China recently enacted Rules on Counteracting Unjustified Extra-territorial Application of Foreign Legislation and Other Measures. These "Blocking Rules" are designed to block the extraterritorial application of foreign laws and measures that may endanger the fundamental national security and economic interests of China and of Chinese entities. For example, they may prohibit Chinese entities, including Chinese subsidiaries of foreign companies, from complying with US export controls and US secondary sanctions. While meant to protect against foreign legislation restricting Chinese business, the Blocking Rules may mean more conflicting requirements for Chinese companies and foreign companies operating in China. We recommend that multinational companies doing business in and with China closely monitor legislative and enforcement updates, assess the risks they may face, and take mitigation measures where necessary.

Background

The tensions between the US and China have escalated in the past few years, with China increasingly becoming the target of US export control and sanctions measures. These measures restrict US and (as a result of their extra-territorial applicability) non-US parties from engaging in certain business with China. Some US export control and sanctions measures also restrict China itself from engaging in certain business with targeted countries and parties. An example is the US secondary sanctions against Iran which, together with relevant US export controls, have been aggressively enforced against Chinese companies, such as ZTE (see our March 2017 and May 2017 articles).

China views these measures as encroaching on its sovereignty and as an attempt to stifle its development. In response, it has taken various counteractions, including launching an Unreliable Entity List (see our November 2020 article) and certain provisions in its revamped Export Control Law (see our January 2021) article. The Blocking Rules further add to these countermeasures.

In brief, the Blocking Rules seek to block the extra-territorial application of third-country legislation or measures that adversely affect China, if there is no justification for extra-territorial legislation to apply. An official English translation of the Blocking Rules is available here.

Scope of application

The Blocking Rules apply to situations where the extra-territorial application of foreign legislation and measures unjustifiably prohibits or restricts Chinese parties from engaging in normal economic, trade and related activities with parties of a third country or region. The Blocking Rules do not provide a list of specific foreign laws subject to blocking. Rather, they allow the competent authorities to determine which extra-territorially applicable foreign legislation qualifies as unjustified and are therefore subject to being blocked.

The Blocking Rules only provide that they do not apply to the extra-territorial application of foreign legislation and other measures as provided for in treaties or international agreements to which China is a party. The rules also do not apply to parties of the country that enacts such legislation and measures. For example, a US company established and acting outside China is not bound by the Blocking Rules where a US authority restricts the party from engaging in business with a targeted Chinese party (even though it may still be targeted under the Unreliable Entity List).

When determining if there is an unjustified extra-territorial application of foreign legislation or other measures, the following factors must be considered:

• whether international law or the basic principles of international relations are violated;
• if there is a potential impact on China's national sovereignty, security and development interests;
• if there is a potential impact on the legitimate rights and interests of Chinese parties; and
• any other factors that should be taken into account.

These factors are all phrased in broad terms and open-ended, leaving the competent authorities ample room for discretion. The Blocking Rules will be administered by an inter-departmental "Working Mechanism", led by China's Ministry of Commerce (MOFCOM).

It follows from the above that the scope of application of the Blocking Rules is as yet unclear, However, the primary aim of the rules is widely regarded as seeking to counter US secondary sanctions; that is, US sanctions restricting non-US (and, particularly, Chinese) parties from engaging in certain transactions with parties subject to US sanctions under threat of significant penalties.

Reporting obligation

Where a Chinese party is restricted by extra-territorially applicable foreign legislation from transacting with a third-country party, that Chinese party must truthfully report this to MOFCOM within 30 days. This report is confidential, if so requested. This reporting obligation applies to citizens, legal entities and other organisations of China, and is believed to include Chinese subsidiaries of foreign companies. A foreign company is not required to report. MOFCOM has the discretion to impose a fine on Chinese parties that fail to truthfully report as required. This seems to suggest that the MOFCOM-led Working Mechanism can also undertake a review of relevant foreign legislation on its own authority, where there is no report. So far, no reports have been made public.

Prohibition order

If the Working Mechanism confirms the existence of unjustified extra-territorial application of foreign legislation or measures, it may decide that MOFCOM will have to issue a prohibition order to the effect that such foreign legislation or measures are "not recognised, executed, or observed". The Blocking Rules do not specify what this implies or what exactly a prohibition order would provide for. Nor do they specify who has to abide by a prohibition order. However, there does seem to be consensus that it will be binding on Chinese parties, including the Chinese subsidiaries of foreign companies.

The Blocking Rules are silent on whether a prohibition order may also be directed at any third country parties, which gives rise to much confusion. Applicability to third- country parties may seem contradictory, as it would imply the extra-territorial applicability of a prohibition order that seeks to counter the extra-territorial applicability of foreign legislation. Moreover, the fact that only Chinese parties can ask for an exemption, as discussed below, could indicate that prohibition orders will only be binding on Chinese parties. However, others have argued that, if its goal is to counter secondary sanctions without extra-territorial application, the Blocking Rules will be all bark, and no bite. After all, if there were no intention to bind third- country parties, the applicability of any prohibition orders could have been explicitly limited to Chinese parties, as was done with the reporting obligation discussed above. For now, this remains unclear.

So far, no prohibition order has been issued.

Exemption

While a prohibition order is intended to protect the interests of relevant Chinese Parties, it may at the same time create risks for other Chinese parties, whose best interests may be to simply comply with what has been blocked by the prohibition order. For example, if MOFCOM prohibits compliance with US secondary sanctions against Iran, any Chinese party complying with this prohibition and engaging in certain business with Iran could face aggressive US enforcement. Chinese parties may therefore apply to MOFCOM for an exemption from a prohibition order, indicating the reason for, and desired scope of, the requested exemption. Any such request must be decided on within 30 days. Whether an exemption will be made public is unknown.

Choosing to follow the exemption process route is not without its risk. By applying, a company draws the competent authorities' attention and, if no exemption is granted, it will have no choice but to abide by the relevant prohibition order. As no clear criteria have been given on how exemptions will be granted, the outcome of any application is uncertain.

Where a prohibition order may apply to both Chinese and third-country parties, as discussed above, only Chinese parties may apply for an exemption.

Judicial remedy

A Chinese party that is affected by another party's compliance with any blocked legislation may file a claim before the Chinese courts for losses suffered from the other party's violation of the relevant prohibition order, unless the other party is granted an exemption.

The Blocking Rules also intend to override court rulings based on a blocked foreign law. If a Chinese party is affected by such a court ruling, it may seek damages in a Chinese court from the party benefitting from that ruling. Whether this will provide any relief in practice remains to be seen, as it will likely concern foreign court rulings having their effect outside China.

Other countermeasures

In addition to the above, the Blocking Rules provide that, in response to the unjustified extra-territorial application of foreign legislation and other measures, the Chinese Government may take other "necessary counter-measures based on actual circumstances and needs". No indication is provided as to what these measures entail. China recently announced further legislation "against external sanctions, interference and long-arm jurisdiction" for the coming year, as reported by the English language Chinese newspaper Global Times. Naturally, we will keep you posted on any such developments.

Broader impact

Given the potentially wide application of the Blocking Rules, it seems inevitable that Chinese companies – including Chinese subsidiaries of foreign companies and, possibly, foreign companies engaging with China – may at some point have to choose between complying with obligations under foreign law (particularly US law), and relevant Chinese prohibition orders prohibiting the same compliance.

Recommendations

The Blocking Rules only provide a skeleton framework. It remains to be seen how they will be interpreted, applied and, ultimately, enforced. Nevertheless, multinational companies doing business with China and potentially bound by extra-territorially applicable foreign legislation (notably US sanctions and export controls) that may become the target of any Chinese prohibition order, are advised to take the Blocking Rules into consideration. This is particularly important for those companies with Chinese subsidiaries.

• These companies should assess and continuously monitor their exposure to extra-territorially applicable legislation potentially affecting China, whether directly or indirectly, that may become the target of any Chinese prohibition order.
• Chinese subsidiaries will have to evaluate whether such legislation prohibits or restricts them from engaging in normal economic, trade and related activities with a third-country party under the Blocking Rules and consider on a case-by-case basis if this could trigger a reporting obligation under the Blocking Rules.
• Once a prohibition order is issued, companies should analyse its scope and implications, and communicate timely across relevant group companies. Companies should also assess the consequences of observing Chinese law and foreign law, respectively, and reach internal alignment. Consider the prospect of applying for exemption under the Blocking Rules.

Finally, companies may need to carefully review the sanction and export control clauses in contracts with Chinese parties that require those Chinese parties to comply with sanctions and export control or other laws of other countries, notably the US. If these laws are blocked by a prohibition order, Chinese contracting parties cannot comply with those clauses. Going forward, Chinese parties may now be unwilling to accept these clauses or they may require additional language, making the clauses applicable only to the extent permissible under Chinese law.