BIS Foreign Military Intelligence Rule Could Create Due Diligence Concerns for Exporters

A Commerce Department rule designed to cut off U.S. shipments to foreign military intelligence agencies in China, Russia and beyond could create a host of due-diligence issues for exporters, industry lawyers said. Those issues could be compounded by industry uncertainty surrounding the scope of the rule, which may be unclear without BIS guidance. “We're getting an enormous number of questions,” said Giovanna Cinelli, an export control lawyer with Morgan Lewis. “I think the rule is open to interpretation, and that’s creating uncertainty.”

The interim final rule, issued by the Bureau of Industry and Security in January and effective March 16, will place new controls on activities and goods destined to foreign military intelligence end-users and end-uses in several countries of concern, including China, Cuba, Russia, Venezuela and other “terrorist-supporting” countries (see 2101140035). The rule was issued less than a year after BIS imposed separate restrictions that increased export controls for military end-users and end-uses in China, Russia and Venezuela. That 2020 MEU rule (see 2004270027) also caused uncertainty for companies that struggled to determine whether their customers qualified as a military end-user (see 2007090075).

While BIS’s latest rule may capture a more narrow group of end-users and end-uses -- such as companies that are affiliated with a foreign military intelligence apparatus -- lawyers said due diligence may be just as difficult as BIS’s 2020 MEU rule. Companies often struggle to identify customer affiliations in countries like China and Russia due to complicated ownership chains, lawyers said, and are also sometimes unsure about how thorough their due diligence must be to satisfy BIS enforcement officials.

As an added concern, BIS’s January rule captures a broader range of goods and activities than the agency’s 2020 MEU rule, which only imposed a license requirement on certain items, including certain electronics, mass-market encryption hardware and software, and parts and components for commercial aircraft.

“It's really cutting off U.S. persons and U.S. items writ large from the military intelligence establishments of these countries,” said Ajay Kuntamukkala, an export controls lawyer with Hogan Lovells and a former senior BIS official from 2003 to 2005.

Kuntamukkala said companies may struggle to determine which entities qualify as a military intelligence end-user. Although he said exporters can pinpoint entities that are most likely to be off limits, such as Russia’s Federal Security Service and various Chinese intelligence bureaus, other customers might have hidden connections to entities captured by the rule. “Given the lack of transparency in China, how do you identify whether an entity is owned or controlled by an intelligence entity?” Kuntamukkala said. “That’s really challenging.”

In comments due in March, companies may ask BIS to publicly name entities that are captured by the rule, similar to lists issued by the Trump administration last year that identified companies with ties to the Chinese military (see 2012220027), said Alex Lamy, an export controls and sanctions lawyer with Baker McKenzie. Although BIS issued a list of six intelligence agencies last month, a more complete list could further help with compliance.

“This new rule raises the same kind of concerns that companies had about the military end-use and end-user rules,” Lamy said. “This is difficult to try to determine from a due diligence perspective unless there is a clear list from the U.S. government about who's captured by these rules.” But such a list wouldn't solve all of industry's due diligence problems, Lamy said. “The MEU list is helpful, but I think the concern is it's not exhaustive,” he said. “Companies still have to do their due diligence of: Are you dealing with somebody who may be using your products for a military end-use in one of these countries?”

A BIS spokesperson pointed to its January guidance on the 2020 MEU rule (see 2101200016) and the list of six intelligence agencies it issued last month. “The [rule] clearly sets out a list of impacted foreign military-intelligence organizations and this list was compiled to facilitate industry compliance,” the spokesperson said Feb. 19. “BIS will carefully consider the public comments submitted by March 1, 2021, to assess what, if any, revisions to the rule and/or additional guidance may be warranted.”

Cinelli said she is getting questions from companies that are unsure if they have to update their current due-diligence processes, compliance training, oversight and auditing. While some companies implemented new due diligence measures after the 2020 MEU rule -- such as obtaining end-user and end-use statements from customers in China, certifying that the end-user has no military connection -- companies are unsure whether that will be enough to comply with the new rule. “The problem with intelligence is it could mean a number of different things other than just the classic national security agencies or central intelligence agencies,” Cinelli said. “Until you put a few more clothes on that mannequin, it's unclear just exactly how far that extends.”

In addition, some Chinese parties may object to providing end-user statements or signing off on contractual language designed to protect U.S. companies from running afoul of BIS’s 2020 MEU restrictions, Kuntamukkala said. He said U.S. companies should try their best to conduct due diligence but also recognize their limits.

Kuntamukkala said Chinese companies may be “more reluctant to agree on U.S. export control language” given China’s recently issued blocking law, which was intended to protect its firms against extraterritorial U.S. sanctions (see 2101110042). “The bottom line is diligence is difficult and companies are going to have to be very careful.”

Many companies are opting to not even try to proceed with their transactions. Kuntamukkala said a few of his clients chose not to apply for a license under the 2020 MEU rule, partly due to BIS’s presumption of denial policy. “I think a lot of U.S. companies are reluctant to proceed with a Chinese company if they identify any associations with the military,” he said, adding that the same concern may arise with BIS’s January rule. “At this point, as a U.S. company, you're taking enormous risks if you're dealing with the intelligence apparatus of Russia or China.”

Lawyers also noted that the rule was not part of the Biden administration’s regulatory freeze, which was imposed last month as it reviews last-minute actions pushed through by the Trump administration, especially those that relate to China. Kuntamukkala said some companies may be employing a “wait-and-see” attitude in case the rule is rescinded or revised. “People are not hitting the panic button on this rule quite yet,” he said.

Cinelli, who previously served on a Commerce Department technical advisory committee, said she doesn’t expect a “dramatic” change. “Like all the rules that relate to China across agencies, I think there is an evaluation underway to determine what can be kept, what may need to be modified, what should be revoked,” she said. “It’s something that we're monitoring.”