Saturday, December 20, 2014

Ruling of the Week 18: Transfer Price

Customs valuation is subject to its own rules and requirements. Importers apply those rules and requirements when reporting the value of merchandise to Customs and Border Protection. As you likely know, when the buyer and the seller are related, the sales price between the parties is suspect and Customs can seek to determine whether the relationship affected the sales price. If so, the related party price might be rejected as a basis for transaction value, causing Customs to apply a different basis for valuation. That is a compliance hassle that no one wants.

Over on the income tax side of things, they have their own statutory rules and tests to determine whether transfer prices are an acceptable means of valuing products. The problem for customs compliance professionals is that the IRS tax compliance often drives transfer pricing and customs compliance must find a way to make due with the result. IRS compliance is sometimes the big dog that wags customs valuation as a small tail. When the customs compliance professionals press for changes to the transfer pricing system, the response is sometimes "We can't touch that, it is controlled by tax." That is not always the case and customs compliance people can make their lives a lot easier by educating tax professionals on customs issues.

Customs HQ Ruling H2043 (Aug. 18, 2014) illustrates some of that tension. In the ruling, the company involved was buying pharmaceutical products from its related party in Germany. The two companies were operating under a bilateral Advanced Pricing Agreement for tax purposes. This agreement required that the selling party maintain a certain level of profit to establish what the IRS and foreign tax authorities considered to be an arms-length level of profits. To accomplish this, the companies made accounting adjustments to transfer money back and forth over a period of years to get the seller to the level of profitability required by the APA.

Because the U.S. company was smart, it realized that these adjustments were made to the cost of goods sold to the U.S. company and might represent changes to the dutiable value of the imported goods. Consequently, the company filed a prior disclosure with Customs and Border Protection. The disclosure identified the adjustments and argued that they are not dutiable because the adjustments were for tax purposes and did not reflect the value of the merchandise.

In this case, Customs found that the way the APA worked, the adjustments were made to cost of goods sold with the intention that the adjustment affect the profitability of the seller. Based on this, Customs found that the adjustments had a direct impact on the price paid for the imported goods and, therefore, were part of the customs value of the merchandise.

That causes a potential problem for the importer. Between related parties, transaction value is only applicable where the relationship did not affect the price. If you think about the reason for these adjustments, you can see that the adjusted price was clearly impacted by the relationship between the parties. The parties were making the adjustments for the express purpose of managing the profitability of the seller, with the blessing of the IRS. That necessarily raises the question of whether transaction value is applicable.

Customs has established a five-part test to determine whether transaction value is applicable to related party transactions subject to a formal transfer pricing policy. Under that test, the transfer price is acceptable where:

(1) A written transfer pricing policy is in place prior to importation and the policy is prepared taking IRS code section 482 into account;
(2) The U.S. taxpayer uses its transfer pricing policy in filing its income tax return, and any adjustments resulting from the transfer pricing policy are reported or used by the taxpayer in filing its income tax return;
(3) The company’s transfer pricing policy specifies how the transfer price and any adjustments are determined with respect to all products covered by the transfer pricing policy for which the value is to be adjusted;
(4) The company maintains and provides accounting details from its books and/or financial statements to support the claimed adjustments in the United States; and,
(5) No other conditions exist that may affect the acceptance of the transfer price by CBP

 The theory is that where these factors are present, the adjustment to sales represents the application of an objective formula, which has always been acceptable for transaction value.

In this case, the importer apparently did not provide information supporting the application of transaction value on the basis of the five-part test. As a result, Customs found that the importer could not claim the benefit of an objective formula, which would have allowed for refunds in the case of adjustments that lowered the purchase price.

Instead, counsel for the importer argued that the five-part test is inapplicable. Rather, counsel argued that the circumstances of the sale indicate that the relationship did not affect the price. This is also a legally viable way to preserve the application of transaction value. As Customs and Border Protection puts it: "[T]ransaction value is an acceptable basis of appraisement only if, inter alia, the buyer and seller are not related, or if related, an examination of the circumstances of the sale indicates that the relationship did not influence the price actually paid or payable, or the transaction value of the merchandise closely approximates certain 'test values.'” 19 U.S.C. §1401a(b)(2)(B); 19 CFR §152.103(l).

Unfortunately, the company did not submit sufficient information to prove that the circumstances of the sale indicate the relationship did not affect the sale price. As a result, increases in value need to be reported and, to the extent duties are applicable, duties paid.

Sunday, December 14, 2014

Another Loss for Customs Trolls

It has been said, possibly only by me, that every object will become the object of obsession for at least one person. In the Internet age, people who share an interest or passion for something mundane can find one another and form tribes of fellow aficionados willing to obsess over their chosen totem. Here are a few examples: spoons, fishing lures, antique bottles, pepper mills, and my personal favorite old computers (that's the first computer I ever purchased). It turns out, that there are also pencil aficionados (here, here, and here), one of whom was the unnamed plaintiff in United States ex rel. John Doe v. Staples, Inc. et al.

Let's backtrack a bit. The False Claims Act is an 1863 law enacted to fight fraudulent claims for reimbursement by the government following the Civil War. Under the FCA, the government can bring a case against anyone making a false claim seeking payment from the government and against anyone who makes a false statement to avoid making a payment to the government. Technically, the latter is a "reverse false claim," but it works the same way.

In cases where an individual has information that would support an FCA case that the government has not brought, the individual can commence the case in the name of the government. If the government can then decide whether to take up the case. If, for whatever reason, the government decides not to take the case, the individual, known as the "relator," can continue to press the case on its own, though legally in the name of the United States. If the defendant is found to have violated the FCA, it can be liable for treble damages. The successful relator can be awarded up to a third of the recovery, making a substantial incentive to start these cases.

But, there are limits built into the FCA to discourage opportunistic lawsuits filed by individuals without any direct independent knowledge of the alleged fraud. In the customs law context, I have dubbed these individuals "customs trolls." The main impediment to customs trolls is that the case must not be built around information or allegation that have previously been publicly disclosed. Sources of public disclosure include the news media and administrative reports. An exception to public disclosure is where the relator is an original source of the information with direct and independent knowledge.

In this case, the relator is an unnamed pencil aficionado who claims to be an industry insider. He claims to be able to spot a Chinese made pencil from a number of physical characteristics. Noting that there is an antidumping duty order on pencils from China, this person was smart enough to realize that there is an incentive for pencil importers (or their suppliers) to falsely state that the origin of their pencils is other than China. This would avoid the imposition of antidumping duties and would also violate the FCA.

Source: Art Discount UK


Like the customs troll in Victaulic, this relator also undertook some PIERS data mining to see how major pencil importers were reporting the country of origin to Customs and Border Protection. Using that data and the relator's personal expertise to spot Chinese-origin pencils, the relator alleged fraud on behalf of Staples and others.

The United States District Court for the District of Columbia dismissed the case on the basis of the public disclosure doctrine. In this Appeal, the United States Circuit Court of Appeals for the District of Columbia affirmed that dismissal.

There are two parts to a successful qui tam action, as private FCA cases are known. The first is proving that a claim has been made. The second is that the claim is false, which is proved by showing the true facts. To be barred by the public disclosure doctrine, both parts must have been disclosed. In this case, the PIERS data showed the claims: the country of origin asserted at the time of entry. PIERS is a media source of information that qualifies, for a limit group of trade and logistics geeks, as "news." Thus, the PIERS data was publicly disclosure.

The second part of the claim is establishing the true origin of the pencils. In this case, the relator identified a number of physical characteristics that are unique to Chinese-origin pencils including a distinctive method of joining the halves of the pencil, off-center leads, low quality erasers, inferior paint, and loose ferrules (those metal bands joining the pencil and the eraser). The problem for the relator is that many of these characteristics were also listed in the International Trade Commission report. The relator argued that these elements were obvious and should have been enough to alert the importer to the actual origin of the pencils and to alert the government to the false claims.

Unfortunately, that argument cuts against the relator's claim that the information was not publicly disclosed. The ITC report identified the relevant characteristics. The ITC report is an administrative report that constitutes a public disclosure. Furthermore, the fact that the physical characteristics should have alerted both the government and the importers to the actual origin of the pencils, indicates that the public disclosure was effective (which is not even a requirement). The Court of Appeals, therefore, found that "Relator has thus pled [sic] himself out of court."

Using some satisfying language, the Court went on to say (emphasis is mine):

Under Relator’s theory, however, anyone armed with the information in the ITC reports could troll the aisles of any office-supply store for pencils with loose ferrules or off-center leads. The would-be plaintiff could then determine whether the retailer had paid the required antidumping duties by reference to other public information, and if it had not, then voilĂ , the plaintiff would be entitled to millions of dollars in qui tam compensation. But these sorts of lawsuits, brought by “opportunistic plaintiffs who have no significant information to contribute of their own,” are precisely the kind the public disclosure bar seeks to prevent.

So, is this the end of customs trolls? Not likely. This case only controls in the DC Circuit. Other Circuits may take a different approach until the Supreme Court says otherwise. What it does is make customs-related FCA cases harder for individuals outside of the import supply chain (i.e., the trolls). Individuals who work within the supply chain, including importers and brokers, are direct and independent sources of information that might still support FCA claims. My guess is that the next step for customs trolls is to start renting hotel conference rooms to hold seminars on how compliance people can make millions by signing on as relators.

Epilogue: What is with the crappy erasers? I find I am forever running into terrible erasers on pencils. Many do more damage to the page than they succeed in removing mistakes. I have here a Dixon Oriole and a Spider-Man wrapped novely pencil labeled "Made in China." Both have hard and smooth erasers that make a mess of the page. Rather than erase the offending line, the Oriole seems intent on spreading it out so that I end up with a wide swatch of graphite on my page. The Spider-Man pencil doesn't so much remove the pencil mark as it does create an apparently permanent blot of pink particles embedded on the page. In contrast, a Staedtler 134-HB cleanly erases the mark without leaving an additional residue on the page. I am similarly happy with a Dixon Ticonderoga HB 2, which seems to remove more of the mark. A second Oriole seems to work just fine. What gives, are the erasers inherently bad or do they go bad over time?

Wednesday, December 10, 2014

GRK Backlash

GRK Canada, Ltd. is a big deal. I have already posted about it twice (here and here) and this is a third time. It goes to the very heart of how Customs and Border Protection and the U.S. Court of International Trade should interpret the Harmonized Tariff Schedule of the United States. If you are a diligent compliance professional, this is likely far more important to your day-to-day work life than is the decision in Trek Leather, which has caused much teeth gnashing.

Recall that the issue in GRK is the proper tariff classification of "wood screws." The Court of International Trade looked very closely at the physical characteristics of the screws and did not focus on the apparent common use of the screws, which is to fasten wood. Unable to differentiate between wood screws and self-tapping screws on the basis of physical characteristics, the CIT employed General Rule of Interpretation 3(c) and classified them as self tapping screws, the last tariff provision in numerical order. The Federal Circuit reversed and held that the CIT should not ignore the use of the product when the eo nomine designation (i.e., the name of the thing) suggests a particular use.

I was unhappy with that analysis, which is almost wholly irrelevant. On the other hand, GRK Canada was also unhappy. That matters because the company was able to file a petition for rehearing en banc in which it asked the entire Court of Appeals to reconsider. The Court has done so and rejected the petition over a strong dissenting opinion written by former-CIT judge Evan Wallach and former trade practitioner Jimmie Reyna. That dissent is worthy of a very close read.

The dissent correctly notes that there are several distinct types of tariff items. The first are eo nomine, meaning that the tariff text describes the item by name. Tariff items covering "woodwind instruments," "beverages," and "motors" are eo nomine provisions. Another type of tariff item is the use provision in which classification is determined based on the use of the item. For example, HTSUS item 8413.70.10 covers "Stock pumps imported for use with machines for making cellulosic pulp, paper or paperboard." Another example is 8477.10.40, which covers injection molding machines "for use in the manufacture of optical media." A third type of tariff classification is the basket provision, which is not relevant here.

When construing an eo nomine item, the Court (and by implication Customs and Border Protection and importers) must look to the text of the heading and then to the relevant legal notes that define the scope of the heading. That is General Rule of Interpretation 1. The Court must then determine whether the item in question fits within that scope.

Classifying in a use provision works differently. Under Additional U.S. Rule of Interpretation 1(a), the scope of the a heading or tariff item controlled by use is determined by the principal use of goods of the same class or kind. The class or kind is determined under the co-called Carborundum factors. But, ARI 1 is only applicable in cases where the tariff classification is based on use. GRI 1 through GRI 6 do not implicate the use of the product and most classifications are resolved by the application of GRI 1. Because of these two distinct analytic approaches, the Federal Circuit has repeatedly said that it will not read a use limitation into an eo nomine provision unless the name of the article inherently suggests a type of use.

That last bit about the name of the article suggesting a use is the problem here. In its original opinion, the Federal Circuit latched on to that and said "[O]nce tariff terms have been defined, it may be the case that the use of subject articles defines an articles' identity when determining whether it fits with the classification's scope." From that, the Federal Circuit held that it was appropriate to look to the Additional U.S. Rule of Interpretation to distinguish articles by name based on their use.

This is the heart of the problem the dissenting judges see. It is, to put it in pop culture terms, crossing the streams. We all know that is dangerous.


According to the dissent, "Any suggestion that the ARIs may need to be reached in the context of an eo nomine analysis is foreign to our classification case law, and conflicts with the clear statutory language of the ARIs." Furthermore, the dissent sees sloppy language [Note: that's my term] mixing up "intended use," "predominant use," and "primary use," which does not clarify the analysis. There are two kinds of use: principal and actual. Any use analysis should be based on one or the other.

The majority of the Federal Circuit is not wholly without support. There is an old case called Quon Quon in which the Court of Customs and Patent Appeals took a similar approach. But, that case was under the old TSUS, not the HTSUS and the current GRI and ARI did not control. So, this is a different statutory context. More recently, the Federal Circuit decision in Camelback seems to indicate that use is a factor in some eo nomine classifications. We previously discussed how that case deviated from traditional HTSUS analysis (even though I was OK with the result). The dissent says Camelback is an exception because the addition of the liquid bladder transformed the backpack into something other than what would be within the scope of the eo nomine description. Use was not the primary driver of the decision in Camelbak.

The dissent then makes a very interesting observation: "Indeed, if an eo nomine heading did 'inherently suggest[] a type of use,' it would appear proper to convert it to a use provision." Where have I heard that before? Oh, right here, where I said it. The dissent goes on to say "[I]f, as the majority holds, the subheadings at issue are truly defined by use, the majority should have reconsidered the parties' legal stipulation that the relevant subheadings are eo nomine. A narrower holding that, although the subheadings appear to be eo nomine, they are as a matter of law use provisions governed by the use analysis, would have avoided disruption of our well-settled precedent."

Amen to that.

This case is headed back to the CIT where I have no idea what will happen.

Monday, December 08, 2014

Jurisdictional Sprouts/Ruling of the Week 17

This is the last of the cases I have in my cue.

General Mills, Inc. v. United States is one of those cases only a lawyer would love or would hate, depending on which side of the dispute you happen to be. The problem for General Mills is that it wants the Court of International Trade to review a ruling in which Customs and Border Protection determined that Brussels sprouts from Belgium that were packaged with frozen butter sauce chips in Mexico are not entitled to duty-free entry to the United States under the North American Free Trade Agreement.

Part I: The Ruling

Let's start with with ruling, so that I can also call this my Ruling of Last Week 17. The relevant ruling is HQ H212296, which is in the January 29, 2014 Customs Bulletin starting at page 89. The NAFTA portion of the ruling is in dispute and is interesting.

Keep in mind that the imported product is just frozen Brussels sprouts from Belgium packed in pouches in Mexico with frozen butter chips. The finished product is classifiable in Heading 2004 as "Other vegetables prepared or preserved otherwise than by vinegar or acetic acid, frozen, other than products of heading 2006." At first blush, the NAFTA rule of origin for the prepared sprouts requires a change from any other chapter. The non-originating frozen sprouts are classified in Heading 0710. So, it looks like there is a qualifying tariff shift from 0710 to 2006.

But, Customs and Border Protection disagrees. General Note 12(s)(ii) says that:

Fruit, nut and vegetable preparations of Chapter 20 that have been prepared or preserved merely by freezing, by packing (including canning) in water, brine or natural juices, or by roasting, either dry or in oil (including processing incidental to freezing, packing, or roasting), shall be treated as an originating good only if the fresh good were wholly produced or obtained entirely in the territory of one or more of the NAFTA parties. 
According to Customs, this precludes a finding that the packaged sprouts are NAFTA goods because the fresh produce was not wholly obtained in North America.

General Mills, of course, sees it differently. According to it, the sprouts are not "merely" frozen because they are combined with butter chips, which are not water, brine, or natural juices. That leads to the logical conclusion that Note 12(s)(ii) does not apply. Ergo, Brussels sprouts from Belgium are NAFTA goods when packed with originating butter chips in Mexico.

Customs and Border Protection takes a bit of a hand-waving approach to its conclusion. Finding that the Note applies, Customs said only that the butter sauce chips "are akin to a natural juice" and that any extra ingredients are incidental to the sprouts themselves. This is the nub of what General Mills wants reviewed. This single conclusion changes the duty status of the sprouts and is probably worth a lot of money to the importer, which is why it went to Court. Also, I have eaten many Brussles sprouts, notably the best ever from Chicago's Girl and the Goat. In no case have I ever seen natural sprout juice that was akin to butter.

Part II: The Court of International Trade

Apparently, General Mills has not made liquidated entries of these sprouts on which Customs has denied NAFTA treatment. If it did, General Mills would most likely have protested the liquidations and gone to court for review of the denied protest under 28 U.S.C. § 1581(a).

There are two other ways that importers can get a CBP decision reviewed. The first is under § 1581(h), which seems right on the money. Under that provision, an importer can directly challenge a negative ruling from CBP. The problem is that to get into Court that way, the importer needs to show that it will suffer "irreparable harm" if the decision is not reversed. When all we are talking about is money, it is almost impossible to show irreparable harm. Money can always be returned as damages in a lawsuit, so financial losses are usually reparable.

In this case, the plaintiff opted for § 1581(i)(4), which is part of the broad grant of residual jurisdiction to the Court of International Trade to review other CBP decisions regarding the administration and enforcement of the customs laws. But, a plaintiff may not rely on (i) jurisdiction if another specific grant of jurisdiction is available and not manifestly inadequate.

Here, the Court of International Trade found that General Mills had the option of importing some of the product, making a NAFTA claim, having the claim denied, protesting, having the protest denied, and then going to Court. The fact that this is a possibly circuitous route to Court or that it was a waste of time because CBP was certain to deny the claim, does not relieve General Mills of the ability to seek review. Consequently, General Mills can only get into Court if this route to relief is "manifestly inadequate."

Relief is only manifestly inadequate when it is an exercise in futility or will not produce any result. This is a relatively high standard as Congress did not intend that imports be able to avoid the usual route of reviewing a denied protest. Getting onto a slightly different tack, General Mills argued that creating test shipments for litigation will lead to a number of costs that cannot be addressed in the protest review process. But, the Court saw this as the test for irreparable harm rather than manifestly inadequate. Absent a showing that the protest process is manifestly inadequate, the Court dismissed the case.

On top of that, it refused to transfer the case to a United States District Court.

The moral of that story is that most CBP decisions involving rate of duty are going to subject to judicial review only after the importer goes through the administrative protest process.

Sunday, December 07, 2014

Oh, The Humanity

Hydrogen fuel cells are likely to play a significant role in powering the future. We are on the cusp of seeing passenger cars powered by fuel cells. Fuel cells are used in spacecraft and in more mundane setting like the devices that spray air fresheners in public washrooms. The nature of a fuel cell was also front and center in the recent U.S. Court of International Trade decision in Rubbermaid Commercial Products, LLC v. United States, which involved air fresheners and a similar device that squirts cleaners into public toilets.

Here is a little science that will help explain the legal issue. Keep in mind that water is two hydrogen atoms bound to a single oxygen atom. A fuel cell consists of zinc and water with a cathode and an anode. The cathode is a negatively charged electrode, which attracts positively charged particles. The anode is positively charged and attracts negatively charged electrons. In the fuel cell, the zinc and water are chemically reacting with the oxygen in the water oxidizing the zinc to produce zinc oxide, which has the formula ZnO. Junior chemists will note that when the zinc and oxygen bond, hydrogen is left to its own devices. In other words, free hydrogen gas is the byproduct of the production of zinc oxide.

The physicists among us will recognize an additional byproduct. There are two free electrons liberated in the process of making ZnO. The negatively charged electrons in the water solution are attracted to the anode. The anode and cathode are connected by a conductor, allowing the electrons to flow back to the water where the reaction produces hydroxyl ions and hydrogen.

Source: Wikipedia


So, the fuel cell is two things. In part, it is a chemical reactor in which zinc is oxidized to produce hydrogen and zinc oxide. It is also an electrical circuit that captures and channels free electrons produced in the chemical process. Fuel cells are a useful technology for both reasons. Hydrogen is a clean burning fuel that can run internal combustion engines. Of course, history shows that filling lighter-than-air vehicles with hydrogen is not the best idea. The bonus product of electricity is valuable for innumerable other uses large and small. And, this process is completely free of burning hydrocarbons. Water is the principal fuel with hydrogen or electricity as the byproduct, depending on your design.



 This is all relevant to the Rubbermaid case, which had to determine whether the fuel cell powered dispensers are classifiable in Heading 8543 as electrical machines or apparatus or in 8424 as mechanical appliances. This is a question because the dispensers are effectively pumps that are powered by not the electricity generated in the fuel cell but by the physical pressure of hydrogen gas. When the pressure hits a pre-determined level, it is strong enough to force some of the liquid out of the storage chamber. That is an entirely mechanical process, but it depends on electrical action as a motivator. Furthermore, the frequency of dispersing the liquid depends on how an electrical resistor is adjusted. When more electricity flows into the solution (as opposed to being dissipated in the resistor), the reaction is faster and liquid is dispensed more frequently.

The Explanatory Notes to the Harmonized system help differentiate between Chapters 84 and 85 by explaining that Chapter 84 covers machinery and mechanical apparatus while Chapter 85 covers electrical goods. [Side note from Larry: Why are computers in 8471? Is it because they used to be hand-cranked adding machines?] The Notes also provide that machinery not more specifically provided for in Chapter 85 are classified in Chapter 84, even if electric.

The distinction between 84 and 85 is, however, hardly clear. In an effort to cut to the chase, I will say only that after a thorough analysis of the Explanatory Notes, the Court of International Trade concluded that devices that depend on the properties or effects of electricity to operate will be classified in Chapter 85 unless they are described specifically in Chapter 84. [Like computers, for example.]

So, the first question is whether these items are covered by a specific heading of  Chapter 84, which would then preclude their classification in Chapter 85. As I said, these are analogous to a pump but are more similar to a mechanical appliance for dispersing or spraying liquids of Heading 8424. In this case, they do not spray. Rather, they release drops of fluid. Rubbermaid contended that this is dispersing. The court disagreed and found that dispersing requires a jet, spray or dispersion of fluid. Releasing a drip is, on the other hand, "dispensing." So, these are not described by 8424.

That means the Chapter 84 and Chapter 85 basket provisions are what remain in contention. Thus, the next question is whether these devices are "mechanical appliances" for purposes of Chapter 84. To be mechanical, the device must incorporate moving parts to perform work. Here, the hydrogen gas displaces the fluid and performs work in the technical sense. But, the hydrogen gas is generated by the electro-chemical action of the fuel cell. Consequently, the Court found the fuel cell to be the "predominant factor" in evaluating the whole device. The other moving parts are incidental and the device is not a "mechanical appliance."

That leads to the question whether the devices rely on the property or effects of electricity to operate. If so, Chapter 85 will prevail. As described above, these devices contain an electrical circuit between the anode and cathode that drives the production of hydrogen gas, which dispenses fluid. According to Rubbermaid, this is not sufficiently "electric" to be classified in Chapter 85. Rubbermaid pointed out hat the devices operate without an external power source and that the sole function of the fuel cell is to make hydrogen gas, not electricity. The free electrons are incidental to the hydrogen gas. For its part, the government points out that the production of hydrogen gas depends on the electrons to reduce the water.

According to the Court, "electricity" is a broad concept that does not require that electrons enter or leave the system. Rather, it is the action of the physical properties of electrons. Here, the hydrogen gas is released due to the action of electrons on the water. The fuel cells, therefore, are electrical in nature. This is consistent with the use of an electrical resistor to control the frequency of dispensing liquid. The fact that controlling the flow of electricity determines the useful life of the fluid cartridge further indicates the electrical nature of the devices.

After all that thorough analysis, the Court concluded that the air freshener and toilet cleaner are electrical machines because they depend on the effects of electricity. They have no specific classification in Chapter 84. As a result, Customs and Border Protection properly classified then in 8543.90.88.

Three down and my battery is dying. Hot tip for chess parents out there: get to the tournament venue early enough to secure a seat near a power outlet.




Saturday, December 06, 2014

Obligor, Obligee, Life Goes On

Hartford was a surety in the marketplace
Sunline imported crawfish from abroad
Sunline says to Hartford, "Man, I need your cash"
And Hartford says this while it shakes Sunline's by the hand

Obligor, obligee, goods come in
Lala, how the goods come in

If you are visiting this blog, you probably know that most importers use a bond secured by a surety company. The surety agrees that if the importer defaults, the surety will pay Customs and Border Protection any duties owed. In return, Customs agrees to release the merchandise to the importer before the entry is liquidated and duties paid. The surety bond is the oil that lubricates the whole system. Without the security of the bond, Customs would hold on to merchandise until it had cash in its metaphorical agency hands.

Surety bonds are a common means of insurance for all kinds of deal including your local bail bondsman to complicated financial transactions. As a result, there is a lot of law surrounding the relationship between the surety, the obligee (i.e., CBP, the party protected by the bond), and the obligor (i.e., principal on the bond, meaning the importer). One aspect of the law is that the surety cannot be held to have secured an obligation that includes more risk than was disclosed to it. If one of the parties withholds information that would have altered the surety's risk assessment, the surety can be released from the obligation.

So, what happens if U.S. Customs and Border Protection as an importer under investigation at the time the importer goes to a surety for a bond? Does Customs have to tell the surety that the sketchy importer is not a good risk? That's the basic issue in Hartford Fire Insurance Company v. United States, a recent decision from the Court of Appeals for the Federal Circuit. I am not a journalist nor am I bound by any journalistic ethics; nevertheless, you might read this with the knowledge that my firm handled this case.

The underlying facts here are that the importer, a company called Sunline Business Solution Corporation, imported fresh crawfish tail meat from a Chinese producer called Hubei. These entries were subject to a 223% antidumping duty order. Hubei sought a new shipper review, during which time is was permitted the rely on a bond to secure the payment of duties rather than make cash deposits. Eventually, it was determined that Hubei was not entitled to an individual dumping rate and Sunline refused to pay. That left the surety, Hartford, on the hook.

Hartford's complaint is that had it known that Customs was investigating Sunline for import violations, it would have either not secured the bond or done so on different terms. According to Hartford, that constitutes an abuse of discretion by Customs, which unreasonably increased its risks. As a result, it believes it should be released from the obligation.

No such luck, according to the Federal Circuit. The Court found that the bare allegation that Customs was investigating Sunline was not sufficient to plausibly suggest an abuse of discretion by Customs. The investigation itself remains confidential and Hartford did not plead facts establishing a connection between the investigation and the entries of the Hubei merchandise.

The Court seems to have focused on the fact that sureties are in the business of undertaking risk for third parties. As such, part of the surety's business is assessing that risk. One Court cited in the decision said "The policy behind surety bonds in not to protect a surety from its own laziness or poorly considered decision." That is harsh and possibly from a different context, but there it is. The Federal Circuit quoted the government's brief, which argued that "Hartford's claim improperly seeks to convert Customs' obligation to protect the revenue of the United States into a duty owed to Hartford and impermissibly shift the responsibility for assessing a surety's risk from the surety to the Government."

The reason I say that the harsh statement above might come from a different context is two fold. First, I freely admit that I have not read the cited case. Second, in the case of a customs surety bond, we do not have a free market in which information flows unimpeded between the surety, the obligor, and the obligee. Instead, sureties operate in a strange world in which Customs, the obligor, knows a lot more about the potentially sketchy businesses seeking the services of the surety. This means that CBP, by accepting the terms of the bond in exchange of the release of the merchandise, effectively creates the potential liability for the surety. Because it withholds relevant information from the surety, it necessarily increases the surety's risk. If this were three private parties, that would not fly and the surety might be released.

But, this is not a contract between three private parties. Furthermore, Customs cannot go around telling the world that an importer is under investigation. Maybe it could have simply refused to accept the bond amount or rejected the entries in their entirety without comment. That would be the equivalent of what lawyers call a "noisy withdrawal," which sounds dirty but isn't. In the noisy withdrawal, the lawyer tells the Court "I need to quit, your honor, but I am not at liberty to say why and, by the way, any other lawyer who takes this case should be wary." That is code for "My client is lying to the Court." Customs could have made some kind of noisy withdrawal to alert Hartford that there was additional risk here. Customs did not do that.

This case is a motion to dismiss for failure to state a claim. The case was dismissed on the pleadings and not because of a failure of the legal theory. Maybe a better case will come along to test the theory.

Two down. Apologies to Lennon and McCartney.

Roche Vitamins

The U.S. Court of Appeals for the Federal Circuit has affirmed the decision of the Court of International Trade that "BetaTab," a mixture of beta-carotene, antioxidants, gelatin, sucrose, and corn starch, is not "particularly suitable" for a specific use. Rather, it is properly classified as "provitamins, unmixed" under HTSUS item 2936.10.00.

The reason Roche Vitamins, Inc. v. United States is a tricky classification case has to do with HTSUS Note 1 to Chapter 29, which states that "Except where the context otherwise requires, the headings of this Chapter apply only to: [certain products] with an added stabilizer (including anticaking agent) necessary for their preservation or transport."

Furthermore, the Explanatory Notes to Heading 2936 states:

The products of this heading may be stabilized for purposes of preservation or transport: 
  • by adding anti-oxidants,
  • by adding anti-caking agents(e.g., carbohydrates),
  • by coating with appropriate substances (e.g., gelatin, waxes, or fats) whether or not plasticized, or
  • by adsorbing on appropriate substances (e.g., silicic acid), 
provided that the quantity added or the processing in no case exceeds that necessary for their preservation or transport and that the addition or proceeding does not alter the character of the basic product and render it particularly suitable for specific use rather than for general use.
According to the government's theory of this case, the BetaTab has been processed to such a degree that it has a specific use as a nutritional ingredient in vitamin tablets and capsules. For its part, Roche maintained that none of the added ingredients or processing prepare the BetaTab for use in tablets and that the product remains useful as in ingredient in tablets, capsules, foods, and as a colorant.

This is the odd classification case in which there is no dispute as to the meaning of the tariff. Instead, this was all about the question of fact of whether BetaTab has a specific use. In that circumstance, the Court of Appeals reviews the Court of International Trade for clear error. On this standard, there was no clear error in the CIT's finding that the additional ingredients and processing in the BetaTab do not render it suitable for a specific use. As a result, the Federal Circuit affirmed the CIT.

One down, a bunch more posts to follow.

Thursday, December 04, 2014

Book Review: Chasing Aphrodite

I just got around to reading Chasing Aphrodite: The Hunt for Looted Antiquities at the World's Richest Museum by Jason Felch and Ralph Frammolino. Anyone interested in the compliance aspects of the trade in cultural properties and antiquities should read this book. The details of the illicit trade and the evolution of thinking within the museum community are fascinating. The book is well researched and travels between illegal excavations in Italy to the NY apartments of wealthy collectors, and finally to the halls of the Getty Museum in California. There is not a lot of legal background here other than references to the 1970 UNESCO convention and the National Stolen Property Act. But, this is not a legal text. It is more about the culture of the antiquities trade.

From a legal perspective, this is a great case study on how our clients can sometimes self-blind and delude themselves into believing they have compliance. Or, more cynically, how companies can create the appearance of compliance (i.e., "compliance theatre") while not substantially moderating their behavior.

Here is information on the book: http://chasingaphrodite.com/
The authors have a Twitter feed at @chasingaphrodit