United States: BIS Activates Export Denial Against Chinese Telecom Titan ZTE

Pursuant to a denial order issued by the U.S. government on April 15, 2018 (the "Order"), U.S. persons and foreign companies purchasing U.S. items can no longer export or re-export U.S.-origin products to ZTE, facilitate ZTE's receipt of such products, or ship goods or software to service any ZTE-owned or controlled products. This type of sudden development demonstrates why exporters must be vigilant in assessing changes in U.S. trade restrictions that may occur at any time and that could significantly impact business operations. ZTE's smartphones use Qualcomm microchips and Corning glass, and U.S. companies provide an estimated 25 to 30 percent of the components used in ZTE's products. ZTE is China's second-largest telecom equipment manufacturer and the fourth-largest seller of smartphones in the United States.

Violation History

On April 15, 2018, the United States Department of Commerce, Bureau of Industry and Security (BIS) activated a suspended denial order on ZTE following a history of false statements made to the U.S. government regarding U.S. export controls and compliance within the company.

Earlier, on March 23, 2017, ZTE entered into a settlement agreement for a combined civil and criminal penalty and forfeiture of $1.19 billion. The penalty and forfeiture related to ZTE's practice of illegally shipping telecommunications equipment to Iran and North Korea, making false statements, and obstructing justice by failing to disclose to and misleading the government. Under the terms of the settlement agreement and an order dated March 23, 2017, $300 million of the civil penalty and a denial of export privileges were suspended for a probationary seven-year period, subject to several conditions.

The settlement agreement required ZTE to complete and submit audit reports regarding compliance and make truthful disclosures of requested information, and effectively prohibited ZTE from continuing to make false or misleading statements to the government. Subsequently, BIS requested a status report from ZTE regarding certain named individuals who ZTE reported had been subjected to harsh discipline as an indication of ZTE's commitment to compliance. The disciplinary actions ZTE reported had not in fact been taken, and many of the employees received their full bonuses. ZTE admitted to BIS that the statements in its correspondence with BIS were false.

On March 13, 2018, BIS informed ZTE of its proposed activation of the conditionally suspended sanctions based on ZTE's false statements. BIS found ZTE's response to the proposed activation lacking in substance and seriousness. BIS determined that ZTE had continued its pattern of deception and practice of making false statements to the U.S. government.

Text of the Order and Prohibited Activities

The text of the Order issued on April 15, 2018, prohibits ZTE Corporation and ZTE Kangxun Telecommunications Ltd., and when acting for or on their behalf, their successors, assigns, directors, officers, employees, representatives or agents, from "directly or indirectly, participat[ing] in any way in any transaction involving any commodity, software or technology . . . exported or to be exported from the United States" that is subject to the Export Administration Regulations (EAR), and engaging in other activities, including, but not limited to (1) applying for or using export licenses or license exceptions, (2) negotiating transactions involving exports and (3) benefiting from export transactions.

The Order further provides that "no person may, directly or indirectly, do any of the following:

A. Export or reexport to or on behalf of a Denied Person any item subject to the Regulations;

B. Take any action that facilitates the acquisition or attempted acquisition by a Denied Person of the ownership, possession, or control of any item subject to the Regulations that has been or will be exported from the United States, including financing or other support activities related to a transaction whereby a Denied Person acquires or attempts to acquire such ownership, possession, or control;

C. Take any action to acquire from or to facilitate the acquisition or attempted acquisition from a Denied Person of any item subject to the Regulations that has been exported from the United States;

D. Obtain from a Denied Person in the United States any item subject to the Regulations with knowledge or reason to know that the item will be, or is intended to be, exported from the United States; or

E. Engage in any transaction to service any item subject to the Regulations that has been or will be exported from the United States and which is owned, possessed or controlled by a Denied Person, or service any item, of whatever origin, that is owned, possessed or controlled by a Denied Person if such service involves the use of any item subject to the Regulations that has been or will be exported from the United States. For purposes of this paragraph, servicing means installation, maintenance, repair, modification or testing."

The Order continues, "after notice and opportunity for comment as provided in Section 766.23 of the [Export Administration] Regulations, any person, firm, corporation, or business organization related to a Denied Person by affiliation, ownership, control, or position of responsibility in the conduct of trade or related services may also be made subject to the provisions of this Order."

Final Thoughts

The Order prevents ZTE from obtaining essential U.S. components for the manufacture of its products, which will have a significant impact on ZTE's manufacturing operations and ability to sell products outside of China. The Order also prevents U.S. component manufacturers from supplying products to ZTE, directly or indirectly. This will also have a significant impact on those U.S. parties that have historically supplied products to ZTE. The Order takes effect immediately, without grandfathering of pending orders.

The Order comes amid rising trade tensions between the United States and China. The Chinese technology sector has been a hot topic in the broader discussions about trade and economic policy, with President Trump accusing Chinese tech firms of intellectual property theft. The U.S. is also not alone in asserting itself against China – he United Kingdom's National Cyber Security Centre warned companies against using ZTE's parts and services, as doing so poses risks to national security in its opinion.

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