Chinese semiconductors are ubiquitous within the United States and its private- and public-sector supply chains. To contend with the attendant national security and economic risks (whether real or perceived), Congress recently took decisive action via the annual defense authorization process to prohibit federal procurement of electronic parts, products, or services that include certain Chinese semiconductors, as well as federal contracting with an entity to procure or obtain electronic parts or products that include such semiconductors.
Enacted as Section 5949 of the National Defense Authorization Act for Fiscal Year 2023 (NDAA FY23), the new law raises substantial new questions and compliance risks for government contractors—similar in kind, though not necessarily in scope, to Section 889's blanket prohibition on certain Chinese telecommunications equipment within federal procurement. It reflects merely the latest (and, presumably, not the last) effort by policymakers to combat Chinese state-owned influence within, and national security threats to, the U.S. economy, infrastructure, and supply chains.
As we recently previewed, this alert is designed to shine a light on this sweeping new prohibition, including its motivation and anticipated implementation, and to help provide clarity to contractors making fundamental business and compliance decisions in the near (and distant) term as Section 5949 comes into force. While regulations implementing the Section 5949 prohibitions are not expected for three years—and compliance with the prohibitions will not begin for five years—federal contractors should take steps now to determine the impact that Section 5949 will have on their supply chains and how they can start preparing for the forthcoming regulatory requirements and avoid costly compliance obligations in several years.
Background—Section 889, Legislative Effort to Expand Section 889, and Enactment of Section 5949
In bipartisan fashion, policymakers in recent years have repeatedly prioritized challenging the predominance of Chinese manufactured technology in U.S. supply chains, whether through prohibitions of certain technology and regulatory classifications or through the encouragement of and investment in more domestic, onshore manufacturing. In the procurement arena, Section 889—enacted via the NDAA for Fiscal Year 2019—is particularly familiar to (or, infamous among) private sector entities that contract or do business with the federal government.
Motivated by national security and counterespionage concerns, Section 889 prohibits federal agencies from contracting for (Section 889 "Part A")—or even with entities using (Section 889 "Part B")—certain Chinese manufactured telecommunications and video surveillance services or equipment. As we have extensively covered before, Section 889's prohibitions continue to raise substantial compliance risks for government contractors, especially given the law's scope—reaching not only the procurement of such equipment but also a contractor's own internal use of such equipment—and relatively short timeline for implementation. For example, Section 889's Part B "use" prohibition took effect just two years after enactment.
In September 2022, U.S. Senate Majority Leader Chuck Schumer (D-NY) and Senator John Cornyn (R-TX) unveiled a bipartisan legislative effort to directly amend Section 889 to expand its coverage to products containing certain Chinese manufactured semiconductors, including those "designed or produced by, or any service provided by, Semiconductor Manufacturing International Corporation (SMIC), ChangXin Memory Technologies (CXMT), or Yangtze Memory Technologies Corp. (YMTC) (or any subsidiary, affiliate, or successor of such entities)." Filed initially as an amendment to the NDAA as passed by the U.S. House of Representatives, the effort would have added such "covered semiconductor products or services" to Section 889's Part A "procurement" and Part B "use" prohibitions.
In short, the proposed amendment would have prohibited federal agencies from contracting (or extending or renewing a contract) with any entity that "uses any equipment, system, or service that uses" the covered semiconductor products or services "as a substantial or essential component of any system, or as critical technology as part of any system."
Reaction to the effort—in both support and objection—was swift. Members of the national security community, as well as the American Free Enterprise Chamber of Commerce, hailed the amendment as "a critical matter of national and economic security" and "an opportunity to help keep America's government secure and her people prosperous by protecting against Chinese cyber threats and any dependence on China for our critical infrastructure and defense capabilities."
In contrast, a coalition of trade associations, including the U.S. Chamber of Commerce, stressed that absent changes to the proposal, "adding the covered semiconductors to part B of section 889 would harm federal agencies' ability to procure the essential goods and services they need to promote our nation's well-being, while putting added financial pressure on businesses that are operating in an inflationary economy." According to the coalition letter:
Semiconductors are small subcomponents found in every system with electronics—such as a toaster containing a couple of semiconductors to a vehicle containing hundreds of semiconductors. Including semiconductors in part B would make policy design and implementation unquestionably vague, overly inclusive, and not risk based. For example, under the amendment, a company with both federal and nonfederal customers would be barred from selling to the government because it "uses" a coffee service that "uses" the covered semiconductors.
As is evident below, at least some of the concerns raised by industry stakeholders proved impactful. In December 2022, Congress adopted a compromise version of the Schumer/Cornyn amendment, now codified as Section 5949 of the NDAA FY23. And, rather than amend Section 889, Section 5949 stands as its own independent prohibition on certain technologies within federal procurement.
Even in its compromise form, Section 5949 raises similar (and substantial) compliance questions for government contractors, who should diligently plan and prepare for its eventual implementation. Moreover, although the recent bipartisan push to impose a "use" prohibition on Chinese semiconductors fell short this year, a similar ban may very well reappear in next year's NDAA.
A Closer Read of Section 5949
In similar fashion to Section 889, Section 5949 has both a Part A and Part B that impose related but distinct prohibitions within the contracting arena.
Part A
Subparagraph (a)(1)(A) of Section 5949 provides that the head of an executive agency may not "procure or obtain, or extend or renew a contract to procure or obtain, any electronic parts, products, or services that include covered semiconductor products or services."
The law directly targets certain manufacturers of semiconductors, defining "covered semiconductor products or services" as a "semiconductor, a semiconductor product, a product that incorporates a semiconductor product, or a service that utilizes such a product, that is designed, produced or provided by" Semiconductor Manufacturing International Corporation (SMIC), ChangXin Memory Technologies (CXMT), Yangtze Memory Technologies Corp (YMTC), and any subsidiary, affiliate, or successor of such entities.
Similar to Section 889, Section 5949 provides that others may be added to the list of prohibited semiconductor manufacturers, if "the Secretary of Defense or the Secretary of Commerce, in consultation with the Director of the National Intelligence or the Director of the Federal Bureau of Investigation, determines [such entity] to be an entity owned or controlled by, or otherwise connected to, the government of a foreign country of concern." In contrast to Section 889, however, Section 5949 provides for the possibility of covering entities operating out of other foreign countries "of concern," such as Russia, North Korea, and Iran.
Part B
Subparagraph (a)(1)(B) of Section 5949—relying on the same definitions quoted above—provides that the head of an executive agency may not "enter into a contract (or extend or renew 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."
Astute contractors should keep in mind two key points relating to Section 5949's Part B.
First, the originally proposed Schumer/Cornyn amendment would have prohibited federal contracting with a contractor that merely "uses" covered semiconductor products or services within the contractor's own internal, non-government operations. Thus, Section 5949's Part B on its face differs in scope from Section 889's Part B, only prohibiting the government's ability to contract with an entity to procure or obtain "electronic parts or products" that themselves "use any electronic parts or products that include covered semiconductor products or services."
Second, Section 5949's Part B prohibition does not extend to "products or services . . . in a system that is not a critical system." By cross-refence to another statute, the law generally defines "critical system" as "a telecommunications or information system operated by the Federal Government, the function, operation, or use of which . . . involves intelligence activities . . . cryptologic activities related to national security . . . involves command and control of military forces . . . involves equipment that is an integral part of a weapon or weapons system . . . [or] is critical to the direct fulfillment of military or intelligence missions."[1]
While Section 5949 leaves room for "additional systems" to be considered a "critical system," context suggests that Part B will generally apply only to procurements concerning key military and intelligence systems.
Timelines, Waivers, and Other Notable Provisions
Section 5949 provides important waivers and rules of construction that all contractors should bear in mind. For example, nothing in the law's prohibitions shall be construed "to require any covered semiconductor products or services resident in equipment, systems, or services as of the day before the applicable effective date . . . to be removed or replaced," or "to prohibit or limit the utilization of such covered semiconductor products or services throughout the lifecycle of such existing equipment." In short, Section 5949 is not retroactive.
Section 5949 also grants limited waiver authority to the Secretary of Defense, Director of National Intelligence, Secretary of Commerce, Secretary of Homeland Security, and Secretary of Energy if waiving the law's prohibitions is in the "critical national security interests" of the United States.
Moreover, unlike Section 889, Section 5949 provides a comparatively longer runway for contractors to prepare and adjust (if necessary) their actions and supply chains to comply with the prohibitions.
First, Section 5949's prohibitions (both Part A and Part B) will take effect five years after the date of enactment, which occurred on December 23, 2022.
Second, within three years of the date of enactment, the Federal Acquisition Regulatory Council (FAR Council) must prescribe regulations implementing the law's prohibitions. Among other requirements, the regulations shall:
- "provide that contractors who supply a Federal agency with electronic parts or products are responsible for (A) certifying to the non-use of covered semiconductor products or services in such parts or products; (B) detecting and avoiding the use or inclusion of such covered semiconductor products or services in such parts or products; and (C) any rework or corrective action that may be required to remedy the use or inclusion of such covered semiconductor products or services in such parts or products";
- "provide that the costs of covered semiconductor products or services, suspect semiconductor products, and any rework or corrective action that may be required to remedy the use or inclusion of such products are not allowable costs for Federal contracts";
- provide that "any . . . Federal contractor or subcontractor who becomes aware, or has reason to suspect, that any end item, component, or part of a critical system purchased by the Federal Government, or purchased by a Federal contractor or subcontractor for delivery to the Federal Government for any critical system, that contains covered semiconductor products or services shall notify appropriate Federal authorities in writing within 60 days"; and
- "provide that Federal bidders and contractors . . . may reasonably rely on the certifications of compliance from covered entities and subcontractors who supply electronic parts, products, or services when providing proposals to the Federal Government."
Key Takeaways for Government Contractors
Section 5949 represents a substantial, but not unprecedented, shift in the federal government's procurement posture. And as China—and other foreign countries "of concern"—seeks to extend its global influence, Section 5949 may only be the latest in a stream of new compliance considerations and costs for government contractors relating to federal supply chains.
As with Section 889, the devil may be in the details. But if Section 889's past is prologue, it is clear that, starting at dollar one, government contractors (even if only providing commercial products) will be called upon to detect and avoid the use or inclusion of such covered semiconductor products or services in such parts or products, and then certify to such. This alone will require additional and costly compliance infrastructure, and of course subject government contractors to additional liability (such as treble damages under the False Claims Act). Accordingly, contractors should not sit idly by as these new prohibitions are interpreted and implemented.
Rather, contractors should not wait until the FAR Council issues its proposed rule to begin evaluating their supply chains and taking early steps, where feasible, to identify and exclude potentially banned semiconductors from new equipment that Section 5949 will likely implicate.
Contractors should also consider proactive engagement in the policymaking process, whether by engaging directly with Congress if additional clarity is needed in the statutory language of Section 5949 or by reviewing the FAR Council's proposed rules once published and submitting comments during the public notice and comment rulemaking process. Participation in this process—as in any public rulemaking—can greatly impact the scope, applicability, and impact of the eventual rules, including their impact on one's own organization. As demonstrated in the rollout of Section 889, and even now, several years later, some terms and concepts remain vague and ambiguous, making compliance that much more difficult. Early input, such as amendments to the legislative language or simply engaging with the FAR Council, could help mitigate against ambiguity and unintended consequences in the future.
While Section 5949 could have gone further—as evidenced by the originally proposed amendment—it still represents a sizeable risk and, for many contractors, significant costs. Venable will continue to closely track and provide timely analysis of the new law's implementation.
If you have questions about how Section 5949 may affect your organization or its ability to compete for federal procurement opportunities in the future, or wish to discuss how you might be able to provide input to Congress or the FAR Council on the interpretation or implementation of the statute and/or promulgated rules, please reach out to these Venable authors.