRC”). The proposed changes will purportedly loosen controls on many exports intended for civil end-use while tightening restrictions on exports that may contribute to the PRC’s military capabilities. The proposed changes include a revision to the review policy for all items destined for the PRC under a license and stricter controls for 47 ECCNs on the Commerce Control List (“CCL”) where there is knowledge of military end-use. The proposed changes also create additional end-use certification requirements. 

Because the proposed changes could give rise to uncertainties and additional burdens on exporters, exporters should closely monitor its development and be prepared to adapt to these changes should they ultimately be implemented. The proposed rules will be open to public comment until November 3, 2006.

Primary Elements of Proposed Rule

The proposed rule change would effect the following changes:

  • All license applications for the PRC, regardless of ECCN, would be 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.”

  • New restrictions would be put in place for 47 specified ECCNs where there is “knowledge” of a “military end-use” on exports to the PRC. 

  • Controls on exports to the PRC would be subject to additional restrictions based on notification from the Department of Commerce Bureau of Industry and Security (“BIS”) of actual or potential military end-use, with respect to a particular end-user. 

  • There would be additional reviews by BIS of license applications for items controlled for chemical, biological, nuclear and missile technology proliferation reasons to determine if the end-user may be involved in proliferation activities.

  • A new process would be instituted to identify and qualify “validated end-users” (“VEUs”) in certain destinations, including the PRC, to whom certain specified items could be exported or reexported. VEUs would have to meet a number of criteria, including a demonstrated record of engaging only in civil end-use activities and not contributing to the proliferation of weapons of mass destruction or otherwise engaging in activity contrary to U.S. national security or foreign policy interests.

  • Exporters would be required to obtain an End-User Certificate from the PRC Ministry of Commerce (“MOC”) for items requiring an export license (for any reason), which are valued over $5,000. 

  • Although the current requirement that exporters submit end-user certificates to BIS with their license applications would be withdrawn for the PRC, exporters would still be required to include the serial number of the PRC End-User Certificate in the license application, and retain the PRC End-User Certificate in accordance with the recordkeeping provisions of the EAR. 

Proposed Rules Could Raise Significant Concerns for Exporters

Several concerns are raised by the proposed rule changes. For example, the “knowledge” standard applicable to military end-use creates uncertainty regarding the extent of an exporter’s due diligence responsibilities. The proposed standard is that in Section 772.1 of the EAR, which defines knowledge as “positive knowledge that the circumstance exists or is substantially certain to occur,” and also “an awareness of a high probability of its existence or future occurrence. Such awareness is inferred from evidence of the conscious disregard of facts known to a person and is also inferred from a person’s willful avoidance of facts.” This standard has proven problematic in other contexts and can be expected to have a larger impact in respect to the proposed rule because of the volume of trade with the PRC. 

Further contributing to the difficulty in conducting due diligence for exports to the PRC is that the rule proposes to broadly define “military end-use” as “incorporation into, or use for the production, design, development, maintenance, operation, installation, or deployment, repair, overhaul, or refurbishing of items” (1) described on the U.S. Munitions List (“USML”); (2) described on the Munitions List as set out on the Wassenaar Arrangement Web site at http://www.wassenaar.org; or (3) listed under ECCNs ending in “A018’’ on the CCL in Supplement No. 1 to Part 774 of the EAR. If read broadly, this could, for example, affect sales of components that are used in the production of items that are intended for sale to military and commercial customers even though such items have no real military value or function. 

Another cause for concern for exporters is the proposed new control based on BIS notification that an item is or may be intended for military end-use in the PRC. Commerce has not specified how much notice it would give before such notices become effective and so exporters may find themselves required to act quickly to halt exports on short notice. 

Additionally, the proposed requirement for a PRC MOC End-User Certificate may prove burdensome for exporters and problematic in practice. The MOC may not be able to reliably provide certificates in a timely fashion or may be unwilling to do so for political or other reasons. Therefore, securing a certificate could require significant efforts and associated costs and there is a risk that such certificates will not be provided in spite of those efforts. 

With regard to Commerce’s selection of VEUs, the process set forth in the proposed changes may prove too cumbersome and intrusive. Further, because the rule does not specify the potential effect of a denial of a VEU request, the VEU program may have only uncertain benefits for exporters. It would, in any event, frequently require a more careful and costly assessment of licensing needs.

As these proposed rules could have wide-ranging impact on timing and the approval process, exporters with business in the PRC should pay close attention to their development. Exporters should consider participating in the development of these rules, and actively prepare for their possible implementation. In this regard, the Commerce Department hosted a public hearing to answer questions on the proposed rules on July 17, 2006. The Commerce Department acknowledged that important parts of the proposed rule (e.g., the interpretation of the “knowledge” standard and the development of the VEU process) require further consideration and will require further clarification before it is implemented. Commerce anticipates and welcomes comments on the proposed rule.  

Gibson, Dunn & Crutcher’s International Trade Regulation and Compliance Practice Group is monitoring the development of new export control rules for China and is prepared to address any questions regarding these rules or regarding export controls for other countries.  For further information, please contact Judith A. Lee (202-887-3591), Jim Slear (202-955-8578) or Dave Wharwood (202-887-3579) in the firm’s Washington, D.C. office.

© 2006 Gibson, Dunn & Crutcher LLP

The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.