When lithium-ion battery manufacturer A123 Systems experienced financial trouble, it did what many struggling companies do to stay afloat and arranged to sell off a stake in the firm. But when Congress raised concerns, the Chinese buyer pulled out, waited for A123 Systems to file for bankruptcy, and purchased the assets at auction — conveniently avoiding a national security review by the U.S. government.
Wanxiang Group Corporation made that move in 2017, but China has been acquiring sensitive national security technologies through similar bankruptcy exploitation for years, and the U.S. judicial system isn’t properly equipped to handle the problem, according to intellectual property attorney Camille Stewart, a member of the Foundation for Defense of Democracies’ Transformative Cyber Innovation Lab.
“[T]he judiciary traditionally has not felt like part of the national security apparatus and has not operated as such,” Stewart told the Washington Examiner. “And we’re seeing there is an opportunity here for the judiciary to close the gap.”
Business acquisitions involving national security technologies that could be used by a foreign government are reviewed by the interagency Committee on Foreign Investment in the United States. But Chinese companies can skirt this review by buying up an American company’s assets in bankruptcy proceedings.
With these technologies in hand, China can not only increase its own capacities but damage those of the United States.
“In addition to enhancing their own military capabilities, foreign adversaries can leverage the information acquired to discover and exploit vulnerabilities in the technology to launch highly tailored, sophisticated, and potentially catastrophic cyberattacks and to insert into U.S. supply chains malicious or compromised technology that can be exploited at a later time,” Stewart wrote in an article for the Journal of National Security Law & Policy.
National security officials have long been concerned about adversaries hacking software, but a 2016 University of Michigan study showed how a hacker can exploit circuits in computer hardware, bypassing traditional security precautions. A report in 2019 revealed that the F-35 fighter program incorporated Chinese parts, sparking concerns that the most expensive weapons program in history may be vulnerable to a prime U.S. adversary.
China has also used the bankruptcy process to exploit strategic resources. Leshan Shenghe Rare Earth Co., as part of an American-led consortium, acquired mining rights through a minority interest in the Mountain Pass mine in 2017, the only functioning rare earths mine in the United States. Rare earths are used in the production of everything from cell phones to fighter jets and have been identified by Congress as a major weak point in the U.S. national security infrastructure.
While Chinese companies are technically privately held, the Communist Party has influence over many of the major firms. Chinese firms participate in 10% to 16% of all venture capital deals, according to Stewart, with Chinese investors participating in 16% of the value of all technology deals in 2015 alone. The Council on Foreign Relations found that Chinese venture capital investment skyrocketed past $45 billion in 2016, a significant increase over the $15 billion spent the year before.
“This included acquisitions of not just established firms but also early-stage businesses and new initiatives from existing companies in nascent or newly developed technologies, in health and pharmaceuticals, in artificial intelligence (AI), and in other advanced technologies that could have cutting-edge military applications,” its report said.
The Chinese government plans to transition from being a global manufacturer of goods to a global innovator through its Made in China 2025 plan. Its rapid acquisition of foreign technology is seen as a way to address its historic weakness in creating intellectual property.
Congress expanded the Committee on Foreign Investment in the United States’ review powers in 2019 to include transactions “pursuant to a bankruptcy proceeding or other form of default on debt,” but Stewart says, the laws can only be applied properly if the judiciary understands the problem and knows what to look for.
“Training will not turn judges and attorneys into national security experts,” Stewart wrote. “However, training can elevate the issue for judges and provide enough background that they can ask questions to begin to determine the sensitivity of a technology.”