Thursday, August 26, 2010

Oh, Canada!

I do a lot of NAFTA work. For years, there have been unanswered questions concerning the ability of producers or exporters to allocate non-originating good to domestic customers and originating goods to customers in other NAFTA countries. That would maximize the benefit to the customers but might result in otherwise dutiable merchandise never being the subject to duty. The Canadian International Trade Tribunal recently got a crack at part of that question in Tara Materials, Inc. v. President of the Canada Border Services Agency, Appeal No. AP-2009-016 (Aug. 3, 2010).

Tara exports artists’ canvases from the United States to Canada. Apparently, it dual sources fungible fabric used to make the canvases and some of it comes from outside of North America. In an on-site verification by CBSA, it was determined that Tara’s production resulted in goods that are originating 72% of the time and non-originating 28% of the time.

In these circumstances, the NAFTA permits the producer to employ an inventory management system to determine the origin of the material used to produce any given finished item. This is set out in Article 406 of the NAFTA, which states in part that: “where originating and non-originating fungible materials are used in the production of a good, the determination of whether the materials are originating need not be made through the identification of any specific fungible material, but may be determined on the basis of any of the inventory management methods set out in the Uniform Regulations.” In other words, NAFTA  personified does not care if canvas number 1 is really originating and canvas number 10 is really non-originating, so long as only 72% of the canvases are treated as originating.

The U.S. regulations implementing this provision are at 19 C.F.R. Pt. 181, App. § 7(16). The origin of the fungible materials may be determined based upon an inventory accounting methodology set out in Schedule X. Those methodologies include specific identification, First In First Out, Last in Last Out, and averaging. 

In Tara, everyone agreed that finished canvases produced from originating fabric are originating and that finished canvases made from non-originating materials are not originating. The disagreement relates to the application of the Schedule X to fungible goods.

Under the averaging methodology, the producer determines the ratio of originating to non-originating materials in inventory. Schedule X states that the ratio can be applied to determine the origin of materials withdrawn from inventory. However, with respect to fungible goods, the determination applies to “each shipment” of fungible goods. "Crap!," you say. That means each shipment must be treated as nearly 30% non-originating, and that makes certification a hassle. It also creates grief for the customer. 

Tara countered that it had selected the averaging methodology applicable to fungible materials, not fungible goods so the “per shipment” limitation applicable to finished goods did not apply to its products. As a result, Tara claimed the right to allocate 100% of its originating goods (or 72% of its production) to exports to Canada, where they benefit from NAFTA treatment. The remaining 28% would be sold to U.S. customers, who do not necessarily care about the NAFTA status of the goods. 

The tribunal disagreed and held that the two regulations address two distinct segments of the production and distribution process. Section 7(16)(a) deals with production while section 7(16)(b) deals with the finished goods. Thus, the two determinations are applied in succession. Schedule X requires that the latter determination be applied to shipments.

The regulations with respect to fungible goods apply only where the goods are combined or mixed in inventory. In this case, found that the originating and non-originating canvases were mixed in inventory.
Thus, the remaining question was whether § 7(16.1) requires the use of the same inventory accounting methodology for materials and for goods. That is required where “both fungible materials and fungible goods are withdrawn from the same inventory.” According to Tara, it maintained inventories of materials and finished goods in separate rooms. Consequently, it may choose to apply the specific identification methodology to its finished goods and is not bound by the application of the averaging ratio to shipments. 

CBSA disagreed, arguing for an expansive definition of inventory that encompassed both materials and finished goods. The Tribunal refused to accept Tara’s narrow definition because it is unlikely that producers would ever physically mix production materials and finished goods. Rather, the Tribunal found it sufficient that Tara had finished goods and materials in the same warehouse. As a result, § 7(16.1) applied, forcing Tara to apply the averaging methodology to each shipment of finished goods.

This certainly not the best result for producers. Companies would like to have the maximum flexibility in allocating their originating goods to customers who can most benefit. Nevertheless, this decision, assuming it remains the final word, does provide a solid basis on which producers can determine how to manage their NAFTA systems.

Tuesday, August 24, 2010

Court Update

There have been several recent customs-related decisions from the Court of International Trade recently. I have read them and generally don't find much in any that require comment. At the same time, I don't want you to think that I am slacking off. So, here are short summaries.

Aromont USA, Inc. v. United States, involves the classification of a viscous "stock"  made from animal bones or vegetables. The issue was whether Customs and Border Protection properly classified the merchandise as soups and broths rather than as other food preparations. Initially, the Court had to hold that because the merchandise at issue in this case was not identical to merchandise that had been the subject of a previous Customs ruling, the ruling did not bind Customs and Border Protection. The primary difference seems to be the commercial designation of the merchandise. Here, the goods were called "stock," which is said to be equivalent to a "demiglace." I will check with my foodie friends on that.  On the substance, the Court found that "soup" and "broth" are use provisions and that the principal use of the imported merchandise was as a flavoring agent in gravies and in industrial food preparation. Thus, Customs' classification was reversed  and a win for the plaintiff.

BP Oil Supply Co. v. United States, is a  rare evidentiary dispute at the Court of International Trade. The underlying issue has to do with denied claims for duty drawback and an otherwise routine motion for an amendment to the Court's scheduling order controlling the progress of the case.  The U.S. responded with a motion to strike arguing that BP improperly included confidential settlement negotiations in its memorandum in support of the requested scheduling change. The theory is that the judge should not know what private discussions the parties have had about settlement as that might skew the judge's thinking if he or she has to actually decide the case. After finding that some of the text included with the motion should be considered confidential settlement discussions, the Court stated that: "Prudence therefore dictates that it would be exceedingly unwise for the court to give any consideration to these materials or to allow them to become part of the record. The emails, proposed stipulation of facts, and documents related to that proposal are therefore inadmissible on this motion pursuant to FRE 408 and its underlying policies. In the interests of judicial economy, however, these items will be disregarded by the court rather than stricken from the record."

Citizen Watch Co. of Am. v. United States, deals with the always vexing question of what constitutes a container classifiable in Heading 4202 of the Tariff Schedule of the United States. For reasons relating to pending litigation, I am dancing around this one. The merchandise involved was cardboard and fabric watch boxes that were said to be sturdy enough for only 10 to 50 open and close cycles. Customs and Border Protection classified these as similar to jewelry cases of 4202. The Court found that the boxes were not suitable for long-term use (even though they need not be able to survive as long as the watches). Consequently, they were not sufficiently similar to jewelry cases to be classified in 4202. Rather, they end up in the more general provision for containers in 4819.

Lastly, Tip Top Pants, is back on a motion for rehearing. First, I think rehearings present a semantic problem. In many decisions on rehearing, it seems the Court reviews the merits of the case, finds no error and, therefore, denies the motion for rehearing. It seems to me that the motion ought to be granted whenever the movant identifies a reason to take a second look but that the rehearing might then result in no change in the decision. But that is just me. On the merits, the Court stuck to the decision that Customs has to respond to petition to mitigate a penalty before moving on to collect the penalty in Court.

Tuesday, August 17, 2010


[Tip of the hat to my partner David Forgue, who has been thinking about this issue out loud longer than me.]

At what point is compliance with a trade agreement so risky that it becomes unworkable? Do the powers that be know that the trade agreements they negotiate might be effectively nullified by the cost of compliance? These are questions raised by the Federal Register Notice Customs and Border Protection published today.

Nominally, the notice finalizes changes to the regulations implementing the Dominican Republic-Central America-United States free trade agreement. However, the response to one comment is particularly telling. Here is the relevant text:
Comment: The commenter asserted that Sec. 10.585(a)(1) and (a)(2) impose impossible obligations on the importer. These provisions state that an importer who makes a claim for preferential tariff treatment under the CAFTA-DR (1) will be deemed to have ``certified'' that the good is eligible for such treatment; and (2) is responsible for the truthfulness of the claim and the information in the certification. According to the commenter, unless the importer has conducted an audit of the producer's books and records, it cannot ``certify'' that the good is eligible for preference or attest to the truthfulness of the claim and the information in the certification. In this regard, the commenter noted that some producers may be reluctant to open their books and records to their customers, including U.S. importers.
CBP's Response: CBP disagrees with the commenter's assertion that the importer should not be responsible for certifying that the goods are eligible for preference or for the truthfulness of the claim and the information in the certification. It is the responsibility of the U.S. importer of the goods for which preference is sought to file the appropriate entry with CBP and make the claim for preferential tariff treatment for the goods. In making this claim, the importer is responsible for exercising reasonable care to ensure that the goods are entitled to such treatment. CBP acknowledges that some producers may be reluctant to open their books to importers, but notes that an importer who has not acted fraudulently but nevertheless made an incorrect claim, is not subject to penalties if the importer promptly and voluntarily makes a corrected declaration and pays any duties owing. (19 CFR 10.585, 10.621, 10.623)
Basically, this says that importers are on the hook for what their suppliers tell them. You can ask for a certificate of origin, but it remains the importer's responsibility to exercise reasonable care to ensure that the certificate you received is true. As the commenter suggests, this may be difficult. What is the importer to do if the supplier provides a CO and refuses to permit the importer to review backup documents? Does reasonable care dictate that the importer reject that CO?

Conceptually, "reasonable care" should be based upon the standard of care that would be exercised by a similarly situated importer acting reasonably. Unfortunately, we have no real idea what that means in everyday practice. In retrospect, it will be easy for Customs to say that the importer should not have trusted the supplier. See the unfortunate precedent of Golden Ship Trading and my prior discussion of this in the NAFTA context.

A corporate compliance manager is likely to see this as a dilemma. The manager has only a few choices and none of them are great. First, the manager might simply choose to rely on COs from suppliers based on an examination of the four-corners of the CO itself. If it looks good on its face, accept it. The problem with that is that it might expose the company to liability down the road for duties and penalties if the COs eventually turn out to be invalid.

To avoid that possibility, the manager might decide to only accept COs from suppliers willing to permit a thorough vetting of the supporting documents. While that is safe from liability, it adds complication and expense to the supply chain. Would most companies authorize travel to Guatemala to review production records at a supplier? In addition, it probably precludes the use of suppliers who will refuse the increased scrutiny, which is more likely if materials costs must be disclosed.

The middle ground is to strategically review suppliers based on the criteria relevant to the particular importer. High MFN duty rate products and high volume imports present greater risk and greater potential liability. Those should get greater scrutiny than low volume, low duty imports. Some goods engender more risk of unscrupulous supplier conduct and deserve more attention. A product with a complicated rule of origin should be the subject of a more searching review than a simple rule. For example, apparel is trickier and more subject to shenanigans than is coffee. This strategy might limit liability, but does not eliminate it.

Another approach is to include in purchase contracts language requiring that the goods be originating under the appropriate rules of origin and require indemnification for losses resulting from that being untrue. If the application of this clause is contested, it might require litigation or arbitration in the supplier's home jurisdiction.   That may be expensive and impractical.

Credit should be given to Customs for pointing out in the Federal Register Notice, that an importer can avoid liability by voluntarily correcting an entry that asserted an incorrect claim. That is true and does provide a safety valve. But, it presupposes that the importer knows that the claim was invalid.

In the end, each importer needs to weigh the risks and rewards of compliance. Keep in mind that this issue runs throughout most of our preference programs including GSP.

It did not need to be this way. Look at NAFTA. Under that agreement, the importer is pretty clearly (note important hedge) permitted to rely on the certificate of origin from the exporter. The CO and the verification system put the burden of proof on the exporter, not the importer. Granted, the importer might be on the hook for additional duties if the exporter fails a verification. Further, if the importer's reliance on the document was unreasonable, it could be subject to penalties. But, the focus under NAFTA is clearly on the exporter.

For some reason, the US does not like the NAFTA verification model. The newer trade agreements shift the verification to the importer. And, Customs has made efforts (including the Ford litigation) to use reasonable care and record keeping to shift that burden to the importer. How successful they will be in that effort remains to be seen.

Regardless of what happens with NAFTA, the DR-CAFTA, GSP, AGOA, and other trade preference programs put importers in a bind. Reliance on the exporter is not likely to satisfy Customs and Border Protection as evidence of the exercise of reasonable care. Audits of suppliers are expensive and time consuming. If the duty avoidance is minimal or the potential penalty substantial, the cost of compliance might make the trade agreement a bad deal for importers.

That leads to the last question: Do the policy makers at USTR and in the White House know that the on-the-ground implementation of trade agreements might actually nullify the benefits they were intended to generate? Does it help Central America or Sub-Saharan Africa to have a trade preference program that is so risky that importers think twice about using it?

Thursday, August 05, 2010

Newsy Stuff

A few news items on note:

Festive Articles

Customs and Border Protection has asked the ITC to study a proposed tariff change to correct the tariff treatment of so-called festive articles that have utilitarian functions. This follows from successful litigation undertaken by my firm that showed that holiday-themed articles, even those that have utilitarian functions, can be entitled to duty-free entry under Chapter 95 of the tariff schedule. The problem is that in an effort to "correct" what Customs viewed as this erroneous classification decision, the modifications to the 2007 tariff schedule made non-revenue neutral changes, which is not a favored result. This tariff study is aimed at correcting that by changing the tariff classification but preserving the duty-free status of the goods. Should this happen, the change will be effective for goods entered on or after February 3, 2007.

Lacey Act

APHIS has published a proposed definition of "common cultivar" and "common crop food" for purposes of Lacey Act compliance. These plants will be exempt from reporting requirements.

A common cultivar will be a plant, other than a tree, that:

  • has been developed through selective breeding or other means for specific morphological or physiological characteristics; and
  • is a species or hybrid that is cultivated on a commercial scale; and
  • is not listed: (1) in an appendix to the Convention on International Trade in Endangered Species of Wild Fauna and Flora (CITES); (2) as an endangered or threatened species under the Endangered Species Act of 1973 (16 USC 1531 et seq.); or (3) pursuant to any State law that provides for the conservation of species that are indigenous to the State and are threatened with extinction.
A common food crop would be a plant that
  • has been raised, grown, or cultivated for human or animal consumption, and
  • is a species or hybrid that is cultivated on a commercial scale; and
  • is not listed: (1) in an appendix to CITES; (2) as an endangered or threatened species under the Endangered Species Act of 1973 (16 USC 1531 et seq.); or (3) pursuant to any State law that provides for the conservation of species that are indigenous to the State and are threatened with extinction.

State Department is going to require Comodity Jurisditction requesssts to be submitted electronically via form DS-4076. Keep in mind that your block 5 descritptions will be published in the CJ determinations list. Keep proprietary information in block 15. This is effective inon Friday, September 3.

Tuesday, August 03, 2010

Federal Circuit Web Site 2.0

Am I the last person to see the new Federal Circuit web site? It is a major improvement over the previous page. Thanks to whatever federal IT workers did the job.

The main element of the new  home page is an attractive photograph of one of the Court's impressive courtrooms. There are navigation links above and below. The links at the top have scrolling submenus that appear when the cursor hovers over them. The links at the bottom are direct links to the referenced information. It is simple, but it works. On a quick look, it is not clear why the navigation tools are organized as they are. For example, "The Court" at the top has a submenu for "Judges," which is also a standalone item on the bottom right. Daily dispositions is also in two places, but that might just make the information easier to find.

The Federal Circuit hears appeals from the Court of International Trade concerning decisions by Customs and Border Protection. Consequently, I visit this site relatively often. It is nice to see "Opinions & Orders" prominently on the bottom. Even nicer is that on the page for opinions and orders, visitors can sort by the origin of the appealed decision. That means I can finally see a list of only appeals from the CIT. That will be very handy for most customs lawyers and even more handy for the patent lawyers who do not care at all about customs cases.

Note: I am tagging this as "off topic," but only slightly.