As a preface to this blog, I recently gave a presentation with Nate Picarsic and Emily de la Bruyere at the American Bar Association Public Contract Law Section Fall Procurement Symposium on “China’s Military-Civil Fusion Strategy Supply Chain Implications.” China’s Military-Civil Fusion strategy poses increasing threats to our defense supply chain. Countries and entities around the globe that engage in infrastructure and other investment relationships with China are exposed to the risk of having a coercive economic dependence on China. For example, China has strategically acted to obtain significant control over rare earths which are integral to production of those IoT devices that civilians and the military rely on. Similarly, China’s steps to engage in the Belt and Road initiative to finance various countries’ and entities’ infrastructure projects have resulted in an ability to leverage those countries and entities for their own purposes. China’s recently announced Asia-Pacific Trade Pact, which has been touted as creating the world’s biggest free trade bloc, also poses similar risks and future challenges to the defense supply chain.
With this as background, President Trump’s Executive Order on “Addressing the Threat from Securities Investments that Finance Communist Chinese Military Companies,” (EO) issued on November 12, 2020, is a development to which contractors should pay attention. The EO notes the threats of China’s Military-Civil Fusion strategy as presented through the development of technology and products by civilian Chinese companies that are then used to support China’s military, intelligence, and other security apparatuses. These Chinese companies have been traded on public exchanges in the U.S. and abroad. U.S. investment in these companies, according to the EO, has been used to support the development and modernization of China’s military.
The EO targets this asymmetric threat. Specifically, starting on January 1, 2021, except to the extent permitted by statute, regulation, order, directive, or license, the EO prohibits U.S. persons or entities from engaging in transactions in publicly traded securities, or their derivatives, of any Communist Chinese military company. The EO also prohibits any U.S. persons or entities from engaging in activities to “provide investment exposure to” securities of such Communist Chinese military companies. The EO allows U.S. persons or entities to sell such securities for divestiture purposes up to November 11, 2021. As additional Chinese military companies are identified, U.S. persons or entities will have up to 60 days from the date of that determination to divest. Transactions or conspiracies to evade or avoid this EO are prohibited. The EO directs all agencies, including specifically the Secretary of Treasury, Secretary of Defense, and the Director of National Intelligence, to take appropriate actions within their authority to implement regulations and orders to carry out this EO.
Under the EO, “Communist Chinese military company” means
(i) any person that the Secretary of Defense has listed as a Communist Chinese military company operating directly or indirectly in the United States or in any of its territories or possessions pursuant to section 1237 of Public Law 105-261, as amended by section 1233 of Public Law 106-398 and section 1222 of Public Law 108-375, as of the date of this order, and as set forth in the Annex to this order, until such time as the Secretary of Defense removes such person from such list;
(ii) any person that the Secretary of Defense, in consultation with the Secretary of the Treasury, determines is a Communist Chinese military company operating directly or indirectly in the United States or in any of its territories or possessions and therefore lists as such pursuant to section 1237 of Public Law 105-261, as amended by section 1233 of Public Law 106-398 and section 1222 of Public Law 108‑375, until such time as the Secretary of Defense removes such person from such list; or
(iii) any person that the Secretary of the Treasury publicly lists as meeting the criteria in section 1237(b)(4)(B) of Public Law 105-261, or publicly lists as a subsidiary of a person already determined to be a Communist Chinese military company, until the Secretary of the Treasury determines that such person no longer meets that criteria and removes such person from such list.
The EO also provides that Executive Branch agencies are required to report to Congress on these matters.
As a government contractor, this may affect your investments and your supply chain. If you own securities or interests in covered Chinese companies, you need to determine whether and to what extent you will be required to divest under rules issued to carry out this EO. If your supply chain includes covered Chinese companies, you will need to carefully consider what impact the rules promulgated will have on your ability to continue to use these companies. Given the precedent of rules promulgated under Section 889 of the NDAA FY 2019 and the Supply Chain Risk rule, it is not difficult to imagine a scenario where there could be a challenge to a contractor’s or subcontractor’s present responsibility, its ability to receive a contract award, or its being used in the performance of a government contract where it is found to have investments or interests in covered Chinese companies.
What do you do now? Questions remain. This EO is coming towards the end of the current administration. How fast will rules be implemented? Will this EO be rolled back or implemented further by the next administration? Time will tell. However, the threats posed by Chinese Military-Civil Fusion Strategy have been documented and rules requiring rip out and replacement of covered Chinese products are already being implemented as a result of the laws passed with bipartisan support. Be on the lookout for future blogs on the topic.
If you have questions about supply chain risk matters contact the author or your Stinson counsel.