U.S. Court Blocks Trump-Era Designation Of Xiaomi As A Chinese Military Company And Permits Continued Trading In Its Securities - Securities

On March 12, 2021, a U.S. district court granted a temporary injunction requested by the Hong Kong-listed, Chinese electronics giant, Xiaomi Corporation ("Xiaomi"). The injunction blocks the U.S. Department of Defense ("DoD") from enforcing its designation of Xiaomi as a Communist Chinese Military Company ("CCMC"), which would have prohibited U.S. investment in Xiaomi's publicly traded securities. The Xiaomi injunction follows other court injunctions rejecting the Trump administration's attempts to block Chinese technology companies from the U.S. market. While the Xiaomi injunction is not necessarily a bellwether for successful injunctions in favor of other companies designated as CCMCs, we predict it will spur more litigation challenging export controls and sanctions designations from the Trump administration.

I. Background

Executive Order ("EO") 13959, issued by then-President Trump on November 12, 2020, is the basis for the CCMC sanctions program administered by the U.S. Treasury Department Office of Foreign Assets Control ("OFAC"). This program prohibits U.S. persons from purchasing or holding CCMC publicly traded securities or the derivatives of such securities after certain deadlines have been reached. As we reported in our previous alert, on December 28, 2020, OFAC issued guidance indicating that it would interpret EO 13959 broadly. We also reported here that, on January 13, 2021, President Trump in his final days in office issued EO 13974 as an amendment to EO 13959 to require U.S. persons to fully divest from CCMC securities within 365 days of a company's designation as a CCMC. On January 14, 2021, DoD designated Xiaomi and eight other Chinese companies as CCMCs under EO 13959. Given that the prohibition on purchasing CCMC securities takes effect 60 days after a CCMC's listing, the investment prohibitions on Xiaomi were scheduled to go into effect on March 15, 2021. However, Xiaomi and three shareholders, who together own three-quarters of the company's voting stock, filed a lawsuit that sought emergency injunctive relief from the U.S. district court in Washington, D.C. Among other claims, the plaintiffs argued that Xiaomi was incorrectly designated as a CCMC.

II. The U.S. District Court's Decision Granting the Injunction

On March 12, 2021, the district court issued a blistering 26-page opinion explaining its decision to grant Xiaomi a preliminary injunction.

Focusing on Xiaomi's likelihood to succeed on the merits of its challenge to DoD's decision to designate Xiaomi as a CCMC, the court concluded Xiaomi was entitled to the preliminary injunction for three reasons:

First, the court found DoD's explanation for designating Xiaomi as a CCMC inadequate. The court observed that, on January 14, 2021, when DoD issued its list designating Xiaomi and eight other companies as CCMCs, DoD provided no explanation for the designations. During the litigation, DoD supplied a two-page internal DoD document that concluded that "Xiaomi meets the criteria" for CCMC designation because (i) Xiaomi's CEO had been recognized as an "'Outstanding Builder[] of Socialism with Chinese Characteristics," by the PRC's Ministry of Industry and Information Technology, an organization that purportedly "helps manage military-civil fusion for the state"; and (ii) Xiaomi's five-year plan to invest in 5G telecommunications capabilities and artificial intelligence ("AI") related to "[c]ritical [t]echnologies essential to modern military operations." However, the court found that the DoD document contained no reasoning that made a rational connection between these two facts and the conclusion that "Xiaomi meets the criteria."
Second, the court found that Xiaomi did not meet the criteria to be designated as a CCMC under the relevant statutory provision in the National Defense Authorization Act for Fiscal Year 1999 ("NDAA"). Section 1237 of the NDAA ("Section 1237") states that the CCMC criteria encompass any person that:

"(i) is owned or controlled by, or affiliated with, the [PLA] or a ministry of the government of the [PRC] or that is owned or controlled by an entity affiliated with the defense industrial base of the [PRC]; and (ii) is engaged in providing commercial services, manufacturing, producing, or exporting."

NDAA FY99 § 1237(b)(4)(B). DoD did not dispute that Xiaomi is not "owned or controlled" by any of the proscribed Chinese entities, but argued that it is "affiliated with the Chinese military and defense establishment." The court was not persuaded by the evidence DoD put forward, finding that Xiaomi is "a publicly traded company that produces commercial products for civilian use, is controlled by its independent board and controlling shareholders, and is not effectively controlled or associated with others under the ownership or control of the PRC or its security services."
Third, the court found that DoD's designation of Xiaomi lacked "substantial evidence." The court reasoned that although the 5G and AI technologies in which Xiaomi is investing may have military as well as consumer electronics applications, that fact is not enough to support a conclusion that Xiaomi is a CCMC. Nor was the court persuaded by DoD's reliance on Xiaomi's statement in its 2019 Annual Report that its founder and CEO was awarded the title of "Outstanding Builder[] of Socialism with Chinese Characteristics" by the Chinese government. The court credited Xiaomi's evidence that the award in question was granted to private sector entrepreneurs in recognition of contributions to China's economic development, that over 500 entrepreneurs have been recipients of the award since 2004, and that the purported link to the Chinese Ministry of Industry and Information Technology is "tenuous" because award recipients are not selected directly by that ministry.

Further supporting the injunctive relief, the court also noted that Xiaomi was likely to suffer irreparable harm to its reputation and severe unrecoverable economic injuries if it remained designated as a CCMC pending the final outcome of the case on the merits.

Moreover, the court noted that DoD "could not identify any transfers of technology from Xiaomi to the PRC" and that the CCMC designation process was not critical to maintaining the United States' national security because it "went unused for almost twenty years until a flurry of designations were made in the final days of the Trump Administration."

On March 14, 2021, OFAC issued new guidance, just before the sanctions restrictions would have gone into effect, stating that in light of the litigation, the prohibitions in EO 13959 "do not apply with respect to Xiaomi pending further order of the Court."

III. Conclusion

Most immediately, for U.S. investors and market participants trading in Xiaomi's securities, the court's temporary injunction preserves the status quo, pending a final determination of Xiaomi's CCMC status by the court.

More broadly, we predict this decision will lead to more lawsuits challenging regulatory actions by the Trump administration involving sanctions and export controls. Historically, efforts to challenge sanctions and related measures have been largely unsuccessful, as U.S. laws and regulations afford the government great deference in matters related to national security. That includes recent unsuccessful efforts by Huawei to challenge its designation under Section 889 of the 2019 NDAA, which prohibits the government and companies in the U.S. government supply chain from using equipment produced by Huawei (and other named companies). However, the Xiaomi injunction follows other recent court injunctions that halted the Trump administration's attempts to block Chinese technology companies from the U.S. market. In September, October, and December 2020, federal courts in California, Pennsylvania, and Washington, D.C. enjoined portions of President Trump's Executive Orders 13942 and 13943, which sought to ban U.S. persons from using TikTok and WeChat over concerns that sensitive U.S. user data would be accessible to the Chinese government. In the TikTok and WeChat cases, the Trump administration's trade restrictions were enjoined because the courts found that they overstepped the president's statutory authority.

While we expect more litigation, we would caution against interpreting the Xiaomi injunction as a bellwether for successful injunctions for other companies designated as CCMCs, or more broadly for entities subject to other U.S. government measures. As discussed above, the court's willingness to grant Xiaomi a preliminary injunction relied on facts specific to Xiaomi and to DoD's identified rationale for designating Xiaomi as a CCMC. For other designated CCMCs, a court challenge may turn out differently depending on DoD's rationale for the designation and/or on the nature of those companies' relationships with the Chinese government. We also expect that any companies separately named by OFAC on its Non-Specially Designated National (SDN) Communist Chinese Military Companies (NS-CCMC) List may have additional evidentiary support in the U.S. government's files, given the more robust Treasury process for adding names to sanctions lists.

We should all be prepared for more entities to be emboldened by the Xiaomi decision. In fact, earlier this month, Luokung Technology Corp. filed a lawsuit in federal district court in Washington, D.C. challenging its CCMC designation and it subsequently sought emergency injunctive relief. We expect all of these challenges to result in the issuance of more guidance from the Biden administration.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.