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Highlights
- The James M. Inhofe National Defense Authorization Act (NDAA)
for Fiscal Year 2023, which President Joe Biden signed into law on
Dec. 23, 2022, contains consequential future prohibitions and
requirements vis-à-vis semiconductors in federal government
supply chains. - The 2023 NDAA prohibits the federal government from entering
into or extending contracts with companies to procure electronic
parts, products or services that include semiconductor parts or
services from certain Chinese entities, many of which are existing
vendors or suppliers to large numbers of federal government
contractors. - The semiconductor prohibitions included in Section 5949 will
not take effect until five years after the enactment of the 2023
NDAA, but taking steps to assess supply chain risks now will avoid
costly disruptions down the road.
President Joe Biden signed into law the James M. Inhofe National
Defense Authorization Act for Fiscal Year 2023 (2023 NDAA or
Defense Bill) on Dec. 23, 2022. The Defense Bill, which passed the U.S. House of
Representatives on Dec. 8 and the Senate on Dec. 15, includes a key
provision, Section 5949, that prohibits the U.S. government from
doing business with companies that rely on certain Chinese
semiconductor manufacturers with ties to the Chinese Communist
Party and the Chinese military. It includes several provisions that
mirror the restrictions on the procurement and use of certain
telecommunications equipment, software and services found within
Section 889 of the John S. McCain National Defense Authorization
Act for Fiscal Year 2019 (Section 889).
The enactment of Section 5949 comes as the Biden Administration
and Congress have enhanced their focus on competing with the
Chinese chip industry and mitigating potential national security
concerns related to critical infrastructure and technologies.
Within the last year alone, the U.S. government has imposed new
unilateral export controls pertaining to China on certain advanced
computing and semiconductor manufacturing items,1
prioritized the strengthening of the domestic chip supply chain
through the passage of the CHIPS and Science Act, released an
updated list (through the U.S. Department of Defense) of
“Chinese military companies” operating in the United
States in accordance with Section 1260H of the William M. (Mac)
Thornberry National Defense Authorization Act for Fiscal Year 2021,
and added several Chinese semiconductor manufacturers to the Entity
List issued by the U.S. Department of Commerce’s Bureau of
Industry and Security. The enactment of Section 5949 is the most
recent action in an unprecedented regulatory crackdown on the
Chinese microelectronics sector.
A Closer Look at Section 5949
In an ode to Section 889, Section 5949 prohibits executive
agencies from procuring or contracting with entities to obtain any
electronic parts, products, or services that include covered
semiconductor products or services from certain Chinese entities.
Section 5949 aims to 1) protect national security, 2) reduce U.S.
dependence on China, 3) promote economic security and 4) mitigate
future chip shortages. Notably, to assist industry in compliance
and to assuage any potential supply chain disruptions, the
semiconductor prohibitions in Section 5949 will not go into effect
until five years from the enactment of the 2023 NDAA, and the
Federal Acquisition Regulatory (FAR) Council will issue the
corresponding regulations within three years following the date of
enactment. As with Section 889, Section 5949 includes a Part A and
a Part B.
Part A
Part A prohibits any federal agency from procuring or
obtaining, or extending or renewing, a contract to procure or
obtain any electronic parts, products or services that include
covered semiconductor products or services. “Covered
semiconductor products or services” include any semiconductor
products or services produced by Semiconductor Manufacturing
International Corporation (SMIC), ChangXin Memory Technologies
(CXMT), Yangtze Memory Technologies (YMTC) and their subsidiaries
or affiliates. These companies — including China’s
largest chipmaker — represent a substantial and growing share
of the global semiconductor chips market. A broad range of
electronic equipment imported into the United States (including
mobile phones, networking equipment and automobile parts)
incorporate chips by these entities or their affiliates.
Importantly, Section 5949 also gives the U.S. Secretaries of
Defense and Commerce the authority to designate other products or
services as “covered” if they determine that the product
or service is provided by an entity owned, controlled by or
connected to the government of a “foreign country of
concern,” including China, Russia, North Korea and Iran.
Part B
Part B prohibits any federal agency from entering into a
contract (or extending or renewing a contract) with an entity
to procure or obtain electronic parts or products that use any
electronic parts or products that include covered
semiconductor products or services. Unlike Section 889, this
prohibition does not restrict a government contractor’s ability
to use covered semiconductor products or services for their own
internal purposes. Instead, Section 5949 focuses on
procured electronic parts, products or services.
Additionally, unlike Part A, Part B applies only to products or
services that are determined to be part of a “critical
system.”2
Although Part B of Section 5949 is not as onerous from a
compliance standpoint as Part B of Section 889, government
contractors supporting “critical systems” will still be
required to take steps to inventory all U.S. government
deliverables to ensure they are not procuring products or services
for their internal use that contain the prohibited
microelectronics. Notably, however, the 2023 NDAA does not require
any covered semiconductor products or services to be removed or
replaced on a retroactive basis; instead, the prohibitions apply
only as of the five-year-out effective date.
The FAR Council Will Issue Regulations Implementing Section
5949
Within three years after the enactment date, the FAR Council
must promulgate regulations implementing the prohibitions. Major
aspects of the regulations include:
- a requirement for government contractors that supply electronic
parts or products to agencies to certify the non-use of covered
semiconductor products or services in those parts or products,
detect and avoid the use or inclusion of covered semiconductors in
such products or services, and pay for any rework or corrective
action required to remedy any use or inclusion of covered
semiconductors in such products and services; the cost of any
rework or corrective action would not be allowable under federal
contracts - a requirement of “covered entities,” prime
contractors and subcontractors to report to the government in
writing within 60 days if the entity “becomes aware, or has
reason to suspect” that an end item, component or part of any
“critical system” purchased by or for the government
contains covered semiconductor products or services - a requirement for prime contractors to incorporate the
substance of the prohibitions and implement contract clauses into
contracts for the supply of electronic parts or products
Notable Exceptions, Waivers and Safe Harbors
Several provisions are included within Section 5949 that reduce
the compliance burden on both industry and the federal government,
especially in comparison to requirements of Section 889.
- As noted above, prohibitions under Section 5949 are not
retroactive and, as such, entities are not required to remove or
replace any covered semiconductor products or services that are
considered “resident” (i.e., found within
existing equipment, systems or services). - The Federal Communications Commission (FCC) is not required to
designate covered semiconductor products and services to its List
of Covered Communications and Equipment Services maintained under
Section 2 of the Secured and Trusted Communications Networks Act of
2019 as it does with certain telecommunications equipment, software
and services pursuant to Section 889. - Section 5949 authorizes the U.S. Secretaries of Defense,
Commerce, Homeland Security and Energy, as well as the Director of
National Intelligence, to waive the semiconductor prohibitions
after the date of enactment if the waiver is in the “critical
national security interests” of the United
States.3 - Importantly, government contractors can reasonably rely on
certifications from covered entities and subcontractors regarding
the inclusion (or not) of covered semiconductor products or
services in electronic products and parts. This means that
government contractors are not required to conduct third-party
audits of their subcontractors or formal review of those
certifications. Further, government contractors and subcontractors
that notify the government that a critical system contains actual
or suspected covered semiconductor products or services will not be
subject to civil liability or determined to be non-responsible if
they have not manufactured or assembled the impacted products. If
the notification involves parts or products manufactured or
assembled by the notifying contractor/subcontractor, that company
must make an effort to identify and remove the covered products or
services.
Implications for Industry
Businesses with a nexus to the microelectronics sector in China
should exercise caution when selecting products, service providers,
vendors, suppliers and contract manufacturers. Section 5949 imposes
concrete U.S. government supply chain prohibitions on some of the
largest and most prolific chipmakers in China. Section 5949
provides executive branch agencies with the authority to designate
additional companies to the prohibited list if they determine that
the product or service is provided by an entity owned, controlled
by or connected to the government of a “foreign country of
concern,” including China, Russia, North Korea and Iran.
Considering the heightened regulatory scrutiny of the
microelectronics sector, businesses — especially federal
government contractors — must have effective visibility into
the materials and services involved in U.S. government
deliverables. This means conducting comprehensive due diligence of
suppliers, vendors and contract counterparties and considering
appropriate contractual provisions to address the new supply chain
risks. Adherence to Section 5949 will require an enhanced
understanding of your company’s global supply chains and
component parts. Preparing now will minimize future disruptions and
help ensure that your business is in compliance with U.S. law when
Section 5949 prohibitions go into effect.
If you are seeking assistance in preparing for compliance with
Section 5949, expanding your company’s supply chain due
diligence system or understanding the implications of Section 5949
on U.S. government contracting, reach out to the authors or another
member of Holland & Knight’s International Trade Group or Government Contracts Group.
Footnotes
1. For more information, see previous Holland &
Knight alert: “Commerce Department Rolls Out Measures to
Strengthen Export Controls on China,” Oct. 21,
2022.
2. “Critical System” is identified in the 2023
NDAA to mean 1) “a telecommunications or information system
operated by the Federal Government, the function, operation, or use
of which: A) involves intelligence activities; B) involves
cryptologic activities related to national security; C) involves
command and control of military forces; D) involves equipment that
is an integral part of a weapon or weapons system”; or E) is
critical to the direct fulfillment of military or intelligence
missions; 2) other systems identified by the Federal Acquisition
Security Council; and 3) additional systems identified by the U.S.
Department of Defense. “Critical System” does not include
systems used for routine administrative and business applications
(including payroll, finance, logistics and personnel management
applications).
3. Other heads of executive agencies can also waive
Section 5949 prohibitions in consultation with the Secretary of
Commerce and the Secretary of Defense or the Director of National
Intelligence, including for reasons of
non-availability.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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