Federal Contractors and Their Suppliers are in Limbo Awaiting Fast-Approaching Deadline for Implementation of Section 889 Supply Chain Restrictions

As the August 13, 2020 statutory deadline for the US Government to implement the supply chain restrictions of Part B of Section 889 of the 2019 National Defense Authorization Act (NDAA) fast approaches, US suppliers of technology, services, and medical care are in a state of uncertainty as to what the scope of those restrictions will be. These rules will have enormous consequences for doing business with the US Government. Part B of Section 889 prohibits the US Government from contracting with any entity that merely uses certain Chinese telecommunications technology or services in any part of its company, including a company’s overseas operations.

Although industry and government leaders alike are expressing concern, the Office of Management and Budget (OMB) has yet to issue a rule clarifying how the restrictions will be applied. Sen. Ron Johnson recently proposed an amendment to the 2021 NDAA that would modify and delay implementation of Part B, but its prospects remain unclear in the face of opposition from senators critical of China. Companies that provide goods or services to the US Government should carefully evaluate potential exposure throughout their entire organization, as non-compliance in any component could result in the entire organization being barred from contracting with the US Government.

Background on 889

As we have addressed in prior alerts (here and here), Section 889 of the 2019 NDAA imposed restrictions on government procurement related to “covered telecommunications equipment or services.” The NDAA defines “covered telecommunications equipment or services” to include telecommunications equipment or services provided by Huawei Technologies Company, ZTE Corporation, Hytera Communications Corporation, Hangzhou Hikvision Digital Technology Company, and Dahua Technology Company, as well as their subsidiaries and affiliates. The NDAA also authorizes the Secretary of Defense to designate additional Chinese companies as providing covered telecommunications equipment or services.

Section 889 includes three primary procurement restrictions:

• Effective as of August 13, 2019, subsection (a)(1)(A) prohibits direct government procurement of “any equipment, system, or service that uses covered telecommunications equipment or services as a substantial or essential component of any system, or as critical technology as part of any system.”
• Effective beginning August 13, 2020, subsection (a)(1)(B), referred to as Part B, bars the US Government from contracting with any entity that “uses any equipment, system, or service that uses covered telecommunication equipment or services as a substantial or essential component of any system, or as critical technology as part of any system.”
• Also effective beginning August 13, 2020, subsection (b) bars recipients of government grants and loans from using federal funds to purchase goods or services that use covered telecommunications equipment or services.

Subsection (a)(1)(A)

On August 13, 2019, the US Government published an interim final rule that generally prohibits government agencies from acquiring goods or services that use certain covered telecommunications equipment or services. Congressional supporters of Section 889 have nevertheless continued to criticize the Trump Administration for alleged lack of enforcement of the law. In February 2020, a federal district court rejected Huawei’s lawsuit against the US Government in which Huawei argued that the application of Section 889 to Huawei was unconstitutional.

Subsection (a)(1)(B)

Part B requires extension of the contracting prohibition to any entity that merely “uses” covered telecommunications equipment or services, even if the targeted technology is not part of the goods or services that the US Government is purchasing. The prohibition is limited to use that is “a substantial or essential component, of any system, or as critical technology as part of any system.” But the impact of that limitation is not clear, and the draft implementing guidance continues to be delayed. If the US Government implements a broad interpretation of the statute, it could exclude a large number of companies, including prominent US suppliers, from federal contracting – an outcome that neither industry nor agencies want, but may result from the language of the NDAA.

In February 2020, representatives from the Department of Defense, which is the government agency charged with drafting the rule implementing Part B, indicated that the working draft of the rule at that time encompassed companies that merely have a commercial relationship with Huawei or ZTE or that use goods and services of a company that relies upon Huawei or ZTE. They offered the practical example that the rule would potentially bar procurement from a company that has an office in Germany that uses a local internet service provider deploying Huawei routers.

In recent comments Ellen Lord, Under Secretary of Defense for Acquisition and Sustainment, indicated that she favors taking a “risk based” approach to implementation or even allowing a year-long delay in order to allow contractors to come into compliance. But the authority to make those decisions currently rests with OMB, which has yet to release implementation guidance.

Subsection (b)

The August 13 deadline is also looming for subsection (b) of 889, which would potentially apply to recipients of federal grants and loans, such as research and academic instructions. On January 22, 2020, the US Government published proposed changes to its grants and agreements regulations that would prohibit any “grant, cooperative agreement, or loan recipient” from using government funds to enter into contracts “with entities that use covered technology.” This is a potentially expansive interpretation in line with the approach taken in implementing (a)(1)(A). And like subsection (a)(1)(B), this prohibition would extend to entities that merely use covered technology. Comments on the proposed rule closed on March 23, 2020, and a revised rule has yet to be released.

Looking Ahead

What approach the final rule takes, or even whether a final rule will be issued, remains uncertain, and the heightened tensions between China and the US Government (including both the Trump Administration and Congress) makes it unlikely that significant accommodations will be made.

The increasing divide between China and the United States is reflected in various measures that – independent of Section 889 – will have a significant impact on US-China trade:

• The US Government issued an advisory cautioning businesses about the supply chain risks associated with China’s human rights abuses in Xinjiang that closely followed legislation addressing the same concerns.
• Earlier this year the Department of Defense issued a list, which included Huawei and China Mobile, of Chinese companies operating in the United States that it determined are owned or controlled by the Chinese military.
• The Commerce Department issued broader restrictions targeting Huawei as well as Chinese military end users.
• The US Government reinvigorated the Team Telecom process (prior alert here) and recommended that the FCC revoke or deny the licenses of several Chinese telecommunications companies.
• The Federal Communications Commission officially designated Huawei and ZTE as national security threats, prohibiting the use of Universal Service Fund money to purchase or support equipment or services provided by Huawei and ZTE.

Time is running out, with a real prospect that the US Government may fail to implement the provisions of 889 by August 13, 2020, or impose restrictions with little or no opportunity for the business community to react and to come into compliance. Consequently, companies should carefully evaluate their potential exposure and take appropriate steps to identify “covered technology” and develop a plan so that they are prepared to come into compliance if and when the rules are released.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Lisa Monaco, an O’Melveny partner licensed to practice law in the District of Columbia and New York, Greta Lichtenbaum, an O’Melveny partner licensed to practice law in the District of Columbia, and John Dermody, an O’Melveny counsel licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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