Client Alert
Commerce Simplifies—but Expands—the Foreign Direct Product Rule for Huawei
August 19, 2020
By Tom Best, Behnam Dayanim, Scott Flicker, Charles A. Patrizia, Haiyan Tang, Shaun Wu & Talya Hutchison
On the morning of Monday, August 17, the Department of Commerce issued a press release previewing a formal rule announcement in the Federal Register: the Bureau of Industry and Security (“BIS”) planned to take additional action directed at Huawei Technologies Co., Ltd. and its Entity List-designated affiliates (collectively, “Huawei”) by not only letting the Temporary General License (“TGL”) expire and adding an additional 38 affiliates to the Entity List, but also further revising the foreign direct product rule as applied to Huawei. The official implementation of this policy came a few hours later with the publication of an immediately effective final rule in the Federal Register.
The foreign direct product rule governs the way in which certain foreign-produced items become subject to the rules and restrictions contained in the Export Administration Regulations (“EAR”), the primary set of regulations controlling the export, reexport, or transfer of those “dual-use” (civilian) goods and technology regarded as subject to U.S. jurisdiction. This latest action by BIS adds to existing restrictions to prohibit the transfer to Huawei of any foreign-produced item that is either: (a) the direct product of specified software or technology subject to the EAR; or (b) produced by a plant or major component of a plant that is, itself, the direct product of U.S.-origin software or technology. This specially applied foreign direct product rule also clarifies that the restrictions apply not only where Huawei is the end user of the item, but also to any transaction where Huawei is the purchaser or otherwise serves as an intermediate consignee. While the previous version of the rule only restricted the transfer to Huawei of items in which Huawei had some input as to the design or specifications of the final item, the revision eliminates that proviso and places restrictions on any transactions involving the items identified where Huawei is involved in any way as an end user, purchase, or intermediate or ultimate consignee, absent a license from BIS (the application for which is generally subject to a policy of denial).
Temporary General License & Addition of 38 New Huawei Affiliates
Shortly after Huawei’s initial designation to the Entity List back in May of 2019, BIS issued the TGL. The TGL exempted three categories of transactions with Huawei that otherwise would have required a license pursuant to the Entity List designation. BIS extended the period of the TGL several times, further accommodating certain activity that would have been subject to a policy of denial. On August 13, 2020, BIS allowed the TGL to expire without further extension. In the August 17 Federal Register notice, BIS stated that only one provision of the TGL warranted being codified as part of the revised rule: the disclosure to Huawei of information regarding security vulnerabilities in certain circumstances for items owned, possessed, or controlled by Huawei. The other two exceptions provided in the TGL—transactions necessary to support the continued operation of existing networks and equipment and support to existing personal consumer electronic devices and Customer Premises Equipment—no longer exist and such transactions are now subject to the full scope of licensing requirements and restrictions of the Entity List.
Since Huawei’s initial designation, a total of 115 Huawei entities had been added to the Entity List. On August 17, 2020, BIS added an additional 38 Huawei affiliates to the Entity List—bringing the total number of unique designated Huawei companies to 153.
Foreign Direct Product Rule: Footnote 1
On May 15, 2020, BIS issued an interim final rule to expand the applicability of General Prohibition Three of the EAR as related to Huawei. General Prohibition Three outlines how foreign-produced items can be “subject to the EAR” and, accordingly, restricted for transfer to companies on the Entity List.[1] This expansion was codified in a new Footnote 1 to the Huawei Entity List entries (“Interim Footnote 1”). However, Interim Footnote 1, which was unique to the Huawei entries, was complex, requiring careful parsing to understand its applicability. In BIS’s action on August 17, the agency simultaneously simplified and expanded the scope of Footnote 1 (“Final Footnote 1”).
In order to be caught by Interim Footnote 1 and thus subject to the Entity List restrictions, a foreign-produced item must have been the direct product of Huawei input (such as Huawei-developed semiconductor designs) or manufactured pursuant to direct input from Huawei (such as chipsets manufactured from Huawei-produced specifications). Therefore, items that were foreign-produced but sold to Huawei as “off-the-shelf” versions of a product were not captured by Interim Footnote 1 and could still be sold to Huawei. Final Footnote 1 eliminates this requirement.
In Final Footnote 1, foreign-produced items that either are a direct product of specified software or technology subject to the EAR or are produced by any plant or major component of a plant that is, itself, the direct product of U.S.-origin technology or software are subject to restriction. If a person has “knowledge” that such an item will be incorporated into, or will be used in the “production” or “development of any “part,” “component,” or “equipment” produced, purchased, or ordered by Huawei then a person cannot export, reexport, or transfer such an item to Huawei.[2] Further, if a person has “knowledge” that Huawei is acting as a purchaser or intermediate consignee in a transaction—regardless of the ultimate end user of the item—the transfer of any such item is also prohibited. The BIS standard of “knowledge” includes not only actual positive knowledge, but also reason to know, reason to believe, or “awareness of a high probability” that a circumstance is likely to occur.
Therefore, if a foreign-produced item is the direct product of any enumerated software or technology subject to the EAR—or if the item is produced by any plant or major component of a plant that is, itself, the direct product of specified U.S.-origin technology or software—then a person cannot engage in any transaction involving that item, if the person has reason to know that Huawei is involved as the purchaser, intermediate consignee, end user, or ultimate consignee.
In Interim Footnote 1, BIS provided much-sought-after clarity about what constitutes a “major component of a plant”: “equipment that is essential to the ‘production’ of an item, including testing equipment.” In Final Footnote 1, BIS left that clarification unchanged. However, BIS also provided additional, explicit guidance: “A foreign-produced item includes any foreign-produced wafer whether finished or unfinished.” This guidance appears to be directed explicitly to foreign semiconductor manufacturers who may have previously interpreted the rule to permit them to provide wafers to Huawei under Interim Footnote 1.
Final Footnote 1 leaves very little doubt: BIS is attempting to fully and completely cut Huawei off from the production of semiconductors that have any nexus to U.S.-origin software or technology whatsoever.
Savings Clause
The Federal Register notice provides three distinct savings clauses that provide a reprieve to companies whose products may now be subject to restrictions under Final Footnote 1. First, for those transactions that would now require a license to send to Huawei based on either the expiry of the TGL or the addition of the 38 new entities to the Entity List, any items that were en route aboard a carrier to a port of export, reexport, or in-country transfer on August 17, 2020 pursuant to actual orders may proceed to the destination. Second, for foreign-produced items that are the direct product of specified technology or software subject to the EAR, shipments of such items are permitted if they were on dock for loading, on lighter, laden aboard an exporting or transferring carrier, or en route aboard a carrier to a port of export or to the consignee/end-user on August 17, 2020 pursuant to actual orders. Third, for foreign-produced items that are the direct product of a plant or major component of a plant that is, itself, the direct product of specified U.S.-origin software or technology, any shipments of such items that have started “production” prior to August 17, 2020 may proceed if such shipments are exported, reexported, or in-country transferred on or before September 14, 2020.
This third savings clause—for items that are the direct product of a plant or major component of a plant that is, itself, the direct product of specified U.S.-origin software or technology—is unique in that it does not require the products to be currently under production pursuant to “actual orders.”
Nevertheless, companies should carefully evaluate any future orders by a Huawei entity to ascertain whether the entity was previously designated as an Entity List company or is newly designated as such. If the Huawei company was designated in the August 17, 2020 action, then the relative leeway of the third savings clause would not apply and only items that were currently en route to the newly designated entities would be eligible for the savings clause.
Next Steps for Companies Transacting with Huawei
BIS’s action represents the latest effort to increase regulatory pressure on Huawei and China by the Trump Administration. Final Footnote 1 contains three changes that are particularly important for companies to review in order to confirm compliance with the EAR.
First, where Interim Footnote 1 was only triggered by the involvement of Huawei in the design of items that were to be subject to the EAR and prohibited from sale to Huawei, Final Footnote 1 prohibits even “off-the-shelf” products from being delivered to Huawei if they are either the direct product of specified software or technology or produced by a plant or major component of a plant that is, itself, the direct product of specified U.S.-origin software or technology.
Second, the restrictions in Final Footnote 1 not only apply where Huawei is the ultimate consignee or end user but also in transactions where Huawei acts as the intermediate consignee or purchaser. Therefore, even if the ultimate end user is not Huawei, if Huawei is involved in the transaction, its role must be closely analyzed to confirm compliance with Final Footnote 1 and the EAR more broadly.
Third, if there were any doubt that wafers were considered to be a “foreign-produced item” subject to the footnote, BIS has removed this uncertainty by clarifying that any foreign‑produced wafer is unequivocally a foreign-produced item, whether the wafer is finished or unfinished.
With the expiration of the TGL, only one exception survives: the ability of companies to disclose to Huawei certain information regarding security vulnerabilities in items owned, possessed, or controlled by Huawei. The August 17, 2020 rule was effective immediately, and companies should be immediately reviewing not only transactions with Huawei as the end user, but also transactions that may involve Huawei in other capacities. As noted above, “knowledge” is defined very broadly to include reason to know or an “awareness of a high probability”—and any provision of items subject to the EAR with knowledge that they are destined for Huawei or a transaction that involves Huawei could constitute a violation of the EAR.
We regularly advise clients engaging in cross border transactions both involving China and navigating U.S. export control regulations, and we would be happy to assist with any questions on these topics.
[1] Companies designated on the Entity List cannot receive items that are “subject to the EAR” without a license from BIS. License applications in such cases are largely subject to a policy of denial. Additional details on the restrictions of the Entity List and BIS’s initial implementation of Interim Footnote 1 can be found here: https://www.paulhastings.com/publications-items/details/?id=58885b6f-2334-6428-811c-ff00004cbded.
[2] Terms in “quotations” are defined in the EAR, in accordance with 15 CFR § 772.1.
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