The battle against tech companies with ties to the Chinese Communist Party picked up in the final days of the Trump administration. Much of the focus was on TikTok, but the White House also made use of an obscure and previously unused section of the 1999 National Defense Authorization Act, allowing the Pentagon to designate Chinese Communist military companies to be sanctioned (I wrote about the sanctions here).
When the administration moved to add dozens of these firms to a U.S. government blacklist in the latter half of 2020 and through 2021, Xiaomi, the world’s third largest smartphone manufacturer, was among them, meaning that under an accompanying executive order, Americans would be barred from trading shares in the company.
But U.S. officials seeking to take on the Chinese tech industry for its links to the People’s Liberation Army now face a significant hurdle: American courts.
On Friday, federal judge Rudolph Contreras struck down the Pentagon’s decision to add Xiaomi to its Chinese military-company blacklist, issuing a preliminary injunction against the move because, he wrote in his decision, the designation was not likely to withstand further scrutiny under the Administrative Procedure Act.
My NR colleagues better-versed on the ins and outs of administrative law might have an informed legal perspective to add, but the defeat of the designation seems to have been unnecessary.
The problem is that the Pentagon’s task was to prove that the Chinese consumer-tech company could be named under Section 1237 of the 1999 defense authorization bill that created a way to sanction companies with ties to China’s military and its industrial base — and they could barely do that, according to the judge.
Contreras seemed particularly troubled that, called on to defend the Xiaomi designation, the Defense Department’s lawyers provided a shoddily reasoned two-page memo that described the government’s reasoning behind the designation. In the document, not only does the Pentagon erroneously quote the section of the legislation under which it’s justifying the government’s actions, it only cites two pieces of evidence to support the designation: that Xiaomi was investing in 5G and A.I. technology and that company CEO Lei Jun was awarded a prize by a Chinese ministry. Contreras complains that the government’s lawyers failed to prove that this alone demonstrates ties to the Chinese military — it’s only natural that a large consumer-tech company would be interested in A.I. and 5G, and the award in question was granted to some 500 other executives, including those of companies with clearly no military ties.
Then, the judge attacks the department’s claim that Xiaomi is affiliated with the Chinese defense establishment, ruling in favor of a definition of the word “affiliated” offered by the smartphone company’s lawyers, which is to say, “a company effectively controlled by another or associated with others under common ownership or control.”
According to Contreras, Xiaomi, therefore, is not affiliated with the Chinese military or related companies:
Having determined the proper definition of the term “affiliated,” the Court concludes that based on the evidence before it, Xiaomi is not an affiliate of any of the proscribed entities identified by Congress in Section 1237. Xiaomi is a publicly traded company that produces commercial products for civilian use, is controlled by its independent board and controlling shareholders, and is not effectively controlled or associated with others under the ownership or control of the PRC or its security services. Accordingly, Xiaomi’s classification as a CCMC exceeded the Department of Defense’s statutory authority under Section 1237
Judge Contreras’s contention that Xiaomi is “not effectively controlled or associated with others under the ownership or control of the PRC or its security services” does not, however, stand up to scrutiny.
Like most major Chinese companies these days, being privately held does not equate to independence from state aims. Xiaomi might have an independent board and many shareholders, but the Communist Party also has a say in how the company is run. Companies operating in China are legally obligated to form “internal party committees” when the number of Party employees within the organization reaches a certain threshold. In December, Macro Polo analyzed the prevalence of these organizations within China’s top 500 privately-held firms:
Xi believes Party organizations help mobilize companies to support top-level policy agendas. And Top 500 reports show the number of firms that participated in “national strategies” (guojia zhanlüe)—like the Rural Revitalization Strategy and the Belt and Road Initiative—rose from 384 in 2015 to 471 in 2019. Harnessing private sector cooperation makes practical sense for Xi as last year these 500 companies boasted collective assets of 37 trillion yuan ($5.4 trillion).
The Global Times, a CCP tabloid, in 2018 described how Beijing harnesses the dynamism of private companies and directs it toward the Party’s aims, quoting an expert who said the trend reflects “the importance of improving political positioning in the internet sector.” The GT cites Xiaomi’s Party committee as an example:
Another Chinese technology company – Xiaomi Corp – said that Party members are playing an active role in daily work, and their values will also affect other employees, a situation that increases employees’ responsibilities, the company’s CPC committee told the Global Times Wednesday.
As of the end of June, the company had 3,029 Party members, and more than 70 percent were R&D employees.
Although these committees were once viewed as a formality, under Xi, they’ve taken on a greater importance — so much so that such firms can no longer be viewed as distinct from the Party’s aims, including in civil-military-fusion efforts.
The Pentagon could have improved its lot by pointing out that Xiaomi is beholden to the political aims of the Chinese Communist Party, and therefore it paramilitary wing, the People’s Liberation Army. The presence of an internal party committee should be affiliation enough, and if it’s not, Congress should update the statute.
Interestingly, Contreras suggested that other Chinese-military-company designations are questionable:
Furthermore, the CCMC designation authority, as conferred under Section 1237, went unused for almost twenty years until a flurry of designations were made in the final days of the Trump Administration. This lack of use also undermines the notion that the CCMC designation process is critical to maintaining this nation’s security.
But that’s the wrong takeaway. The designations and the sanctions that they enable are critical to U.S. national security, and their importance has only grown under Xi’s rule — it’s just that every president since Bill Clinton had been asleep at the wheel, until Trump made an eleventh-hour move.
Section 1237 has already, through a Republican Study Committee initiative, become one focus of congressional Republicans hoping to hold President Biden’s feet to the fire, by making certain optional sanctions mandatory. They should also consider broadening the statute to account for the realities of China’s Party-influenced corporate governance today.