Xiaomi Corporation (Xiaomi), one of the world’s largest smartphone makers, obtained a preliminary injunction from the DC District Court on March 12, 2021 that barred the US government from enforcing a Trump-era rule that prohibits US persons from buying or possessing Xiaomi in public. traded securities. The ban applied to Xiaomi by virtue of its registration as a Communist Chinese Military Company (CCMC) by the United States Department of Defense (DoD) pursuant to Section 1237 of the National Defense Authorization Act. of fiscal year 1999 (Section 1237) – a decision made by DoD despite the fact that Xiaomi is a non-Chinese government-owned Cayman Islands incorporated company whose shares are listed on the Hong Kong Stock Exchange.
Basically, the District Court found that there was a strong likelihood of success on the merits of Xiaomi’s claim that its designation as CCMC, in the relevant facts and circumstances, was arbitrary, capricious and improper. to the law because it was not based on reasoned decision-making and failed to meet the substantive criteria of Section 1237. The Court issued this decision despite the traditional judicial deference given to national security decisions by ‘executive.
Thus, the implication of the Court’s decision is that other Chinese companies named CCMC, particularly those not directly owned by the government, can potentially challenge their inclusion on the DoD list and, therefore, the applicability of Trump’s trade ban to transactions involving their publicly traded securities. Moreover, recognizing the prospect of such potential claims, the DoD may think twice about designating companies like CMMC that are not government-owned and cannot be shown to be under Army control. popular liberation.
The DoD List of “Communist Chinese Military Companies” and Related Public Trading Ban
For background, as noted in our November 13, 2020 Legal Alert, last year the DoD designated a number of Chinese companies under the authority of Section 1237, more than 20 years after the enactment of the section 1237. Section 1237 defines a CCMC to include a company “owned or controlled by” or “affiliated with” the People’s Liberation Army (PLA) or a Chinese government ministry or “owned or controlled by” an affiliated entity to the Chinese defence. industrial seat.
Subsequently, on November 12, 2020, then-President Trump issued Executive Order 13959 (the Executive Order) prohibiting U.S. persons from trading in publicly traded securities of DoD-listed companies, or any other company specified as CCMC or any derivative thereof. . The US Treasury Department’s Office of Foreign Assets Control (OFAC), which is responsible for implementing the ban, has so far listed 45 companies as CCMCs and is in the process of identifying and add names of CCMC branches. Similar to its recent moves to restrict exports of US semiconductor technology to China, the US targeting of Xiaomi, which makes smartphones, TVs and laptops, is emblematic of US efforts to deprive China US technology and investment to support the development of 5G in China. telecommunications capabilities.
The district court’s decision
In granting a preliminary injunction, the Court concluded that Xiaomi had demonstrated a strong likelihood of success on the merits of its claims made under the Administrative Procedure Act (APA) and that, without relief, it would suffer irreparable harm under the form of serious damage to his reputation. and irrecoverable economic damage.
Citing a decision document that the DoD relied on to appoint Xiaomi as a CCMC (the DoD Memo), the Court found that the DoD failed to engage in the “reasoned decision making” required by the APA. . On the contrary, according to the Court, the DoD Memo misquoted the criteria for designating a company under Section 1237 and cited only two facts from the company’s annual report as the basis for its decision – that is to say., the fact that the CEO of Xiaomi has been recognized by the Ministry of Industry and Information Technology of the PRC, and the description of the report of Xiaomi’s five-year plan to invest in fifth-generation telecommunications (5G) and artificial intelligence, which are considered “critical technologies essential to modern military operations”. The Court concluded that, even considering these two pieces of evidence together, there was “clearly a lack of substantial evidence” to support Xiaomi’s designation.
Further, the Court found that Xiaomi did not meet the legal criteria for designation under Section 1237 and therefore the DoD acted outside of its legal authority in designating Xiaomi. In this regard, Section 1237 requires the DoD to publish and maintain a list of companies that are “owned or controlled by, or affiliated with, the [PLA] or a government department [PRC] where [are] owned or controlled by an entity affiliated with the Defense Industrial Base of the [PRC]and are “engaged in the provision of business services, manufacture, production or export”.
While stipulating that Xiaomi is not “owned or controlled” by any of the prohibited Chinese entities described in Section 1237, the DoD nevertheless argued that Xiaomi is “affiliated” with the Chinese military and defense establishment if it turns out that she has a “common goal,” “shared characteristics” or if she is “closely associated with one another generally in a dependent and subordinate position”.
In short, the Court rejected the agency’s broader definition of “affiliate” in favor of one based on common ownership and control. The Court therefore concluded that Xiaomi is not an “affiliate” of any of the prohibited entities identified in Section 1237.
On the issue of irreparable harm, the Court found that the reputational damage caused by the designation, coupled with the “very serious irrecoverable financial harm” that Xiaomi had already begun to suffer, weighed in favor of granting a preliminary injunction. The court observed that it was “almost incontrovertible” that the designation damaged Xiaomi’s reputation with corporate customers and business partners. In addition, the Court noted that since the announcement of the designation, Xiaomi’s share price had fallen by 9.5%, resulting in a loss of approximately $10 billion in market capitalization, while the stock price shares of peer companies had risen.
Will the decision stand?
The issuance of a preliminary injunction means that the Court has concluded that Xiaomi is likely to succeed on the merits of the case. The US government may file an interlocutory appeal with the DC Court of Appeals to overturn the injunction. The US government may also decide to seek a stay of the injunction pending appeal.
It remains to be seen whether the Biden administration will take those steps and defend the Trump administration’s designation. If, however, appeal actions fail, the US government can still challenge the imposition of a permanent injunction, but it will likely have difficulty doing so.
Will the decision be extended to other sanctioned parties, including other listed CCMC companies?
While the Court’s decision provides a potential avenue of redress for certain CMMC named parties, the availability of this “avenue” may be limited in nature and only available to named companies that have limited or no Chinese government involvement.
Specifically, in finding that Xiaomi’s CCMC designation was likely made in violation of the APA, the Court relied heavily on its finding that Xiaomi is not “owned or controlled by” or “affiliated” with the PLA, or the Chinese government or “detainee”. or controlled by” an entity “affiliated” with China’s “defense industrial base”. In this regard, Xiaomi is an outlier on the CCMC list as it is one of the few companies on the list that is not state-owned. In fact, of the 45 companies listed as CCMC to date, 39 are at least partly state-owned and, therefore, on that basis, could potentially be considered People’s Liberation Army-owned.
Nevertheless, the decision is interesting because, generally, the decisions of US government agencies enjoy a large degree of deference in matters affecting national security. Decisions made by presidential national security authorities are rarely subject to judicial review. Based on the Court’s description of the extremely brief explanation of the DoD’s decision to designate Xiaomi, there is no doubt that other targets of Trump-era sanction actions might wonder, and might consider to contest, if their sanctions designations were sufficiently substantiated and reasoned.