The Chinese electronics company Xiaomi and three individuals associated with it have filed a lawsuit in the U.S. District Court for the District of Columbia challenging the U.S. government’s designation of Xiaomi as a Communist Chinese military company and the resulting restrictions imposed on it. The complaint was brought against the Department of Defense/Secretary of Defense, the Department of the Treasury/Secretary of the Treasury, and President Biden. This post summarizes the details provided in the complaint (dated January 29, 2021) and the amended complaint (dated February 5, 2021) filed by Xiaomi (we will summarize the U.S. government response when it is available). Broadly speaking, the plaintiffs set out three categories of claims: The government’s actions (1) violate the Administrative Procedures Act, (2) are ultra vires, and (3) fail to provide due process under the Constitution.
Background on Xiaomi
According to the complaint, Xiaomi is a consumer electronics company offering “a broad range of consumer products designed for civilian and commercial use, including smartphones, TVs, laptops, wearables, smart speakers, and smart home appliances.” Xiaomi was founded in 2010, and had total revenue of approximately $29.5 billion in 2019. As of January 22, 2021, the company had a market capitalization of approximately $96.8 billion. It is headquartered in Beijing and incorporated in the Cayman Islands.
In terms of raising capital through equity investments, Xiaomi has received nine rounds of pre-IPO funding, “where its principal investors included Morningside Venture Capital, strategic partners such as Qualcomm, as well as other private investment firms such as IDG-Accel.” In addition, Xiaomi Ordinary Shares have been listed on the Hong Kong Stock Exchange since July 2018 and Xiaomi American Depositary Receipts (“ADRs”) have traded in the United States on the NASDAQ OTC Market since 2018. As of December 31, 2020, four of Xiaomi’s top ten shareholders were U.S. investors, and a substantial percentage of the company’s outstanding ordinary shares were directly held by U.S. investors.
With regard to its connections to the U.S. market, Xiaomi has two U.S. subsidiaries and an office in California. It generated more than $300 million in revenue in the United States over the past five years, selling products such as electric scooters and portable power banks.
The Trump Administration’s Designation of Xiaomi as a Chinese Communist Military Company
As explained by Xiaomi, Section 1237 of the National Defense Authorization Act for Fiscal Year 1999 requires the Secretary of Defense, in consultation with the Attorney General, the Director of the CIA, and the Director of the FBI, to identify Chinese Communist military companies (CCMCs) that operate directly or indirectly in the United States, or any of its territories or possessions. “Chinese Communist military company” is defined in the statute as: “any person that ‘(i) is owned or controlled by, or affiliated with, the People’s Liberation Army or a ministry of the government of the People’s Republic of China or that is owned or controlled by an entity affiliated with the defense industrial base of the People’s Republic of China; and (ii) is engaged in providing commercial services, manufacturing, producing, or exporting.’”
The first designations of specific companies as CCMCs under this law came on June 24, 2020, with subsequent designations in August and December of that year. Xiaomi was not on any of these lists.
On January 14, 2021, the Department of Defense published an additional list that designated nine more companies as CCMCs, and Xiaomi was included on this list. According to the complaint, the list is “a one-page document that lists nine companies but provides no other details.” Prior to issuing the list, the complaint alleges, “Defendants did not provide notice to Plaintiff Xiaomi that the Departments of Defense and Treasury were considering such a designation,” and “[n]or have the Departments of Defense and Treasury provided any explanation as to why Xiaomi has been designated a CCMC or identified any material that they believe could support such a designation so that Xiaomi has an opportunity to refute it.” The complaint further states: “Defendants have never provided Xiaomi an opportunity to be heard on the Designation, or to present evidence that it does not qualify as a CCMC.”
With regard to its characterization as a CCMC, Xiaomi responds that “[m]ore than 75% of the voting rights in the company under a weighted voting rights structure are held by co-founders Lei Jun and Bin Lin.” In addition, “[a] substantial number of Xiaomi’s overall shareholders are U.S. persons, and as of December 31, 2020, three of its top ten holders of ordinary shares were U.S. institutional investors, consisting of BlackRock, Inc., The Vanguard Group, Inc., and State Street Corporation.” It asserts that: “Xiaomi is not owned or controlled by or otherwise affiliated with the Chinese government or military, nor is it owned or controlled by any entity affiliated with the Chinese defense industrial base.”
The Harm to Xiaomi of the Designation
According to the complaint, this designation has an economic impact on Xiaomi because of then-President Trump’s Executive Order prohibiting transactions by U.S. persons in securities related to a CCMC. On November 12, 2020, President Trump issued Executive Order 13959, which invokes the International Emergency Economic Powers Act, the National Emergencies Act, and 3 U.S.C. § 301, and declares a national emergency with respect to the “military-industrial complex” of the People’s Republic of China. As amended on January 13, 2021, Executive Order 13959 prohibits U.S. persons from transacting in “publicly traded securities, or any securities that are derivative of, or are designed to provide investment exposure to such securities,” of any CCMC.
Because the Department of Defense designated Xiaomi as a CCMC, Executive Order 13959 prohibits U.S. persons from transacting in Xiaomi securities or derivatives of those securities as of 9:30 a.m. EST on March 15, 2021. Divestment transactions are permitted through January 14, 2022. Effective at 11:59 p.m. EST on January 14, 2022, possession of any Xiaomi securities by any U.S. person is prohibited.
The complaint explains the harm to Xiaomi as follows: By cutting off Xiaomi from U.S. capital markets, “the Designation and related restrictions will damage the company’s ability to conduct, grow and finance its business, sell its products, maintain and grow its business relationships, and recruit and retain employees.”
Xiaomi’s Legal Claims
The complaint alleges that the designation of Xiaomi as a CCMC violates the Administrative Procedures Act (APA), is ultra vires, and violates the Due Process Clause of the Constitution. There were five specific claims set out; only the last two claims included President Biden as a Defendant.
With regard to the APA, the complaint explains that the APA requires a reviewing court to set aside agency action that is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law.” Under the arbitrary and capricious standard, “the agency must examine the relevant data and articulate a satisfactory explanation for its action including a rational connection between the facts found and the choice made.” Here, the complaint states, “Defendants’ designation of Xiaomi as a CCMC is arbitrary and capricious because, among other things, Defendants failed to articulate a reasonable explanation for their decision.” Moreover, “that decision necessarily runs counter to any accurate evidence that was before the agencies, and is otherwise not in accordance with law, because Xiaomi is neither ‘owned or controlled by, or affiliated with, the People’s Liberation Army or a ministry of the government of the People’s Republic of China,’ nor ‘owned or controlled by an entity affiliated with the defense industrial base of the People’s Republic of China,’ as required by Section 1237.”
In a second claim under the APA, the amended complaint explains that Section 1237 authorizes the Secretary of Defense to identify CCMCs that operate directly or indirectly in the United States, or any of its territories or possessions, but “[i]n order to exercise that authority, the Department of Defense must consult with the Attorney General, the Director of the Central Intelligence Agency, and the Director of the Federal Bureau of Investigation, in carrying out such authority.” Here, the complaint alleges, “[t]o the extent that the Department of Defense failed to comply with the requirements for exercise of its authority set forth in Section 1237, including the agency’s obligation to consult with the Attorney General, the Director of the Central Intelligence Agency, and the Director of the Federal Bureau of Investigation in carrying out its authority and designating Xiaomi as a CCMC, Defendants’ designation of Xiaomi as a CCMC is not in accordance with law, in excess of statutory authority, and without observance of procedure required by law, all in violation of the APA.”
The amended complaint also claims that the designation of Xiaomi as a CCMC and the restrictions in Executive Order 13959 are ultra vires, in two ways. First, it states that “Defendants’ designation of Xiaomi exceeded the authority granted to the Defense Department under the statute, both because Xiaomi fails to qualify for such agency designation under the criteria of Section 1237 and because the Defense Department did not consult with the other agencies as mandated by Congress in order to exercise authority to designate entities according to Section 1237.” Accordingly, Defendants’ designation of Xiaomi as a CCMC was “ultra vires and in excess of the Defense Department’s statutory authority.”
Second, Executive Order 13959 provides that its restrictions apply to CCMCs. The amended complaint alleges that, “[t]o the extent that the Restrictions are applied against Xiaomi, that action would exceed the authority that the Executive Order grants the Executive Branch because Xiaomi does not qualify for such designation under the criteria for a CCMC set forth in Executive Order 13959.”
As to the due process claim, the Fifth Amendment to the U.S. Constitution provides: “No person shall . . . be deprived of life, liberty, or property, without due process of law[.],” and Xiaomi, “as a foreign entity that has substantial connections with the United States,” is entitled to the protections of the due process clause. According to the complaint, “[t]he designation of Xiaomi as a CCMC and resulting restrictions under Executive Order 13959 deprive Xiaomi of its property and liberty rights, including its rights to access U.S. capital markets, its contractual relationships with shareholders, financial institutions, and other members of the public, its ability to effectively operate in its chosen business, and its reputation and professional goodwill.” Xiaomi explained that it “received no notice of the Designation before it was published on January 14, 2021, nor did Xiaomi receive any explanation for the Designation, notice of any material on which the agencies relied, or any opportunity to respond and be heard on the Designation and the restrictions imposed by Executive Order 13959.” Therefore, the Designation is unconstitutional “because it deprives Xiaomi of its liberty and property rights without due process of law.”
Xiaomi asks the court for the following relief:
(1) Issue a declaratory judgment pursuant to 28 U.S.C. § 2201(a) that the designation of Xiaomi as a CCMC is unlawful and unconstitutional;
(2) Issue a declaratory judgment pursuant to 28 U.S.C. § 2201(a) that Executive Order 13959, as applied against Xiaomi, is unlawful and unconstitutional;
(3) Issue an order vacating and setting aside the designation of Xiaomi as a CCMC, preliminarily and permanently enjoining Defendants from implementing or enforcing that designation, and preserving the status quo;
(4) Issue an order invalidating Executive Order 13959 as applied against Xiaomi, preliminarily and permanently enjoining Defendants from implementing or enforcing Executive Order 13959 against Xiaomi, and preserving the status quo;
(5) Grant any other and further relief that this Court may deem just and proper.