Mind-Realizing Law

Responsible Value Creation

WeChat Ban – an Opportunity for Tencent and Emerging Companies to Grow & Lead

Posted by on August 9, 2020

On August 6, 2020, Trump administration issued Executive Order on Addressing the Threat Posed by WeChat to wind down any transactions with the Tencent Holding Company related to WeChat China.  We highlight legal and strategic options available to Tencent, and emerging growth companies alike, from corporate and trade policy perspective to transform this challenge into opportunity to grow and lead.  Stakeholders must weight in other equally important perspective such as antitrust clearance, valuation, risk/return tollgate reviews, and focus on business. 

  1. Executive Summary

The WeChat Ban concerns billions of users to connect with families or in expressive activities, business freedom of Tencent and broadly market access of the Chinese ICT ecosystem overseas.  Tencent, and emerging companies alike in the ICT ecosystem, may, however, take the urgency as an opportunity to strengthen technology leadership, market access and local compliance in US, by restructuring into a reformed social media platform at shareholder level, defending its business freedom at company level, and negotiate for resuming market access at US-China level.

2. Analysis

Specifically, the WeChat Ban requires 45 days to wind down “any transaction that is related to WeChat by any person, or with respect to any property, subject to the jurisdiction of the United States, with Tencent Holdings Ltd. …, or any subsidiary of that entity” (“WeChat Ban”). 

Broad Covered Transactions

Covered transactions will be broad from B2B to B2C, especially including user activities on WeChat, which function under the user service agreement and ancillary agreements with WeChat. WeChat’s user service agreement applies exclusively Chinese law, and defines contracting parties broadly to cover broadly with various Tencent entities.  WeChat has total volume of 1.2 billion users, among which around 100-200 million are international WeChat users, US Commerce Department will identify the exact entities within the “covered transactions” within 45 days from this order.

Tencent and Chinese ICT Ecosystem at a Cross-road

Given time is of essence in light of the potential 45-day wind-down, how the WeChat Ban unfolds will establish precedents potentially impacting emerging companies beyond Tencent.

The WeChat Ban forces Tencent, and emerging companies alike establishing global presence, into the cross-road with two diverging directions:

  • Quit US market and shift back to a China-only domestic company despite being a Hong Kong-listed company with majority investors from overseas, as Ebay and Yahoo experienced in China, or change business model to advertisement only, like Facebook who has been blocked in China for a variety of reasons; or

  • Identify and assemble a seamless legal & strategic team with experienced counsels in Washington, DC to take full advantage of the urgency to structure and execute a CFIUS-compliant restructuring deal, while defending business freedom before, during and after the closing of such deal, and transform into a truly global and respectful technology leader separate from yet benefiting Tencent/WeChat at home.

Opportunities for Tencent and Why

Tencent, and emerging companies alike, would be better off if electing route (b) above, and in light of its rights and remedies under US constitution and national security / export control regime.

WeChat Ban Prophylactic Rather Than Punitive

Firstly, Tencent, and emerging companies alike, needs to appreciate the regulatory action is prophylactic rather than punitive, yet with ecosystem-wide cut-off impact.  It arises from national security concerns in US that foreign government(s) uses its software as backdoor to US information infrastructure gain undetected access to sensitive data.

WeChat Ban is not a surprise, but arrives in parallel with the impending August 13 ban that aims to remove allegedly state-connected Chinese information communication technologies (ICT) from federal government information technology networks (See our alert).  Both bans, despite of their differences in terms of targets and scope, are justified by national security concerns regarding undetected or unauthorized access to critical technology, infrastructure and data in US, by allegedly “non-market-economy” behaviors, through companies that US unilaterally deems as state-influenced, either controlled or connected.”

As such, what confronts Tencent is not just deleting WeChat while leaving its game outlets intact. What confronts Tencent is a risk to itself and Tencent’s up/downstream.  Tencent, its upstream suppliers such as cloud services providers, and Tencent’s downstream – mobile phone makers, risk losing the entire US market for their interdependent ecosystem.

Absent sufficient appreciation of the above big picture and effectively engage with US policy makers by a holistic risk management approach, a divestment alone, as floated in media, would not mitigate ecosystem-wide risks confronting Tencent.

Important Business Freedom to Defend with Compliant, Effective, and Non-Self-discriminating Engagement with US Regulators

Secondly, the administration of the executive order remains subject to judicial review under the Administrative Procedure Act, and Tencent has important legal interests to defend.  These legal interests include First Amendment (free speech) for its users and Fifth Amendment (due process) for Tencent to engage with US authorities to address their national security concerns, while protection its legitimate business freedom.

WeChat, is not merely a social media platform for families, which, like twitter, has become a channel and source of news and information for “subscribers” to “official accounts” of not only celebrities, but also US agencies, e.g., US Embassy in China.  Therefore, removing WeChat in essence would block millions if not billions of users from various information access or venues for expression.

Simply deleting WeChat account could potentially invite litigations from aggrieved customers who deem such abrupt cut-off as potential infringement of their First Amendment rights, such as participation in public forum.

Moreover, Tencent has the right to know the vulnerability in its software and data flow from US regulators in order to devise effective mitigation measures as further discussed below. 

US appellate and district courts ruled against the executive branch’s unconstitutional actions restricting access to public forum.  Further, under Fifth Amendment, private property shall not “be taken for public use, without just compensation.”  The Fifth Amendment also commands that “private property (cannot) be taken for public use, without just compensation.”  Tencent must ensure that interaction with US regulators will be effective, compliant and swift to achieve restructuring, and that any mitigation would not in any manner self-incriminate.

Discretion and Options under Executive Order

Thirdly, the executive order itself also provides discretion, primarily at the Commerce Department with respect to the exact scope of covered transaction to be banned.  As such, legally it opens up the option with potential mitigation measures (subject to effective enforcement) to restitute both reputation and escape from the ban entirely.

Engage in US-China Level Trade Negotiation to Achieve Reciprocity

Fourthly, the WeChat Ban could be view from trade policy perspective as a unilateral retaliation measure undertaken by US seeking “reciprocity” for market access of US social media platform and ICT companies.

According to USTR’s Section 301 Report 2019, USTR (United States Trade Representative) holds that US companies face market barriers ranging from content restriction under local law, foreign investment restriction regarding online publishing, broadcasting, and distribution of creative content, and the “secure and controllable” policy “erecting barriers to sales and use of foreign ICT products” in China.  The WeChat Ban and ICT Ban could be viewed as aggressive trade action pursued by US for reciprocity of market access for US counterparts to Tencent/TikTok and Chinese ICT companies. 

It would be a likely choice to Tencent to petition home government to address market access issues under international trade rules.

In sum, Tencent may restructure and re-engineer into a reformed social media platform at shareholder level, while defending its business freedom at company level, and negotiate for market access at US-China level.

Defensive Measures and Compliant Restructuring Scenarios Available

Such restructure may take various forms but requires CFIUS (Committee on Foreign Investment in United States) clearance as follows:

  • Spin-off: spin-off its US entities into standalone company(ies) and cause its shareholders to transfer equity interests to CFIUS-compliant buyer(s)

  • Divestiture: sell its US assets to CFIUS-compliant buyer(s) to integrate further

  • Management buyout (MBO): Tencent’s US management may team up with private equity firm(s) to acquire the US businesses from Tencent.

In either scenario, Tencent may select buyer like Microsoft, who potentially may integrate both TikTok and WeChat into perhaps a rejuvenated MSN massager, to enhance competition and consumer choices in US along with Facebook and Twitter. 

Alternatively, Tencent also has option to consider buyers from private equity firms, who must be managed by general partners who are controlled and managed by U.S. nationals, under the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) (Pub. L. 115-232).  Tencent’s parent company or non-China investors may serve as limited partner without board membership/observer rights, substantive decision-making, or access to sensitive data, to mitigate national security concerns while minimizing interruption to financial returns, subject to CFIUS scrutiny.

The restructure deal, must, from substance (from data access to corporate governance) to form (contracting parties of its user agreements), ensure no “covered transaction” under the current WeChat ban.  Such mitigation measures potentially would also envisage an entirely new and robust compliance function and team separate from control, influence or connection with current Tencent organization.

The above scenarios also apply to emerging companies alike in the stage of establishing global presence, subject to company-specific facts, strength, weakness, and ambitions.

3. Outlook

Tencent, as well as emerging companies alike in the ICT ecosystem, must allocate sufficient time and resources from busy and prosperous life in China, engage with US regulators through experienced trade and investment counsels to zealously defend their interests, hold faith in the rule of law in United States, and turn the ban into an excellent opportunity to differentiate, and grow into a leader of both technology advancement and compliance championship, for itself and for its billions of users.

Please feel free to let us know if you have any questions. Thank you.

About the author: Yi Wang, trade and business attorney with public and private sector experience in mergers & acquisitions, trade regulation, regulatory counseling and compliance defense and may be reached at yi.wang@mind-re.org