By: Jack Shelton
Over the last several days, headlines have been made regarding the US Commerce Department’s sanctions against Chinese telecom giant, ZTE Corporation. In this article, we will provide a brief overview of the regulatory issues at play, and the facts of the case as reported by the US Commerce Department (to be clear, all facts reported here are as alleged by the US Commerce Department, as the settlement agreement with ZTE prohibits ZTE from publicly denying the allegations).
As we all know, the United States has issued comprehensive sanctions against Iran. These sanctions are governed in large part by the Export Administration Regulations (“EAR”). The EAR controls the export of just about everything from the United States that isn’t military-specific or nuclear-energy-related.
Generally, the EAR mandate that certain exports may not be made without a license from the US government, depending on certain criteria such as the type of item to be exported, the country of destination, and the identity of the parties to the transaction. More specifically, in furtherance of US sanctions, the EAR make it illegal for anyone to export anything from the United States to Iran (with some limited exceptions that we don’t need to go into here). Furthermore, once a thing has been legally exported from the United States to a foreign country (for example, China), the foreign recipient is still prohibited from then re-export the thing to Iran (whether in the same state or as a component of another thing).
Naturally, it can be difficult for the US to enforce such rules against foreign firms. Nevertheless, the US has a potent enforcement mechanism to prevent foreign recipients of US goods from re-exporting US-origin items to prohibited countries. The US agency in charge of administering the EAR, the Bureau of Industry and Security (“BIS”), can put an offending foreign company on one of several lists, making it illegal for any US exporter to export items to that company. If that foreign company is reliant on US-origin items for its operations, being placed on such a list may be a death sentence. The ongoing case of ZTE is a perfect example of how this enforcement mechanism is intended to work.
ZTE is the second largest mobile phone manufacturer in China. ZTE incorporates various US-origin items into the phones that it manufactures, and it cannot manufacture its phones without these US-origin items.
According to the BIS charging letter, ZTE began delivering mobile phones incorporating US-origin hardware and software to Iran in 2010, under several contracts valued at hundreds of millions of dollars. ZTE rolled out an internal plan to lie to US exporters about the ultimate destination of the US-origin items and used front companies in order to avoid the export controls. The company internally circulated memoranda explicitly acknowledging that their operations would violate US export controls.
In March of 2012, a news media report published some of the details of ZTE’s dealings with Iran. BIS immediately began to investigate. ZTE responded to BIS’s investigation by forcing its employees to sign a non-disclosure agreement, under the terms of which whistle-blower employees would be forced to pay ZTE $150,000 in the event that they reported information about the violations to BIS. ZTE continued to make shipments of US-origin items to Iran despite the BIS investigation. In order to avoid discovery, ZTE caused evidence of its Iran dealings to be deleted from its databases.
Things eventually caught up to ZTE, and ZTE faced action by the US Justice Department, the Treasury Department’s Office of Foreign Assets Control, and BIS. Notably, in March of 2016, BIS placed ZTE on its “Entity List,” which made it illegal for ZTE to thereafter obtain US-origin items. BIS used the Entity List as a bargaining chip to force ZTE into settlement negotiations. ZTE and BIS agreed on the following settlement:
1. ZTE would pay a civil penalty of $661 million to BIS, $300 million of which would be waived if all of the conditions of the settlement agreement were met.
2. ZTE would pay a criminal penalty of $430,488,798.
3. ZTE would pay a civil penalty of $100,871,266 to the Office of Foreign Assets Control.
4. ZTE would be subject to independent audits for 3 years.
5. ZTE would store various records and make them accessible to BIS.
6. ZTE would provide extensive training on US export controls throughout the enterprise.
7. ZTE would be placed on a seven-year probation period—if ZTE were to violate the terms of the settlement during this probationary period, it would be prohibited from participating in any transactions involving US-origin items.
8. During the seven-year probationary period, ZTE would fully cooperate with BIS, providing full and accurate information to BIS.
In summary, ZTE agreed to pay a record-high $1.19 billion in penalties, $300 million of which would be forgiven if it complied with the settlement agreement. So long as ZTE complied with the settlement agreement, it could continue to purchase US-origin items and manufacture mobile phones—if it were to violate the settlement agreement, ZTE would be prohibited from engaging in any transactions involving US-origin items.
According to BIS, ZTE failed to comply with the settlement agreement. In March of 2018, BIS learned that ZTE had made false statements regarding disciplinary actions taken against certain of its officers. During BIS’s initial and ongoing investigations, ZTE had misrepresented to BIS that, among other actions, bonuses had been withheld from certain officers who had been engaged in the conspiracy to violate US export controls. When BIS learned that these disciplinary actions had not been taken, BIS considered the misrepresentations to be part of an ongoing and concerted pattern of deception.
On April 15, 2018, BIS issued a denial order against ZTE and ordered ZTE to pay the remaining $300 million due under the settlement, reasoning as follows:
BIS is left to conclude that if the $892 million monetary penalty . . . did not induce ZTE to ensure it was engaging with the U.S. Government truthfully, an additional monetary penalty of up to roughly a third that amount ($300 million) is unlikely to lead to the company’s reform.
This denial order may be a death sentence for ZTE. Unable to import US-origin items, the telecom giant may be forced to shut down.
Because of the size of ZTE, and the impact that its closure may have on the Chinese economy (and, perhaps the American economy, given the scale of its reliance on US-origin items), the White House has hinted that the ZTE case may factor into trade negotiations with Beijing. While the result of these negotiations is yet to unfold, the ZTE case marks a historic event in the arena of US export controls and a cautionary tale to foreign entities. It may also mark a historic use of export penalties against a foreign company as leverage in international trade negotiations.
Jack Shelton is Of Counsel in the Nashville office and his practice areas include Corporate and Transactional Law, Commercial and Government Contracts, International Trade, U.S. Export Controls, and Industrial Security.
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