Judicial Checks on Abuse of the National Security Rationale: The Case of Xiaomi

Simon Lester and Huan Zhu

During the Trump administration, national security rose in prominence as a reason for restricting trade, investment and other economic activity. Among other examples, purported national security concerns led to the imposition of steel and aluminum tariffs under Section 232 of the Trade Expansion Act of 1962 (as our colleagues Scott Lincicome and Inu Manak describe here); there were bans on Chinese social media apps WeChat and TikTok; and most recently, the shares of certain Chinese companies, including electronics maker Xiaomi, were prohibited from being traded by Americans.

There are, of course, some legitimate security concerns relating to China specifically and to the world more broadly. However, when U.S. courts have been asked to review the actions of the Trump administration that were supposedly based on national security considerations, they have often rejected the justifications being offered. WeChat and TikTok were granted preliminary injunctions against the Trump administration’s bans (see here and here). And just recently, Xiaomi received a preliminary injunction of its own. While these decisions are not the final word, they do offer some indications of how U.S. courts will approach the issue.

In this post, we first explain the restrictions imposed on Xiaomi, and then turn to the lawsuit and the court rulings. The flaws in the Trump administration’s national security justification in this case are a reminder that the Biden administration should review carefully the Trump administration’s decisions that invoked national security, and should carry out policy in this area in a way that addresses these complex issues with more balance and nuance.

Designation of Xiaomi as a “Communist Chinese Military Company,” and the Resulting Punishment

In the Xiaomi case, the U.S. government actions at issue started with President Trump exercising power under Section 1237 of the National Defense Authorization Act for Fiscal Year 1999 (as amended), which specifies that the Secretary of Defense “shall make a determination of those persons operating directly or indirectly in the United States or any of its territories and possessions that are Communist Chinese military companies and shall publish a list of those persons in the Federal Register.” The President is authorized by this statute to take certain actions against these companies pursuant to the International Emergency Economic Powers Act (IEEPA). Possible actions under the provisions include: (1) prohibiting foreign exchange transactions or (2) prohibiting the import or export of currency or securities. In terms of creating a list, the statute covers any “person” who is “engaged in providing commercial services, manufacturing, producing, or exporting” and is “affiliated with” the Chinese military or a ministry of the government, or “owned or controlled by any entity affiliated with the defense industrial base” of China.

After many years of inaction, in June of 2020 the Department of Defense (DoD) began publishing lists of Communist Chinese Military Companies (CCMC). All together, the DoD has designated 44 Chinese companies as CCMCs, including companies in the aerospace, energy, shipbuilding, construction, technology and communication sectors. Xiaomi was added to the list on January 14, 2021, just before Trump left office. (Other well‐​known companies on the list include Huawei, China Mobile Communications, China Telecommunications Corp and China Unicom.)

Designation of an entity as a CCMC does not automatically lead to a specific punishment, but last November President Trump gave the CCMC list some teeth. He issued Executive Order 13959 entitled “Addressing the Threat from Securities Investments that Finance Communist Chinese Military Companies” (the Order was amended in January of 2021). The Order declared a national emergency pursuant to IEEPA, on the basis that China is “increasingly exploiting United States capital to resource and to enable the development and modernization of its military, intelligence, and other security apparatuses, which … directly threaten[s] the United States homeland and United States forces overseas.” The Order prohibited any U.S. person from investing in or trading any publicly traded securities, or derivatives thereof, of designated companies and their subsidiaries as of March 15, 2021, and requested U.S. persons to divest any such holdings by November 11, 2021. The Office of Foreign Assets Control under the Treasury Department later published guidance clarifying the scope of these prohibitions.

As a result of these actions, the New York Stock Exchange (NYSE) decided to delist China Mobile Communications, China Telecommunications Corp and China Unicom. With regard to Xiaomi, which is not listed on the NYSE, multiple U.S. banks, including Morgan Stanley, JP Morgan Chase and Goldman Sachs, announced that they would suspend trading of Xiaomi stock, and drop their Xiaomi Hong Kong Stock Exchange listings. And Global index publisher FTSE Russell said it would drop Xiaomi from its global and Chinese indexes. These actions almost certainly contributed to Xiaomi’s 9.5 percent stock price drop.

Xiaomi and certain shareholders filed a lawsuit in U.S. district court in late January 2021 (later filing an amended complaint) claiming that the U.S. government actions violate the Administrative Procedures Act, exceed the scope of authority granted by Section 1237 as well as the authority of Executive Order 13959, and violate the Fifth Amendment’s due process clause.

At the time Xiaomi was included on the list, no explanation for the Trump administration’s decision on Xiaomi was provided, but during the course of the litigation the U.S. government supplied the decision document relied on by the DoD. As explained in the court ruling, this document noted that Lei Jun, Xiaomi’s CEO, had been recognized as an “Outstanding Builder[] of Socialism with Chinese Characteristics” by the PRC’s Ministry of Industry and Information Technology; and the document highlighted Xiaomi’s plan to invest in 5G and AI, which are both “[c]ritical [t]echnologies essential to modern military operations,” according to the 2019 DoD Industrial Capabilities Report. The ruling explains that “[t]he decision memo concludes by stating perfunctorily that ‘Xiaomi meets the criteria’ for CCMC classification.”

The U.S. District Court Ruling

In a ruling issued on March 12, 2021, U.S. District Judge Rudolph Contreras focused on the claims under the Administrative Procedures Act. He agreed with Xiaomi’s claims and issued a preliminary injunction against the prohibitions imposed by the Trump administration on Xiaomi. The key parts of his reasoning were as follows.

In evaluating the likelihood of success on the merits (the first prong in the standard for granting a preliminary injunction), Contreras first found that the DoD’s explanation for designating Xiaomi as a CCMC is “inadequate.” In this regard, he said that the DoD memo that provided the basis for the decision to include Xiaomi “skips the most ‘critical step’ of an agency ‘connecting the facts to the conclusion.’”

Furthermore, he noted that “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.” He concluded that “Xiaomi is not an affiliate of any of the proscribed entities identified by Congress in Section 1237.”

In addition, he found that the DoD failed to provide substantial evidence to support its determination. DoD had cited two facts related to Xiaomi’s designation: The award received by Xiaomi’s CEO, and Xiaomi’s plan to invest in 5G and AI. Contreras was not persuaded by these arguments.

In the end, he concluded that “[t]he Department of Defense’s CCMC designation process as to Xiaomi was deeply flawed and failed to adhere to several different [APA] requirements.” After finding that the other factors related to preliminary injunctions were also met, Contreras granted the injunction.

As a result of this injunction, other Chinese companies on the list are pursuing similar lawsuits. In the meantime, the Biden administration said that it is still in the process of deciding the “appropriate path forward” in the Xiaomi case.

Conclusions

A review of the Xiaomi designation as a CCMC was clearly warranted, but the issues here go beyond Xiaomi. What the Biden administration needs to do is carry out a broader review of the Trump administration’s invocations of “national security.” (The Biden administration already started such a review on the TikTok and WeChat bans.) National security is undoubtedly a real concern, but the Trump administration applied it arbitrarily and, in some instances, as a disguised means of protectionism. An overbroad approach to the issue could undermine legitimate security concerns by calling into question the credibility of the concept as it is being practiced.