U.S. Salvo at Chinese Telecom Manufacturer Huawei Could Cause Collateral Damage to American Companies

On May 15, 2019, in a one-two punch, the White House and the U.S. Department of Commerce (DOC) took actions that effectively could ban Huawei Technologies Co. Ltd., 68 of its non-U.S. affiliates, and other unnamed Chinese telecom manufacturers from selling equipment to American telecommunications providers and from buying components critical to Huawei’s products from U.S. manufacturers. Declaring a "national emergency," and stating that "foreign adversaries¹ are increasingly creating and exploiting vulnerabilities in information and communications technology and services" (ICTS)² and committing economic and industrial espionage against the U.S., President Trump signed an Executive Order that bars U.S. telecommunications networks from using equipment from foreign suppliers posing an undue national security risk. Although the Executive Order does not explicitly name any particular country or company, it unmistakably is aimed at Chinese telecom giant Huawei, China’s largest telecom manufacturer and the second largest smartphone manufacturer worldwide, and several other major Chinese telecom gear companies. The Order directs the Department of Commerce to adopt rules within 150 days barring U.S. companies from purchasing ICTS from companies "owned by, controlled by, or subject to the jurisdiction or direction of a foreign adversary." On the heels of the Executive Order, and of more immediate impact, DOC added Huawei and its 68 non-U.S. affiliates to DOC’s "Entity List," which prevents those companies from buying chips, software and other critical components from American suppliers without U.S. government approval and also forbids foreign manufacturers from selling components to Huawei if they include more than de minimus amounts of U.S.-origin parts or are based on U.S. technology.

These actions portend significant pain not just for Huawei and the other Chinese telecom companies targeted by the Order, but also for numerous American businesses. This includes both small and medium-sized telecom carriers and ISPs that have depended on Huawei and other Chinese gear as cost-effective alternatives to more expensive European equipment, and American manufacturers of chips, software and other components that are incorporated into Huawei’s products. While the exact scope of the restrictions remains to be spelled out in forthcoming DOC rules, the coordinated actions of the agency and the White House immediately cast a cloud of uncertainty over many American telecom companies’ infrastructure deployment plans, and on the markets for American component manufacturers’ products. Affected companies should (1) immediately initiate enhanced list-screening to avoid engaging in prohibited transactions with Huawei or its affiliates, (2) consider interim licensing and guidance alternatives until DOC issues rules implementing the Executive Order and delineates the intended effect of Huawei’s inclusion on the Entity List, and (3) actively participate in the Department of Commerce rulemaking proceeding to document the impact that these actions will have on them, to make their concerns and particular circumstances known, and to urge the adoption of sensible rules that do not make American companies and the customers they serve victims of collateral damage.

Background

Chinese telecom manufacturers and network operators – particularly Huawei – have long been in the U.S. government’s crosshairs. Dating back at least two decades, a task force of executive branch agencies known as “Team Telecom” and the Federal Communications Commission (FCC) have imposed conditions on Chinese carriers seeking to provide facilities or services in the U.S., and on U.S. carriers proposing to use Huawei products (e.g., by forbidding use of Huawei gear in submarine cable facilities serving the U.S.) out of concern that use of such equipment would render U.S. telecom networks, and the telecom traffic they transport, vulnerable to Chinese surveillance or disruption.

In recent years, the focus on Huawei and other Chinese telecom manufacturers spread from Team Telecom and the FCC to the agencies charged with enforcing U.S. export control and trade sanctions laws – including the U.S. Department of Commerce Bureau of Industry and Security (BIS). U.S. authorities sought not only to limit which American technology and components could be sold to Huawei and other Chinese manufacturers, but also to restrict those companies from selling products containing more than de minimus amounts of U.S. components to U.S. adversaries, such as Iran. In a notorious incident, Chinese telecom manufacturer ZTE Corporation was caught selling products containing U.S. components to customers in Iran and North Korea in violation of U.S. sanctions. ZTE’s access to U.S. parts was prohibited, causing the company to suspend operations and threatening the company’s future viability. Only after agreeing to pay in excess of $1 billion in penalties, and with intervention at the highest level of government, did the U.S. agree to restore ZTE’s access to U.S. components.

On another front, the FCC has been considering whether to forbid use of the Universal Service Fund and other federal subsidy monies for purchase of Huawei and ZTE equipment by small and rural carriers who depend on such subsidies to support the construction and maintenance of telecom networks in rural and hard-to-serve areas. Although the FCC has not yet adopted these proposals, it has delivered other blows to Chinese telecom companies, most recently voting to block China Mobile from interconnecting with U.S. networks due to concerns that the company might exploit such access.

Similarly, in Section 889 of the National Defense Authorization Act for Fiscal Year 2019 (NDAA), Congress prohibited the U.S. government and U.S. contractors from purchasing equipment manufactured by Huawei or ZTE. (The law does not affect the private sector’s purchase of Huawei or ZTE gear.) Huawei has filed suit, challenging the constitutionality of that law. Following enactment of the NDAA, Congress – in a rare show of bipartisanship – has beaten the drum loudly for the White House and federal agencies to take strong action against the perceived threats posed by Chinese infiltration of U.S. telecom networks.

Finally, with President Trump’s trade war with China dragging on and fears that the U.S. may be losing the race to – and economic and national security benefits of – 5G wireless supremacy, the Administration no doubt has been looking for additional ways to gain leverage in its negotiations with Beijing. The President’s and DOC’s actions, which could significantly deny Huawei and other Chinese telecom manufacturers access to the U.S. market, likely were intended to serve that purpose.

The Executive Order

Against this backdrop, the question has been not whether but when the U.S. would take further action against the Chinese telecom sector. The President’s issuance of the Executive Order, and DOC’s placement of Huawei and its affiliates on the Entity List, answered that question.

The Order broadly prohibits any acquisition, importation, transfer, installation, dealing in, or use of any ICTS designed, developed, manufactured, or supplied by persons owned by, controlled by, or subject to the jurisdiction or direction of a foreign adversary, by any person or with respect to any property subject to the jurisdiction of the United States where the transaction poses:

• an undue risk of sabotage to or subversion of the design, integrity, manufacturing, production, distribution, installation, operation, or maintenance of ICTS in the U.S.;
• an undue risk of catastrophic effects on the security or resiliency of United States critical infrastructure or the digital economy of the United States; or
• an unacceptable risk to the national security of the United States or the security and safety of United States persons.

The prohibition applies to any transaction that “was initiated, is pending, or will be completed after the date of” the Executive Order, i.e., May 15, 2019. And the Order’s prohibitions apply “notwithstanding any contract entered into or any license or permit granted prior to the effective date of” the Order.

The Order reserves to DOC discretion to: (a) design or negotiate measures to mitigate security concerns, which measures may serve as a precondition to approval of an otherwise prohibited transaction or class of transactions; (b) issue regulations, orders, directives or licenses authorizing one, or a class of, transactions; and (c) direct the timing and manner of cessation of transactions prohibited by the Order.

The Executive Order directs the DOC to adopt implementing rules within 150 days of issuance of the Order, i.e., by October 12, 2019. Those rules may, among other things:
determine that particular countries or persons are “foreign adversaries” for purposes of the Order;

• identify persons owned by, controlled by, or subject to the jurisdiction or direction of foreign adversaries for purposes of the Order;
• identify particular technologies or countries with respect to which transactions involving ICTS warrant particular scrutiny;
• establish procedures to license otherwise prohibited transactions;
• establish criteria by which particular technologies or participants in the ICTS market may be recognized as categorically included in, or categorically excluded from, prohibitions established by the Order; and
• identify a mechanism and relevant factors for the negotiation of agreements to mitigate concerns raised in connection with the Order.

Department of Commerce Entity List

Simultaneous with the President’s action, DOC added Huawei and its 68 non-U.S. affiliates to the Entity List. Citing the Justice Department's recent indictment of Huawei for alleged violations of the International Emergency Economic Powers Act (IEEPA) and related conspiracy and obstruction allegations, the DOC based its action on the finding that “there is reasonable cause to believe that Huawei ... [and its non-U.S. affiliates have] been involved in activities determined to be contrary to the national security or foreign policy interests of the United States.” The listing will become effective when published in the Federal Register, which is scheduled for May 21, 2019. Although inclusion on the Entity List does not absolutely forbid access to U.S. markets, a license to conduct such transactions is required and may be denied if a deal would harm U.S. national security or foreign policy interests. Given that DOC stated that the license requirement will be applied “for all items,” that no license exceptions will be available for exports to Huawei and its affiliates, and that any application for a license will be considered under a “license review policy of presumption of denial,” Huawei has little chance of gaining access to U.S. components absent a walk-back by DOC or the President.

The Unknown

Despite the breadth of the Executive Order, and the fact that it is immediately applicable to any transaction that “was initiated, is pending, or will be completed after the date of” the Order, neither the White House nor DOC has provided any guidance regarding how its sweeping prohibitions are to be interpreted or applied. Moreover, implementing rules likely will not be issued by DOC for six months, and there has been no indication whether, when, or in what form interim guidance will be provided. For example, the “undue risk” provisions, which determine whether the Executive Order’s prohibitions will or will not apply, are so vague as to almost defy interpretation. Likewise, although the DOC’s addition of Huawei to the Entity List will be effective today (May 21), a DOC Commerce spokesperson reportedly has stated that the agency is considering granting partial relief from the listing by issuing a temporary general license. Such action could allow Huawei to continue serving existing customers, including ISPs and mobile phone operators in less populated areas, whose networks rely on Huawei gear and otherwise could suffer service interruptions if access to Huawei equipment is suspended. Thus, the real impact of the Executive Order and Huawei’s addition to the Entity List is unclear and may not be known for some time. Even then, it is possible that, should a trade deal be struck, at least some of the shackles on Huawei and its cohorts will be removed, to not only their relief but the relief of smaller U.S. telecom carriers and U.S. component manufacturers. But a trade deal could be many months away.

The absence of guidance has left U.S. telecom companies and other businesses wondering how the Order will be implemented, and what they should – or can – do until final rules are issued. Likewise, American chip, software and component manufacturers are left to assume the worst about their prospects of continued sales to Chinese telecom manufacturers, given that no guidance has been provided as to whether, under what circumstances, or with respect to what components, export licenses may be granted. Questions already raised include, for example:

• Does the Executive Order apply to Huawei equipment already delivered, but not yet installed, under open supply contracts? Or to equipment already delivered but not yet paid for? Or to new purchase orders under prior contracts?
• Will carriers be required to remove Huawei gear previously installed?
• How does the Order affect warranty service for already-installed Huawei equipment?
• Will there be grandfathering provisions and, if so, in what circumstances and to what extent will they apply?
• If carriers are compelled to use more expensive European equipment in the future or, even worse, must also replace existing Huawei equipment, will there be federal assistance regarding the costs of doing so?
• Does the Executive Order apply to telecom networks operated abroad by U.S. companies?
• Does the Executive Order apply to Huawei-manufactured handsets or only to network equipment?

The answers to these and other questions are unclear, underscoring the importance of affected companies actively participating in the upcoming DOC rulemaking. Only by documenting the impact that these actions will have, and making concerns and particular circumstances known, will DOC have the information necessary to fashion sensible rules that do not make American companies and the customers they serve innocent victims of these regulatory actions.

In the meantime, while we await issuance of DOC’s rules and interim guidance, companies should consider taking the following action:

• Conduct enhanced list-screening to ensure that they do not enter into prohibited transactions with any of the designated Huawei entities, or any additional entities that may be listed by DOC in the future.
• e-screen their customers, vendors and others with whom they deal to identify pending transactions that may involve listed Huawei entities.
• Consider filing license applications, applications for temporary licenses, and/or requests for advisory opinions regarding transactions that cannot await the issuance of final rules, bearing in mind that there will be no assurance of prompt action on such requests, or of any action at all.

Violation of the Executive Order or Entity List restrictions could result in serious adverse consequences, including substantial monetary fines and loss of export privileges. Companies should, therefore, proceed with great caution.

1 “Foreign adversary” is defined as “any foreign government or foreign non-government person engaged in a long-term pattern or serious instances of conduct significantly adverse to the national security of the United States or security and safety of United States persons.”

2 “Information and communications technology or service” is defined as “hardware, software, or other product or service primarily intended to fulfill or enable the function of information or data processing, storage, retrieval, or communication by electronic means, including transmission, storage, and display”.