Prohibited Celebration Screening and the Hidden Risks in China Enterprise Transactions

By Tom McVey & Ngosong Fonkem*

 If your organization is doing enterprise with a Chinese language firm, it’s important to concentrate on the dangers related to prohibited events below U.S. export management and sanctions legal guidelines. The US has strict laws prohibiting U.S. firms from participating with sure overseas people and entities. These embody events listed on the Treasury Division’s List of Specially Designated Nationals and Blocked Persons (the “SDN Checklist”), in addition to the Commerce Division’s Entity Checklist, Denied Persons List, and Military End-User List (for sure merchandise), amongst others.  There are additionally sure restrictions on importing merchandise from China’s Xinjiang Uyghur Autonomous Area (“XUAR”) or from events listed on the Uyghur Compelled Labor Prevention Act Checklist (“UFLPA”).  It’s essential to display your transactions to make sure that you’re not doing enterprise with restricted events. That is notably necessary when coping with Chinese language firms, as many Chinese language people and entities have just lately been added to those lists.

The Complexity of Screening for Prohibited Events

Prohibited celebration screening entails extra than simply checking names on a number of lists. As an illustration, below the Workplace of Overseas Belongings Management’s (OFAC’s) “fifty % rule,” if a celebration or events listed on the SDN Checklist personal 50% or extra of an organization, that firm can also be thought of blocked, even when it’s not explicitly on the SDN List.  Exporters often try to determine who the shareholders or members are in any firm with which they’re conducting a transaction to verify that no celebration or events on the SDN Checklist personal 50% or extra of that firm. Sadly, overseas firms typically hesitate to offer correct shareholder data, which exposes U.S. firms to compliance dangers.

Equally, the Commerce Division’s Export Administration Rules (“EAR”) include numerous restricted celebration lists. These lists prohibit the export or switch of sure merchandise to listed events or require further authorizations for transactions. It’s the duty of U.S. firms to find out if the events concerned of their transactions are on these lists. See for instance EAR §744.21(b)(1) which gives: “Exporters, re-exporters, and transferors are chargeable for figuring out whether or not transactions with entities not listed on complement no. 7 or 4 to this half are topic to a license requirement below paragraph (a) of this part.”

Nevertheless, there are hidden  complexities in these necessities. For instance, the EAR’s Army Finish Consumer regulation prohibits exporting sure merchandise to “Army Finish Customers” in China. On this part, the time period “army finish consumer” is broadly outlined as “[T]he nationwide armed providers (military, navy, marine, air drive, or coast guard), in addition to the nationwide guard and nationwide police, authorities intelligence or reconnaissance organizations (excluding these described in § 744.22(f)(2)), or any particular person or entity whose actions or capabilities are supposed to help ‘army finish makes use of’ . . . . ”  This time period consists of not solely events listed on the Military End-User List, but additionally every other celebration that meets the definition of “Army Finish Consumer” in EAR §744.21(g), together with events whose actions or capabilities are supposed to help “army finish makes use of” in China.

The same requirement exists below EAR § 744.22, which prohibits exporting all EAR-regulated merchandise to “military-intelligence finish customers” or “military-intelligence finish makes use of” in China and sure different nations.  Figuring out these connections will be difficult, posing important compliance dangers for U.S. exporters.

Prohibited celebration screening is just not restricted to exporters; it’s also necessary for U.S. importers. With the implementation of the Uyghur Compelled Labor Prevention Act, U.S. importers should excercise due diligence measures to adjust to laws that prohibit importing items from entities linked to China’s XUAR area, or these listed on the UFLPA Entity List. Given the complexity of provide chains, it may be tough to find out whether or not imported merchandise contain prohibited types of labor or are related to listed entities, creating challenges for U.S. importers.

Penalties for non-compliance

Non-compliance with prohibited celebration restrictions can result in extreme penalties. Violations  below the EAR and OFAC sanctions may end up in fines as much as $1 million and imprisonment for as much as 20 per violation.  Beneath the UFLPA, non-compliance can lead to a whole ban on imports of the product into america.

Due Diligence Screening Methodology

There are a number of steps that firms can take to try to cut back these dangers. Along with screening for restricted events, firms often request their overseas counterparties to signal export and import compliance certifications. They’ll additionally embody import and export compliance clauses of their buy and sale contracts. These certifications can require the overseas events to characterize that they’ll function in compliance with U.S. export and import legal guidelines, disclose the names of their shareholders, and make sure that none of their shareholders are listed on any related watchlists. Primarily based on this data, firms can  then display the shareholder names in opposition to the SDN Checklist and different related lists.

Equally, for EAR compliance, firms can require that their overseas counterparties verify, amongst different issues, that they don’t fall below the definition of “army finish consumer” or “military-intelligence finish consumer”. They need to additionally try to verify that the exported product won’t be utilized in any “army finish use” or “military-intelligence finish use” as outlined within the EAR. Within the case of UFLPA compliance, firms can request certifications and documentation from their overseas counterparties confirming that no drive labor was concerned of their provide chain. This documentation might embody  manufacturing facility go to reviews, audit reviews, and provide chain maps, amongst different issues.

Since it’s not unusual for Chinese language and different overseas firms to misconceive the complicated U.S. import and export necessities, U.S. firms often additionally conduct their very own impartial due diligence critiques of the events concerned within the transactions.  Such critiques sometimes would study the overseas firm and its homeowners to achieve perception into their operations and to determine any potential points or considerations. The gadgets to be reviewed will rely on the main points of the transaction concerned, however can embody researching the Chinese language firm’s shareholders, the character of its enterprise actions (together with any connections with Chinese language army businesses or XUAR) and whether or not there are any reviews of fraudulent, legal or compliance violations. These impartial third-party critiques assist the U.S. firms fulfill their compliance obligations and assist show their good religion efforts to adjust to the legal guidelines. By conducting this due diligence, firms can scale back the danger of violating laws and doubtlessly scale back penalties. These critiques additionally present worthwhile details about the Chinese language firm that can be utilized for enterprise or negotiation functions.


China poses distinctive challenges relating to conducting due diligence critiques, primarily because of Chinese language authorities  restrictions on data accessible to overseas firms and governments.

Regardless of these challenges, Harris Bricken has intensive expertise conducting due diligence critiques of Chinese language firms, leveraging important assets to beat these limitations.

When mixed with different compliance practices corresponding to restricted celebration screening and export/import compliance packages, due diligence critiques can function a worthwhile software in safeguarding U.S. firms concerned in Chinese language enterprise transactions.


* The above submit was written by Tom McVey and Ngosong Fonkem.

Tom McVey  is a global company legal professional and enterprise advisor in Washington, Dc. Mr. McVey advises shoppers on the Export Administration Rules, the OFAC sanctions packages, ITAR, the Overseas Corrupt Practices Act, the anti-boycott legal guidelines and the Committee on Overseas Funding in america (CFIUS). He additionally advises on cross-border enterprise transactions together with worldwide gross sales and distribution, joint ventures, mergers and acquisitions, non-public fairness, worldwide enterprise planning and company compliance.

Ngosong Fonkem is a global commerce legal professional at Harris Bricken the place he additionally heads up the agency’s Africa Observe. You will discover out extra about Ngosong right here.