Monday, December 26, 2016

The Three-Percent Solution

In real life, I represent importers and exporters who need to maintain compliance with U.S. laws and regulations concerning international trade. For the most part, that means customs law and export controls. As Bryan Garner once said at a seminar I attended, "hence the title" [of my blog].

One of the more complicated and potentially troublesome areas of compliance for importers involves antidumping and countervailing duty orders. The financial consequences of such an order can be dire for companies that entered into purchase contracts prior to the order or without knowing that an order applied to the goods. Often, the latter happens when suppliers assure the buyer that merchandise is either outside the scope of the order or from a source other than the subject country. Unfortunately, suppliers may be uninformed on the scope of the order, too happy to falsely state the origin of the product, or willing to misrepresent that it is otherwise outside the scope of an order. An unwary importer who ends up receiving a rate advance of 200%, for example, may be in for a world of financial and legal trouble.

Moreover, the scope of orders is becoming increasingly complex. The cases involving aluminum extrusions, tires, and solar products are good examples of complicated case scopes.

As a result, I am spending increasing time on scope and related questions for importer clients. My assumption is that readers of this blog are also seeing more of these issues arise. Consequently, I plan to address more of these cases here. I will not be getting into the weeds of determining subsidy and margin rates. But, to the extent the application of an antidumping or duty order impacts import compliance, I will make more of an effort to note it here.

That said, I give you Kyocera Solar, Inc. v. United States International Trade Commission. This case from the Court of Appeals for the Federal Circuit involves the antidumping and countervailing duty orders on Certain Crystalline Silicon Photovoltaic Products from The People's Republic of China and Taiwan. A common strategy for compliant importers facing the imposition of AD or CV duties is to re-source the product from a country not covered by the order. That can be a successful way to mitigate the impact of the order.

The problem for Kyocera in this case is that the Commerce Department defined the scope of the investigation as covering cells and modules produced in Taiwan and modules "completed or partially manufactured" in other countries from cells produced in Taiwan. Kyocera was importing solar modules from Mexico that incorporate solar cells from Taiwan.

Separate and apart from this case, Kyocera is challenging the scope of the order as it applies to its imports from Mexico. Leave that aside for now. In this case, Kyocera raises the more interesting question of whether the International Trade Commission was required to treat the source of these products as Mexico or as Taiwan for purposes of its investigation of possible injury to the domestic industry.

The root of this question is 19 USC 1671d(b) (for countervailing duties) and 1673d(b) (for antidumping duties), which require that the ITC terminate an investigation if it determines that "imports of the subject merchandise are negligible . . . ." Negligible is defined in 19 USC 1677(24) as follows (with exceptions and details omitted here):

imports from a country of merchandise corresponding to a domestic like product identified by the Commission are “negligible” if such imports account for less than 3 percent of the volume of all such merchandise imported into the United States . . . .
The issue here is the meaning of "a country." According to Kyocera, Mexico is "a country" and is, therefore, entitled to its own negligibility test. Presumably, its exports would be less than the 3% threshold and, therefore, excluded from the order.

The International Trade Commission and the Court of International Trade both rejected that argument. Now, the Court of Appeals for the Federal Circuit has upheld the CIT. According to the Court of Appeals, the negligibility test is applied to the subject merchandise. Here, the order defines the scope as including cells from Taiwan finished into modules in other countries. Accordingly, the Kyocera products that include cells from Taiwan are still products of Taiwan even though finished in Mexico. Consequently, products finished in Mexico are not entitled to a separate negligibility analysis.

What is the lesson for importers? First and foremost, understand that scope is more than just the title of the Federal Register Notice. The scope of the order may, as it did here, encompass downstream or upstream products including products finished in other countries. When that is the case, it is not enough to just move finishing operations to another country. That will not necessarily remove the product from scope and might end up causing additional issues if the effort is seen as either evasion or circumvention.

Finally, as long as I am thinking about these things, keep in mind that HTSUS classification is not a reliable test for whether or not a product is in scope. Every order states that classification is provided for convenience, and that the description of the merchandise controls. The fact that an item is not flagged in ACE or elsewhere as within the scope of an order does not mean it cannot actually be within the scope of the order.

More to follow on this and related issues.

Tuesday, December 20, 2016

Substantial Transformation Redux

Note: I am writing this post while on vacation at an undisclosed location. The Internet here is lousy. I am paying a fair amount of money for "high speed access." Despite that, I feel like I am working on a vintage 3600 baud dial-up modem. Consequently, you will have to make do with two links. I might go back and fill in more when I have a decent connection.
We just talked about a Customs and Border Protection ruling in which I complained about CBP straying from the traditional substantial transformation test of looking for a change in name, character, or use to determine country of origin. Now we run up against Energizer Battery, Inc. v.United States, in which the Court of International Trade addressed essentially the same question. The CIT started out strong and raised my expectations that we would see a very detailed analysis of the test. We did get a thorough and logical opinion. But, I still have some concerns. So, let’s walk through this.

Under the Buy America portion of the Trade Agreements Act of 1979, 19 USC §§ 2511-2518, the U.S. government can procure material from countries covered by the Act. Those are countries that have signed on to the WTO Government Procurement Agreement and U.S.-free trade agreement partners. China is not an eligible country.

The case involves a flashlight assembled in Vermont. Virtually all of the approximately 50 components, including the light-emitting LED’s, the lens assembly, and wires that are pre-cut to size, come from China. After importation, the assembly process involves workers at two stations and takes approximately 7 minutes and 10 seconds. The value of imported materials is $12.96 and the finished cost of the flashlight is $23.55.

The only way to make these flashlights eligible for government procurement is to determined that they are products of the United States by virtue of the assembly operation in Vermont. That requires a substantial transformation. The test for a substantial transformation under the Trade Agreements Act is that the product is “a new and different article of commerce with a name, character, or use distinct from that of the article or articles from which it was transformed.” While there have been few cases applying this test in the context of the procurement agreement, this is the well-established test used for non-NAFTA country of origin marking, some drawback, and for other purposes.

Energizer sought a final ruling from Customs on whether the assembly of the flashlights in the U.S. resulted in a substantial transformation. Customs found that after assembly in the U.S., the LED’s continue to perform their intended function of emitting light and that the assembly process was not complex or time-consuming. Customs also noted the traditional name, character, or use test. Based on its analysis, Customs found no substantial transformation.

The first issue the plaintiff raised is that Customs’ focus on the LED’s and “essential character” is not part of the test for substantial transformation. That is manifestly true. The statute does not reference essential character. The Court, however, noted that it must decide the origin of the flashlight on its own, based on the evidence presented to it. The original analysis CBP performed is, therefore, of limited importance.

Given my most recent post on this question, I was very happy to see the Court of International Trade focus its attention on the name, character, or use test. The Court went so far as to say the “’essential character’ is not an established factor in the substantial transformation analysis, although some courts have looked to the ‘essence’ of a finished article in order to evaluation whether there has been a change in character as a result of post-importation processing.” Essential character is a useful concept for tariff classification. Separately, “essential identity” comes up in the context of U.S. goods returned. Neither is traditionally part of the substantial transformation test. So far, I am happy.

The Court then reviewed the history of the substantial transformation test from its roots in the 1908 Supreme Court decision Anheuser Busch Brewing Ass’n v. United States. Since that time, the test has become “flexible” and the outcome depends on the facts of each case.

The Court noted that a change in name is generally the least compelling evidence of a substantial transformation. That said, let’s keep in mind that the imported components were not called “flashlights.” They were LED’s, wires, screws, switches, and other components all with their own name.

Regarding name, the Court followed the lead of a prior CIT decision in a case called National Hand Tool v. United States. That case involved hand tools that were partially finished prior to importation and machined, etc. after importation. In all cases, the name of the article as imported remained the same as that article in the completed tool. From this, the CIT held that the question is whether the imported components retain their names after assembly into the flashlight. The switch, for example, remains the switch even when it is fully incorporated into the flashlight.

Moving on to character, the Court looked for a substantial alternation in the characteristics of the components. That requires more than a cosmetic change. Rather, the end-use of the imported product must not be the same as (or “interchangeable with”) the end-use of the product after post-importation processing. Here, the Court found that the shape and material composition of the components was unchanged, meaning there was (according to the Court) no change in character.

The Court also noted that that prior cases have found a substantial transformation less likely where the imported item has an intended end-use and the post-importation processing is consistent with that end-use. This is where I start to get concerned. Here, the parts were all imported for the purpose of manufacturing flashlights. The lens assembly, in particular, had no other apparent use. This does not bode well for Energizer.

Regarding use, Plaintiff argued that none of the imported components are useful as flashlights. The Court rejected that approach and held that the correct inquiry is whether the imported parts have a predetermined end-use at the time of importation. Here, the lens head is partially assembled at the time of importation, with four of the five LED’s attached and pre-cut wires soldered to the circuit board. This, and other components, have pre-determined end-uses as parts of the flashlight. Based on this, the Court found no change in use.

To my way of thinking, the unassembled components of a flashlight do not constitute a flashlight and cannot be used as such. As imported, they mostly have functions that are distinct from the function of a flashlight. A switch makes and breaks an electrical circuit. Wires conduct electricity.

The problem for Energizer is that LED’s emit light and the lens assembly directs light. Those are pretty close to the functions of a flashlight, although they are not sufficient to form a flashlight. Keep that in mind as we go forward.

Next, the Court looked at several subsidiary tests for substantial transformation. The most important of these tests is the nature of the assembly process. When assembly is simple, the question is whether it is “minor manufacturing and combining” as opposed to extensive operations resulting in the loss of identity of the imported component, which becomes an integral part of a new article. Summarizing, the Court stated, “However, when assembly operations were manual and required some ‘skill and dexterity to put components together with a screw driver’ but the names of each article and the form and character of each component remained unchanged, and the use of the imported articles was predetermined at the time of importation, the court did not find that substantial transformation had occurred.” The Court found that the production process constituted simply attaching one component to another. It is not a complex process.

Having found no change in name, character, or use and that the assembly process was not complex, the Court of International Trade held that the flashlight components from China were not substantially transformed by assembly in Vermont. Thus, the Court affirmed the final determination from Customs and Border Protection.

I’m not entirely comfortable with this for a few reasons. First, I need to say that this is a well-reasoned opinion and it is clearly following the lead of National Hand Tools. I think that is admirable for purposes of providing predictability and business certainty.

The problem is that as an advocate, largely for importers, I don’t like the result. It is very hard to apply in practice. It seems to me that this decision makes a substantial transformation in the context of assembly very difficult to establish. Most assembly can be reversed by disassembly. That means a switch will always be a switch and an LED will always be an LED even after assembly. This ignores the name changes from switch and LED to flashlight. Furthermore, the use of components will almost never be the use of the finished article, even when the components are imported specifically for incorporation into that finished product. Under the Court’s analysis, an engine assembled into a car remains an engine and does not change its character because it was intended for use as a car engine. Nor does it change its intended end use. But, an engine is not a car. I cannot drive an engine.

By focusing on the components before and after assembly, I fear the Court has set the bar too high. It seems that substantial transformation will occur when the imported part is subject to further fabrication prior to final assembly. The murkier question is when assembly is sufficiently complex to produce a substantial transformation. That will depend on the facts of the case. Unfortunately, it appears to me that under this analysis the complexity of the assembly process—which is not name, character, or use—is firmly part of the name, character, or use test. That seems to go beyond what was required under the 1979 Trade Agreements Act and similar CBP applications of the test.

Thursday, December 15, 2016

White Sauce Attorneys' Fees Upheld

You may recall that the Court of International awarded attorneys fees to the plaintiff in International Custom Products v. United States. This case has a very complicated litigation history. I will not review that here. You should go back and read the original post about the CIT decision on fees. Now, the Court of Appeals for the Federal Circuit has affirmed the CIT's decision. That is a substantial victory for the plaintiff.

What you need to know is that Customs and Border Protection issued a binding ruling to ICP on the classification of its "white sauce." Customs subsequent issued a Notice of Action reclassifying unliquidated entries under a different provision. CBP did not take steps to revoke or modify the prior ruling before taking this action. As a result of the reclassification, and the resulting application of dairy quota, the duty payable on this merchandise increased by 2400%. The subsequent litigation resulted in five judicial opinions including two prior decision of the Court of Appeals.

Under federal law, a court shall award attorneys fees to the non-governmental prevailing party unless the position of the United States "was substantially justified" or there are special circumstances making an award unjust. A position is substantially justified if it could satisfy a reasonable person. Stated in the positive, what that means is that a prevailing party in a case against the United States can be awarded fees where the government took an unreasonable position in the litigation or the administrative process.

The CIT held that Customs' use of the Notice of Action was rooted in its desire to avoid the more complicated, but required, process of revoking the ruling. That, according to the CIT, was not reasonable.

On appeal the United States raised several technical arguments. The most interesting of these is that because the Court of International Trade ruled in favor of the United States on the plaintiff's motion for summary judgment, thereby letting the case go to trial, the government's position was necessarily reasonably. The Federal Circuit had not previously addressed this question and, therefore, looked to guidance in the decisions of other circuits. The Seventh Circuit has held that surviving a motion for summary judgment creates a presumption that the position is reasonable; but that presumption can be rebutted. The Federal Circuit did not go so far as to find a presumption. Rather, it held that it must review the record as a whole to find reasonableness.

That probably brings this part of the case to an end. For those of us who litigate customs issues, this serves as a good reminder that it is possible to get fee awards when the U.S. has taken an unreasonable position. That is an unusual circumstance, but it is good to know the law.

Holiday Edition

This is one of those posts in which I tell you that there are many cases and rulings sitting on my desk, all of which I plan to use as the basis for upcoming blog posts. It is also the end of the year and the time when I contemplate the state of this blog. [Note: Shaking my fist at the ABA Journal] This has been a good blog year, despite having fallen behind on my coverage of rulings. My personal view is that the content remains of acceptably high quality combined with it usually being timely. So that's good. I did earn recognition from the Expert Institute; fifth place out of a large field is not too bad. Thanks for your votes.

I'll continue to plug along here and hope you stay with me in an 2017. As always, I sincerely appreciate my readers. At the recent Court of International Trade Judicial Conference and at a trade meeting in Chicago, folks introduced themselves as readers. That always makes me happy. I hope to see more of you at upcoming events. Feel free to comment on my posts, I would love to see more reader engagement.

That all sets the stage for me to say to you and your families, "Happy Seasonal Holiday of Your Personal Choosing" and a very Happy New Year to you all.

Tuesday, December 06, 2016

Is that a Pine Nut?

I watch competitive cooking the way a stereotypical American male might watch baseball. I don't care if it is Top Chef or Chopped at the high end or the dreck that is Cupcake Wars and The Great American Food Truck Race. I don't watch kids compete, that's where I draw the line. I also like to eat. As a result, I am familiar with a lot of strange food items.

Pine nuts are not all that odd. I recently learned a lot more about pine nuts when I read Specialty Commodities Inc. v. United States, which involves the tariff classification of the seed of the Korean pine nut, Pinus koraiensis.

Customs and Border Protection classified these seeds as "Other nuts, fresh or dried, whether or not shelled or peeled: Other: Other: Shelled: Other" in HTSUS item 0802.90.97. The plaintiff believes they are best classified in 0802.90.25 as "Pignolia: Shelled." Clearly, the question is whether the seed of the Koreas pine, from China, is a "Pignolia" for purposes of tariff classification. Note that both classifications are in subheading 0802.90. This question is all about the last two digits.

While it may seem that a pine nut is a pine nut, that is not the case. The Explanatory Notes to the Harmonized System, which are not binding on U.S. Customs and Border Protection but are authoritative interpretations of the international parts of the tariff, state that the nuts of Heading 0802 include "pignolia nuts (seeds of the Pinus pinea)." It turns out that Pinus pinea is the Italian Stone Pine, which is native to Europe, north Africa and the Mediterranean, which would exclude both China and Korea and is in contrast to the Pinus koraiensis.

Seeds of Pinus koraiensis via Wikipedia

What this comes down to is whether the seeds of the Pinus koraiensis are within the common and commercial meaning of "pignola nuts," giving due weight to the Explanatory Notes additional notation of "Pinus pinea."

This case is a good read for anyone interested in learning how customs lawyers muster lexicographical evidence of common and commercial meaning. Plaintiff put forward a number of definitions broad enough to encompass edible pine nuts of any source. These were taken from dictionaries, trade publications, government sources, and various websites. The government put forward a similar collection of more restrictive definitions taken from other sources and challenged the plaintiff's interpretation of some of its sources. None of this competing reference material was sufficient to resolve the matter.

The plaintiff also pointed to prior CBP rulings as evidence that Customs has established the meaning of "pignolia." These rulings, however, relate to infused oils and do not directly address the classification of the pine seeds.

The Court next looked to the historical treatment of pine seeds in U.S. tariff acts. This is something we don't often see. Prior tariffs are only relevant today when the language is similar to the current law, which is often the case when an item is called out by name (or eo nomine). In this case, the Court looked at the 1921 Summaries of Trade and Tariff Information and the Tariff Act of 1922. The government, however, pointed out that neither the subsequent Tariff Act of 1930 nor the 1946 revision use the word "pignolia." This is meaningful because during that time, all pine nuts appear to have been classified as "other" and the seeds of Pinus pinea only subsequently specified as pignolia. Furthermore, a 1968 tariff report indicates that the pignolia nut is gathered in Italy, Portugal and Spain, presumably excluding similar products from China and Korea.

That took the Court back to where we started: the Explanatory Notes. In 1986, the Explanatory Notes used the phrase "pignolia nuts (Seeds of the Pinus pinea)." That language remained in subsequent editions.

This does not resolve the issue because there is no disagreement as to the proper heading and subheading (i.e., to sixth digit), which is as far as the Explanatory Notes go. Nevertheless, the Notes clearly limit pignolia to the European variety. The U.S. drafters of the HTSUS presumably knew that and were also aware of the 1968 report. Taken together, that indicates to the Court of International Trade, that these particular pine nuts are not pignolia for classification purposes.

This is the point where I usually find something in the decision to pick at. Initially, my concern was that the Explanatory Notes insert a limitation to pignolia that is not in the HTSUS and should, therefore, be ignored. That would broaden the meaning beyond seeds of Pinus pinea. But, the Court addressed this saying that there was not sufficient evidence of a common and commercial meaning to establish a conflict with the Explanatory Notes. Touché.

Now, I will go home, open my basket, and make dinner from pine nuts, squid ink, elk loin, and a Boston cream pie. If my entre does not cut it, I will be Chopped.

Sunday, December 04, 2016

Ruling of the Week 2016.23: Patents and Value

We don't talk enough about customs value here. It is important, complicated, and interesting. It deserves more attention. There are, however, also fewer rulings and cases on valuation questions. Happily, this one (HQ H233376, Sep. 19, 2016) caught my eye. The issue is whether a royalty paid to a U.S. patent holder who is unrelated to the importer is dutiable when the royalty is paid not by the importer but by the importer's parent company.

The patents at issue are all utility patents, meaning that they relate to new and useful inventions rather than to the design aesthetics of the item. A utility patent generally involves the critical technology that defines or empowers the invention. The license grants to the importer (via a predecessor company, just to complicate matters) "to make, have made, use, sell, offer for sale and import Licensed Devices" worldwide. The license also authorizes the licensee to disclose to the manufacturer, who is in Malaysia, the information that is necessary to manufacture the products. Similarly, the manufacturer is authorized to use the patented technology to makes the item and to apply related trademarks.

When goods are imported pursuant to a sale, the customs valuation is usually the "transaction value." That is defined at 19 USC 1401a(b) as the price actually paid or payable for the merchandise when sold for exportation to the United States, plus specified statutory additions including "any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of the sale of the imported merchandise for exportation to the United States."

In 1993, Customs published an official notice detailing how it will analyze royalties for dutiability. We discussed that here. To summarize from my earlier post, under the test, Customs and Border Protection analyzes each royalty agreement on a case-by-case basis and asks three questions:

1. Was the importer merchandise manufactured under patent? If the answer is yes, then the payment is more closely tied to the production of the merchandise and is, therefore, more likely dutiable.

2. Was the payment involved in the production or sale of the imported merchandise? This question goes more deeply into the purpose of the payment. If the importer can show that the payment is for something other than the manufacture, production, or purchase of the imported goods, the payment may not be dutiable. Customs gave two examples in which the Court found that the putative royalty was for the use of the product in the United States, not for the patent rights related to the production or importation of the product. A positive answer to this question, therefore, leans toward dutiablity while a negative answer leans against.

3. Could the importer buy the product without paying the fee? If the fee is not optional and goes to the seller, it is more likely to be a dutiable part of the value of the merchandise. According to Customs, this question "goes to the heart" of whether the payment is a condition of sale. That means a negative answer to this question indicates dutiability.

In this ruling, Customs gave the short answer that the royalty is dutiable. The merchandise was manufactured under a patent and the patented technology is related to the production or sale of the imported item. Furthermore, Customs found that the importer could not buy the merchandise without paying the fee. Nevertheless, counsel for the importer (who was not me) argued against suitability of the royalty in this case.

Counsel first noted that the royalty is not paid to or for the benefit of the seller. This is a common argument and merits attention. How is a royalty part of the "price paid or payable" for the merchandise if it not paid to the seller? The answer is that the statute does not require that the royalty be paid to the seller to be dutiable. Rather, the statute requires that royalties be added to the dutiable value when they are "related to the imported merchandise" and when "the buyer is required to pay [the royalty], directly or indirectly, as a condition of the sale of the imported merchandise for exportation to the United States." Note that the statute does not say to whom the royalty must be paid to be dutiable.

The question is not how much did the seller receive in exchange for the goods. The question is what is the total cost to the buyer to acquire the merchandise. This is entirely consistent with other parts of the statute which, for example, add assists, selling commissions, and packing materials to the entered value for duty. If the buyer did not pay this patent royalty, the seller would have to do so to acquire the legal right to manufacture the item. Because the buyer's parent paid it, the cost to the seller is reduced below what it would otherwise have been. This is exactly why the value of buttons provided by the buyer to the manufacturer for use in the production of shirts must be added to the entered value of the shirts. If the seller had to go buy the buttons, it would increase the price to cover the additional expense. This, therefore, is a losing argument, even when the patent holder is in the U.S.

To stick to this conclusion, Customs had to distinguish several prior rulings that appear to have conflicting results. I'm going to spare you the details. It should suffice to say that a patent royalty might not be dutiable if it is not a condition of the sale to the United States or is not fundamental to the manufacturer of the item. For example, a patent license relating only to the use of some item, as opposed to the manufacturer of it, is less likely to result in a dutiable royalty. Similarly, a design patent is less likely to be dutiable than is a utility patent.

The other question is whether a royalty paid to a U.S. patent holder can be a condition of the sale for export from the foreign manufacturer. After all, what does the manufacturer care if the buyer fails to pay the royalty? That is not its problem. Customs' analysis is more nuanced than that. It held that a condition of the sale exists where the right to use the patent "must be secured, either by the buyer or the manufacturer because the patent is necessary to produce the merchandise to be sold for export to the United States. i.e., [sic] the imported merchandise would not exist it the rights to the patent were not obtained." This gives the requirement that the royalty be a condition of the sale a broad and flexible interpretation that can be interpreted practically as well as under the terms of an individual contract.

All of that led Customs and Border Protection to hold the royalty in this case to be dutiable.

I have a question. The ruling clearly says, "the royalty payments at issue are made to the licensor, [Company A] (a U.S. patent holder who is not related to the company or to the manufacturer of the imported merchandise_, by [Company B], the parent of the company's parent." [Emphasis added.] So am I correct that the buyer did not actually pay this royalty? It was paid not by the parent company but by the grandparent company. This should be discussed in the ruling. The company, presumably the importer, is not responsible for the payment of the royalty. It seems possible that the company did not even know about it.

The statute covers "any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of the sale . . . ." [Emphasis added.] It appears that Customs treated the royalty as indirectly paid, without stating so. Is that right?

I would read "indirectly" as relating to the method of payment to the seller, not to the party making the payment, which seems to be limited to the buyer. How do we know from this ruling that the buyer is required to make this payment, whether directly or indirectly? It seems clear that a related but legally separate entity is required to make that payment. I can see CBP's implied conclusion that this is an indirect payment by the buyer, but I think there needs to be some facts stated to support that conclusion. Otherwise Customs has effectively ignored the separate legal status of the companies and pierced a corporate veil without comment.

Saturday, December 03, 2016

Ruling of the Week 2016.22: Framing Substantrial Transformation

I like bikes. Lately, that is more in theory than in actual usage, but that is my fault. In reality, bikes are a transformative technology. They give kids their first sense of independence. They give everyone a means of transportation with zero carbon emissions. In some cases, the availability of that transportation may be lifesaving.

Thus, when I see something at work that involves bicycles, I usually take note. Such is the case with the September 21, 2016 Customs Bulleting and Decisions in which Customs and Border Protection revoked a ruling, N269994 (Nov. 20, 2015), on the country of origin of bicycles.

The bicycle in question is assembled in the United States from imported components, including frames. Customs had previously ruled that assembling components to a U.S.-origin frame produces a bike with the U.S. as the country of origin. In N269994, it apparently misapplied that same analysis to find the U.S. to be the country of origin of bicycles with imported frames.

In this new ruling, which is HQ H273304 (Aug. 11, 2016), Customs finds that the country of origin of the frame is the country of origin of the finished bike.

The starting point is the law, which requires that all articles of foreign origin be marked in a manner that will indicate to the ultimate purchaser the name of the country of origin. Note that the analysis is different for goods of a NAFTA country, that is not what we have here.

When the item is imported to be further processed, the question is whether the further processing is sufficient to make the item a product of the U.S. when sold to the ultimate purchaser. According to 19 CFR § 134.1(b), "Further work or material added to an article in another country must effect a substantial transformation in order to render such other country the 'country of origin' within the meaning of this part . . . ." A substantial transformation occurs when the article that emerges from a process has a new name, character, or use different from that possessed by the imported article. When that happens, the processor is considered to be the ultimate purchaser and the imported item is exempt from marking.

Here, Customs ruled that the imported frames were not substantially transformed. Customs reasoned that the frame is the most costly and essential component of the finished bicycle. Furthermore, Customs held that the frame provides the overall shape, size and character of the bicycle. "Because the bicycle is assembled in the United States and is one of the bicycle's essential components, the frame, is made outside of the United States, [Customs and Border Protection found] that the country of origin of the bicycle would be imparted by the frame." Accordingly, the country of origin of the bike is the country of origin of the frame.

I hate this decision. For some reason, Customs and Border Protection did a great job of setting up the issue and explaining the legal test for substantial transformation. Then it whiffed at trying to apply that test. The question is whether the finished bicycle has a new name, character, or use different from the imported frame. The question Customs answered is whether the frame is an expensive and important component. Those questions will not always produce the same answer. Furthermore, it seems likely that the "essential component" test Customs applied is less likely to result in substantial transformations than is the actual legal test.

From Manchester Triathlon Club

Let's try it here:

The imported item is a "frame" at the time of importation. No one would call it a bicycle. True, it is an essential component of the assembled bike. It also dictates many aspects of the nature and use of the bike. But, it is a frame. It just is. That is what it is called. Customs has stated many times that a change in name is the least probative of the three elements of name, character, or use. Nevertheless, it cannot be ignored that there is a name change here.

What about "character?" This test is hard to define. We know a few things for certain. The frame is not a completely assembled vehicle as is a bicycle. It has no moving part and is generally uniform in construction (i.e., it is most likely a collection of metal tubes welded together). If you want to move it, you need to pick it up or drag it along the ground. The finished bike, on the other hand, is an assembled, mechanical vehicle. It has moving parts of gears connected by a chain, it has brakes connected by cables to hand controls. It has wheels that rotate about their axle and a front steering mechanism that works with handlebars connected to the fork through the head tube. If you want to move a bicycle, you can roll it or ride it.

And what about use? The imported frame has exactly one use: it can become part of a finished bicycle. A bicycle has as many uses as you can imagine. It can be used to tackle the cobblestones between Paris and Roubaix. It can be used to race across the continent. A bike can help a girl in India get an education. A bike can be used to get documents across town or in an unsuccessful effort to outrun a tornado. A bike can help you "meet the future" or find the basement at the Alamo. When necessary, and with the right help, it can let you fly.

So, as you might be able to tell. I don't buy it. I think an imported frame--in all its carbon, titanium, steel, or aluminum glory--is a static component of a bicycle. Assembling the finished machine, in my view, substantially transforms the frame into a useful bicycle. Customs and Border Protection might not agree. But, if it is going to disagree, it should apply the proper analysis to get there.

Monday, November 28, 2016

Quick Post: Tyco Affirmed

The Court of Appeals for the Federal Circuit has affirmed the Court of International Trade decision in Tyco Fire Products v. United States. You can read the background on this case here. The Federal Circuit held that liquid-filled glass bulbs of the sort used in fire sprinklers are properly classified as articles of glass in Heading 7020 rather than as mechanical appliance of Heading 8424.

There are two interesting points to take away from this decision. The first is that the Federal Circuit, at least this panel, is skeptical of the value of the Brussels Tariff Nomenclature Explanatory Notes when interpreting the current Harmonized Tariff Schedule of the United States. This is in part because Customs declared the HTSUS to be a wholly new system and that the BTN Notes are of no value when interpreting the new text. The CAFC did not definitively decide this issue, but it certainly creates doubt as to the continuing value of the old notes.

The second point is that the CAFC indicates that tariff language requiring a "high proportion" of some material should usually be read to mean "more than 50%." Again, this is not a definitive holding and the Federal Circuit itself pointed out that this will not be the case where there are more than two materials. Nevertheless, this is useful guidance for interpreting the Tariff and the legal notes going forward.

Friday, November 18, 2016

Perpetuating Testimony

I am on the record complaining about the amount of discovery that is requested in many, not all but many, customs cases before the U.S. Court of International Trade. My belief is that in many cases, mostly tariff classification cases, there is not a reasonable basis to dispute the nature of the product. That is not necessarily the case when issues like principal use or essential character are concerned. But, in many cases, the actual physical characteristics of the item are known and not reasonably subject to debate. That physical reality will usually trump arguments based on personal understandings, marketing, and intention. As a general rule, I don't think it matters that Malcom down in Engineering always calls the electric toothbrushes he designs "machine tools." Nor do I think it matters that an Import Specialist at the Port of Smallville, Kansas once said that the electric toothbrush should be classified as toothbrushes rather than as electromechanical domestic appliances. [Or whatever, I am just making this up. If you care, see (HQ 966794, Sep. 7, 2004).]

That said, there are times discovery is important. For example, in a penalty case when the issue is whether someone knew or had reason to know that a statement was false. Also in a penalty case, discovery is necessary when the issue is whether there was "contributory customs error." If the toothbrushes were misclassified because someone at CBP told the company to do it, that is a relevant area for discovery.

This is relevant because of Ganz U.S.A., LLC v. United States. Ganz imports gifts, collectibles, and home décor products. For reasons that relate to a customs valuation ruling, Customs and Border Protection has notified Ganz that it will assess a penalty of nearly $22.7 million, which is enough to get the attention of most companies. But, CBP has not yet filed an action in the Court of International Trade seeking to collect anything. At this point, Ganz is waiting to be sued.

Ganz also knows that it has a defense. According to the CIT opinion, if sued, Ganz will present evidence that the Port of Buffalo instructed Ganz that CBP would allow the company to maintain its current valuation practice pending a decision on the reconsideration of the relevant value ruling. Customs denies that it provided that instruction. Ganz believes that a retired former Supervisory Import Specialist from Buffalo knows the truth. This is the equivalent of a CIT-based Perry Mason Moment waiting to happen.

Ganz is not waiting around to be sued. Nor does it want to risk losing track of the potential witness. CIT Rule 27 provides an opportunity to reduce that risk. Under the Rule, a petition may ask the Court for an order authorizing the deposition of a witness "to perpetuate their testimony." In other words, Rule 27 allows parties to current or threatened litigation to get something on the record now for later use if needed. This option is not always available; it is intended to be used where there is a risk that the evidence might be lost. To be successful the petitioner must show:

(A) that the petitioner expects to be a party to an action cognizable in this court but cannot presently bring it or cause it to be brought;
(B) the subject matter of the expected action and the petitioner’s interest;
(C) the facts that the petitioner wants to establish by the proposed testimony and the reasons to perpetuate it;
(D) the names or a description of the persons whom the petitioner expects to be adverse parties and their addresses, so far as known; and
(E) the name, address, and expected substance of the testimony of each deponent.
 Here, Ganz is sitting on a substantial demand it apparently does not intend to pay. Thus, it has a reasonable expectation of future litigation in the Court of International Trade. Furthermore the penalty creates a clear interest for Ganz. Gans also knows exactly what information it needs and from whom.

Two important facts provide context for why Ganz wants to depose the witness now. First, customs penalty litigation can take a long time. While Ganz can technically force CBP to file suit by declining to extend a statute of limitations waiver, that hurts Ganz's efforts to resolve the case administratively. The Court will not put Ganz, the potential defendant, in that position. Combine that with the fact that the proposed witness is 68 years old. There is the real risk that his recollections will fade, or worse. At best, the witness might move to an inconvenient location.

Given these factors, the Court granted the petition to depose the witness to perpetuate his testimony. This is not particularly controversial. It is, however, a good reminder that this little-used tool is available to the parties. We should all make sure it is in our quiver.

Friday, November 11, 2016

Two Days Left to Vote Bigly

Two days left to vote for my work blog in the Best Legal Blog contest. Because I learn from current events, I would like to modify my previously friendly and polite pitch.

This blog contest is rigged. The IP lawyers and immigration lawyers are out to get me. Lawyers from big firms in NY and Washington are sneaking in, pretending to be niche boutiques, but they are really old, tired, losers with no stamina. My blog is the best, the best. It bigly covers import law, which really is the most important law. I know customs law like no one else. I just do. If you vote for me, you'll see, it will be great. I will win because that's what I do. I will make my blog great again and that will make you all great again. Who will pay for that? Mexico, that's who.

Wednesday, November 09, 2016

Anyone Curious About Withdrawing from NAFTA?

For some reason, I have been asked what it would take for the U.S. to withdraw from NAFTA or another trade agreement. Funny how that comes up today, the day after the U.S. presidential election.

The answer is not 100% clear.

In Article 2205, the NAFTA says the US can withdraw with 6-months written notice. If that happens, the agreement stays in place between Mexico and Canada. How that happens is a question.

The US would certainly be out of the agreement going forward, but most of the implementation of NAFTA was through legislation. That legislation might still be in place until Congress removes it.

Arguably, the legislation might automatically repeal itself. 19 USC 3451 says that if a country withdraws, the amendments made to implement NAFTA “cease to have effect with respect to that country.” It is not clear whether “that country” can be the US or whether that implies that Canada or Mexico has left NAFTA. There would be much litigation. Other trade agreements likely work the same way, but I have not looked.

Also, should the US pull out of NAFTA, the pre-existing US-Canada Free-Trade Agreement comes back from the dead. We would need to brush up on those rules.

Also, if the President tries to impose new duties, he runs up against WTO tariff bindings. US law, specifically so-called Section 301, lets the US increase duties or take other actions to address violations of trade agreements or unfair practices by our trading partners. Countries that feel increased duties are not consistent with WTO obligations can seek relief through the WTO dispute settlement process and, of authorized, retaliate. The potential for serial grievances and retaliation is what we call a "trade war."

Monday, November 07, 2016

Vote for Me, Too

Election day is here. If you have not already voted, get out tomorrow and vote.

After you have voted, come back and vote for this blog in the Expert Institute Legal Blog Contest. There are only about six days left to vote and my early surge is fading. Please show your support.

You can vote at this link.

Friday, November 04, 2016

Customs Law: Presidential Edition

Next week we in the U.S. will have a new president-elect. Getting there has been an unusually disheartening referendum on the mood and direction of the country. Voting always matters, but it might matter more this year than in a very long time.

With that, we take a quick look at Von Stade v. Arthur, 28 F. Cas. 1274 (S.D.N.Y. 1876)(I cannot find a fee link). Here is the decision in its entirety:

SHIPMAN, District Judge.  The second section of the act of June 6, 1872 (17 Stat. 231), provided, that, on and after August 1st, 1872, the existing duties upon the articles which are enumerated in the section should be reduced ten per centum.  The section specifies, among the enumerated articles, "all wools, hair of the alpaca goat, and other animals, and all manufactures wholly or in part of wool, or hair of the alpaca and other like animals, except as hereinafter provided." The question in this case is, whether the duty of fifteen cents per pound upon hogs' bristles was reduced by virtue of the act which has been cited.

Waiving the question, whether it was the intention of congress to reduce the duty upon the hair of all animals, whether such hair was used or not in the manufacture of textile fabrics, I am of opinion, that, in the tariff acts, the article of bristles is separately classified, and is regarded as a different article from hair. This will appear from the act of June 30, 1864 (13 Stat. 212), which prescribes a duty upon bristles of fifteen cents per pound, and upon hogs' hair of one cent per pound. The language of the Revised Statutes of 1874 (page 480) is "Bristles, fifteen cents per pound;" "hair of hogs, one cent per pound." The term "bristles" is used in the tariff acts to denote a separate and distinct article from hair, and the bristles are not included in the general words "the hair of an animal," but have a distinct classification.

Let judgment be entered for the defendant. 
The issue here is whether a bill reducing the duty on certain animal hair applies to hog bristles? My initial thought was, are bristles hair? It turns out that they are, but that they are a unique variety of short, stiff hair. Most important to the decision is that the Tariff Act of 1864 had a separate and more specific paragraph covering bristles. By this early application of the rule of relative specificity, the Court upheld the higher duty collected by Customs.

Why is this my "Presidential Edition?" This is why:

The defendant in this case is the Collector of Customs in New York, a man known as Chester A. Arthur. President Grant had given Republican New York Congressman Roscoe Conkling authority to dole out the federal patronage jobs in New York. The Collector was the plum appointment. In that position, Arthur was able to hire hundreds of customs officers to collect duties at the then-busiest port in the country. The Collector earned as much as any federal official at the time including a portion of the value of seized property and penalties assessed. That created an incentive to find real or imagined violations. Eventually, this stopped and Customs employees became members of a professional civil service with regular salaries.

Arthur continued to rise through Republican ranks. He eventually became the leader of the party in New York and then Vice President to James Garfield. Things did not go well for Garfield.

Garfield, shot by Charles J. Guiteau, collapses as Secretary of State Blaine gestures for help. Engraving from Frank Leslie's Illustrated Newspaper
Thus, the Collector of Customs becomes President of the United States.

Wednesday, November 02, 2016

Ruling of the Week 2016.21: Holy HoloLens!

Over the years, I have opined on the tariff classification of a number of gizmos that I think are probably computers. Often, Customs and Border Protection disagreed with me. Usually, this has to do with whether the particular item is "freely programmable" as opposed to having a specific and limited function. For example, here is a discussion on big industrial digital printers. Here is another on a music editing system and another on a smart watch. I also previously admitted to being a middle-aged Microsoft fanboy. So, this next post is right in my wheelhouse.

If you are not familiar with Microsoft's HoloLens, watch this video.

The imported merchandise is the Microsoft HoloLens and its associated "clicker" controller. HoloLens is a computer [spoiler]. It has a 32-bit processor, 2 GB RAM, 64 GB storage, a graphics processor, and Wi-Fi connectivity. Most important for our purposes, it runs Windows 10 and supports applications written for that environment. What distinguishes HoloLens from your laptop is that it sits on your head, includes sensors to track your position, and places three-dimensional stereo displays before your eyes. The result is that the user can be completely immersed in a virtual world or, perhaps even more exciting, in an augmented version of reality.

I can imagine an entirely feasible scenario of basic law office productivity using HoloLens. In that world, I sit at my desk or walk about my office with Word documents and Excel spreadsheets virtually pinned to my walls until I want them. I might have a 3-D virtual model of a client's product siting on my desk. The old practice of staring into a two-dimensional monitor that sits in a fixed location will be replaced by having the data you want, everywhere you want it. HoloLens and a Bluetooth keyboard for text entry might be the ultimate set up. With cellular connectivity, the headset could replace my main laptop, my tablet, my XBox, and my phone.

Don't get me wrong. I don't expect everyone in a law firm or other enterprise to spend the entire day in a HoloLens headset. I have not been in one, but I doubt they are that comfortable. I am just waxing poetic about the possibilities, not the practical realities. I leave that to those of you who have actual access to a HoloLens (or similar device). [Side note, T-Mobile recently announced it will be selling an Alcatel IDOL Windows Phone with VR goggles, which may be the entry way to VR for many of us.] I view HoloLens as the promise of something between the current headset design and the form factor of Google Glass. That is all the functionality of your phone and PC without ever reaching for a physical device.

So, what about the ruling? Oh, that. It is N273804 (Apr. 7, 2016). Customs noted that the primary function of the HoloLens is data processing. It is a general purpose device that allows users to access multiple applications, of their choosing, including mundane tasks like word processing and spreadsheets. Customs, therefore, had no problem concluding that it is a freely programmable automatic data processing machine. Customs classified it in 8471.41.0150, which is entirely correct.

Thursday, October 27, 2016

Essential Identity & Mobile Homes

When I saw that the Court of International Trade issued an opinion in a case called Pleasure-Way Industries, Inc. v. United States, I was hoping for something more salacious than the tariff treatment of mobile homes from Canada. Despite my prurient disappointment, this is an interesting case and raises a couple interesting questions.

As with many classification cases, the material facts are not in dispute. The plaintiff purchased Sprinter vans in the United States and exported them to Canada. In Canada, the plaintiff converted the vehicles into motor homes (or possibly the "tiny house" to which I aspire). That conversion included new flooring, cabinets, plumbing (including a toilet and shower), kitchenette, and a propane system. When returned to the US, the plaintiff believes the vehicles should be afforded a duty preference under HTSUS item 9802.00.50 as “[a]rticles returned to the United States after having been exported to be advanced in value or improved in condition by any process of manufacture or other means . . . .”

Pleasure-Way took the smart initial step of seeking a binding ruling from Customs on this question. It received a positive response indicating that the imported mobile homes qualified as duty-free under 9802.00.50. Customs, however, subsequently revoked that ruling on the grounds that Pleasure-Way had failed to disclose that similar or identical transactions had taken place or were pending. That is an important lesson. While this rule, 19 CFR 177.1(a)(2)(ii), is often ignored or finessed by both sides, it does technically preclude a ruling in this circumstance. Thus, the bind ruling was revoked and declared void. But, read it. The analysis is perfectly reasonable.

Customs then liquidated the vehicles without the benefit of 9802 and, therefore, assessed duty. Plaintiff protested. Surprisingly, Customs did not adopt the analysis it previously employed in the revoked ruling and denied the protest. That brings us to the Court of International Trade.

The issue here is not whether the vehicle was advanced in value or improved in condition in Canada. It was.  The question is whether the article returned to the US is the same article that was exported. This may seem silly, but it matters because 9802.00.50 only applies to items returned to the US. That means that the processing in Canada cannot produce a new and different article. It if does, the item is new and is not “returning.”

This feels a lot like other customs questions, but it is unique. This is not an issue of substantial transformation and whether the mobile home is an article of Canada. That is a similar question, but it is not what defines 9802.00.50. This is also not a question of “essential character,” with which it is sometimes confused. The question here is whether the exported Sprinter retains its “essential identity” after being converted to a mobile home. Put in that light, this is a more complex question.

The customs regulations address this issue at 19 CFR 181.64. According to the regulation, the duty preference does not apply “to goods which, in their condition as exported from the United States to Canada or Mexico, are incomplete for their intended use and for which the processing operation performed in Canada or Mexico constitutes an operation that is performed as a matter of course in the preparation or manufacture of finished goods.” What this regulation does is tell us that advancing in value and improving the condition does not include the manufacturing of the finished article. In other words, the exported item needs to be the finished article and the processing in Canada or Mexico can only improve on that finished article.

Applying that analysis here, the Court found that the “finished goods” refers to the imported mobile homes, not the exported Sprinters. Further, the Sprinters are exported as part of the supply chain for making the mobile homes, which means the exportation is performed as a matter of course in the manufacture of the mobile homes. Thus, 9802.00.50 is inapplicable and the Court rendered judgment for Customs.

There is a little more to this, and that is where the problems arise.

First, the HTSUS, which is a statute, does not include the limitation found in the regulation. The HTSUS says, in its entirety,

9802.00.50 Articles returned to the United States after having been exported to be advanced in value or improved in condition by any process of manufacture or other means: Articles exported for repairs or alternation: Other.

Ignoring the regulation, can Plaintiff win this case? If so, then the question is whether the regulation is consistent with a “permissible” (meaning “reasonable”) reading of the HTSUS. If Congress made it clear that this HTSUS provision should apply in this circumstance, no regulation from Customs can change that. In that case, the regulation would be invalid as ultra vires. But, I don' think that happened here. The tariff item clearly requires that the article be returned. Implied in that is that it is the same article coming back to the US. The mobile home was, according to the Court of International Trade, not the same article as the Sprinter that was sent to Canada.
On balance, this strikes me as a good result. One thing I really don't like is that rather than focus on "essential identity," as has been done in prior cases, the Court inserted the intent of the exporter into the equation. Intent is notoriously hard to prove after the fact and classification generally should not depend on intent. In this opinion, intent is a small point and not necessary to the holding, so it is not an issue. On the other hand, we should be wary of "intent" creeping into classification where it does not belong.


Wednesday, October 26, 2016

Ruling of the Week 2016.20: Bottle Toppers

Ruling of the Week? Who am I kidding? This is number 20 in my 2016 rulings of the week series, not number 43 as it should be. I'll either try to step it up next year or come up with a more truthful name for the series.

Today's ruling is HQ H264771 (Jul. 28, 2016) in which Customs trods over ground I thought was well settled and reaches the conclusion opposite from what I might have done. Let's see how that happened. It's a close call, so reasonable minds might differ on this one.

The merchandise in question is plastic "SippaTop" bottle toppers. These are plastic, spill-proof, reusable, tops for juice bottles. They are in the form of popular licensed characters and are, therefore, marketed as collectible. According to the company, they give young children more independence and parents more peace of mind, which I take to mean that they don't spill and that keeps everyone happy.

The importer entered these in 3923.50.00 as plastic lids, stoppers, caps or closures. Customs liquidated accordingly. The importer then protested the liquidation, asserting that the bottle toppers are best classified in 9503.00.00 as toys. Customs denied the protest in this ruling.

If you have been around customs classification for a while, you may be experiencing deja vu. The Court of International Trade looked at similar merchandise in a case called Minnetonka Brands back in 2000. That case involved plastic bottles and caps in the shape of various characters, including Cookie Monster and Big Bird. The bottles were accurate representations of the characters with appropriate shapes and colors. Although the caps were removable, according to the Court, "none of the limbs are moveable." (See page 3.) That part will be important later. Finally, the Court noted that when looking at the complete set, it was not immediately obvious that the plastic item was a bottle and cap rather than a plastic model of the character. That is also important.

Together, the bottle and cap were sold filled with bubble bath solution, but the items were imported empty. Testimony presented to the Court stated that the bottles were designed to add "toy or play value" to the company's product line. Regarding the "heads," the Court found that they do not enhance the ability of the bottle to contain bubble bath and do not add to the utility of the overall package.

The CIT held that a "toy" is designed for amusement or diversion, rather than practical utility. Furthermore, it held that Heading 9503 is a use provision requiring evidence that the class or kind of merchandise to which the imported item belong is principally used as a toy. The Court concluded:
the court finds the subject merchandise to be of the class or kind of merchandise whose principal use is amusement, diversion or play, rather than the conveyance or packaging of goods.  The unique physical characteristics of the merchandise, the design and marketing of the merchandise as items of amusement (rather than as bubble bath containers), the anthropomorphic nature of the merchandise, the expectation of the ultimate purchasers that these objects will be used for play, the regular use of the merchandise by children for amusement purposes, the fact that the merchandise does not compete with (and sells at a large premium to) bubble bath in flat plastic bottles, and other facts revealed at trial, support this conclusion.  Accordingly, Plaintiff has rebutted the presumption of correctness (28 U.S.C. § 2639(a) (1994)) that attaches to Custom's classification.

Why the different result?

Here, Customs found that whatever the amusement value of the SippaTops, that value was outweighed by their utility as spill-proof bottle tops. CBP seems to have been taken by marketing copy that indicates the use of the SippaTops would encourage children to drink healthy beverages, which is a matter of practical utility rather than amusement.

Customs cited its prior rulings on similar merchandise. Specifically, in HQ 966633 (Mar. 18, 2005), Customs analyzed plastic bottle toppers as composite goods consisting of a plastic lid and molded character. That makes sense. Using that analysis, Customs held that the plastic lid provided the essential character and that the decorative topper was incidental to the lid. Thus, it was classified in 3923 rather than as a toy of 9503. Customs noted other similar rulings in which it found that bottle toppers lacked value in "manipulative play" as compared to their utilitarian value. Here, Customs did not treat these as composite goods and did not venture beyond GRI 1.

All of that makes sense. The problem I have is that it is not consistent with the Minnetonka decision. Customs distinguished Minnetonka on the grounds that the merchandise there was full bottles, not just toppers. Customs also says that the bottles in Minnetonka had moveable limbs. That does not appear to be correct based on the Minnetonka decision. Moveable limbs would obviously add "play value," which is something future tariff engineers should keep in mind.

I think that Minnetonka turned on the fact that the bottles were designed to be distinguishable from normal, utilitarian, flat bottles that simply hold bubble bath. The bubble bath character bottles did not compete with bubble bath in basic bottles and sold at a premium. They had anthropomorphic designs intended ad amusement and encourage play. Because the bottles had no moveable limbs, that play must have been limited in nature. I image a child in the tub holding the bottle like a crude a puppet, making up imaginative scenes. What I think is key in Minnetonka and is missed here is that if the importer wanted a bottle cap, it could have purchased one without the time and expense of designing three-dimensional characters, paying licensing fees, etc. Why would it go to that time or expense? Not to make a better bottle cap. If anything, the addition of the plastic head detracts from the utility of the bottle cap functioning as a bottle cap. The importer made a bottle cap that appeals to children as an article of amusement or diversion.

The SippaTops are not full bottles and cannot be mistaken for full-bodied representation of the characters. They are clearly bottle tops, which are plastic lids. But, at least to me, diversion is a pretty low threshold. The Michelangelo Teenage Mutant Ninja Turtle SippaTop seen above is designed, marketed, and no doubt functions as a diversion for children. By replacing a normal bottle top, with an entertaining and diverting one, parents can encourage kids to drink. That is useful, but not so useful, at least to my mind, to outweigh the diversion value of the item.

That said, this is a admittedly a close call. At some point, a bottle cap is a bottle cap. If this were a normal bottle cap simple painted with an eye-catching design, would it be a toy? No. But, that is not where we are. What we have are three dimensional, plastic forms that can be collected, traded, and (when the XBox is unavailable) treated like puppets. That strikes me as a toy of Heading 9503.

Tuesday, October 18, 2016

Troll Update

I'm Larry Friedman. You may remember me from such blog posts as Customs Trolls and the False Claims Act. In that post, we talked about the case brought by a company called Customs Fraud Investigations LLC alleging that Victaulic Company had avoided the payment of marking duties by making false statements to Customs and Border Protection. At the time of the first post, the United States District Court for the Eastern District of Pennsylvania dismissed the case as failing to state a cause of action. The Court subsequently refused CFI's motion to amend its complaint in an effort to correct the deficiency. The Court of Appeals for the Third Circuit has now reversed the District Court and sent the case back down for further proceedings.

The case was brought under the False Claims Act. This law was passed after the Civil War as a means of ensuring that the government was not paying out on fraudulent claims. In a typical FCA case, the "relator" alleges that someone submitted a bill to the government for payment without a legal right. You hear about this a lot in cases where health care providers submit false bills to Medicare for payment. Someone, often an insider, who has evidence of the fraud can file a case on behalf of the United States and, if there is a recovery, share in the proceeds.

The amount that goes to the relator depends on what happens. After the case is filed, the Department of Justice reviews the complaint and decides whether to take over the case and prosecute it. In that case, the relator may receive between 15% and 25% of the recovery, If the DOJ does not take on the case, the relator can proceed with its own counsel. If successful, the relator may recover between 25% and 30% of the recovery. In addition, attorneys fees can be reimbursed. This is a good thing as it creates a private incentive to root out fraud on the taxpayers. It has also generated a plaintiffs bar of attorneys who file these claims.

CFI, the relator in this case, is a new kind of enterprise. According to the dissenting Third Circuit opinion, the company appears to have been created solely for the purpose of bringing this case, and presumably similar cases. That makes it similar to what patent lawyers politely call "non-practicing entities." These folks are more often called patent trolls. Non-practicing entities, or "Patent Assertion Entities," collect patents for the purpose of monetizing them not through manufacturing, production, or sales. PAEs, make money by purchasing large numbers of patents and threatening litigation against companies that actually make or sell things in related industries. They threaten litigation in the hope of securing license fees or settlements. They never have an interest in using the patented invention.  The FTC recently released a very thorough report on patent trolls with recommendations that courts take steps to limit the impact of PAEs.

CFI is analogous, which is why I dubbed it a "customs troll." Rather than collect patents, it mines the publicly available data showing what has been imported into the United States via ship and by whom. From that information, it can make some assumptions about the country of origin of various products moving in the commerce of the United States. It can then look for those products and determine whether they have been properly marked with their country of origin. To the extent it find evidence of products imported without proper country of origin marking, it can file an FCA case as a relator and hope for a recovery. This is exactly what it did to Victaulic, a Pennsylvania-based manufacturer of pipe fittings. CFI might also use the ships manifest data to find products subject to antidumping or countervailing duties and, based on resale price in the U.S., deduce that duties had not be properly deposited.

The reason this is analogous to a patent troll is that CFI is not in the pipe fitting business. It is not individually harmed by any alleged misrepresentation as to country of origin. It is also not a purchaser looking to support local business by purchasing American-made pipe fittings. CFI is also no a petitioner in any antidumping or countervailing duty case seeking to protect the domestic industry nor is it an importer of such products who paid the additional duties and wants to ensure that other importers do as well. CFI's only interest in these pipe fittings is as a relator and potential recipient of proceeds from the case.

CFI's complaint does not allege that Victaulic made a fraudulent request for payment from the government. Rather, it asserted that to the extent Victaulic imported improperly marked pipe fittings and failed to tell Customs that fact, it avoiding having to pay the 10% ad valorem marking duties that can be assessed under 19 USC 1304(i). This is a so-called "reverse false claim." By failing to disclose the non-compliant marking, Victaulic avoided the payment of marking duties.

How could CFI possibly know that the pipe fittings were improperly marked? From the manifest data, CFI determined that Victaulic imported 83 million pounds of fittings over a ten-year period. To determined whether the fittings were properly marked, CFI looked on eBay for pictures of Victaulic products. By treating eBay as a proxy for the entire U.S. market, Victaulic calculated that virtually none of the products in the U.S. marketplace are properly marked. In an effort to bolster its argument that it should be permitted to amend its complaint, Victaulic produced an expert witness report stating that its approach is statistically valid, a photograph of an allegedly unmarked part, and a witness who expressed a recollection of seeing an unmarked product.

That is all background, which is really the most interesting part. The third Circuit did not have to decide the merits of the case. The only question before it was whether the District Court properly denied the motion to amend. That is a lawyerly question on which we need not dwell here.

The salient points for customs and trade professionals are:

  1. The FCA is broad enough to encompass as reverse claims "contingent, non-fixed obligations including those relationships with the government that result in a duty to pay the government money.
  2. This extends to marking duties that would be applicable to improperly marked or unmarked goods imported into the United States.
  3. Knowingly concealing from Customs that goods are unmarked results in the releass of merchandise without the payment of marking duties can give rise to a reverse FCA claim.
  4. At least at the pleading stage, it is sufficient to use a statistical model, rather than direct evidence of fraud.
It is this last point that requires additional attention. Under the Federal Rules of Civil Procedure, allegations of fraud require an enhanced level of specificity. General assertions will not do. But the Third Circuit allowed CFI to amend its complaint on the basis of shipping data and eBay pictures. That is a long way from being able to tie a specific unmarked pipe fitting to a specific entry, which is more detail than is required. Despite that conclusion, the Third Circuit expressed its skepticism at this case. Further, it took the unusual step of instructing the District Court to be mindful of the burden this case is likely to place on Victaulic and to manage discovery accordingly.

That may open the door to more cases based on nothing but data mining and statistical modeling by professional customs trolls, which is a far cry from the traditional whistle blower with inside information. While that might expose real fraud, I'm not sure it is how the law was supposed to work.

This is a preliminary ruling. The case has to go back to the District Court.

Note that CFI is the relator in another case involving an alleged failure to pay antidumping duties on standard pipe from Mexico. The complaint in that case was recently unsealed.

Reminder to importers: If you want to avoid being on the receiving end of one of these suits, please make a formal request that Customs designate your manifest data as confidential. Customs will do that.

Thursday, October 06, 2016

Ford Case Transits to Trial

I've been waiting for a potentially block-buster decision in Ford Motor Co. v. United States, which is pending before the U.S. Court of International Trade. We now have a preliminary decision which is interesting, but is not yet in a position to bust any blocks.

This case is about the tariff classification of imported Ford Transit Connect vehicles made in Turkey. At the time of entry, all Transits have swing-out front doors with windows, second-row sliding doors with windows, and swing-out rear doors, some of which have windows. The imported vehicles also have two rows of seats, rear passenger windows, rear passenger seat belts, child-locks on the rear sliding doors, a rear cup holders in the front console, a full length cloth headliner, coat hooks, and a map pocket in the second row. Starting in 2010, Ford created a "cost reduced" second row seat for use in Transit vans. The second row seats lack headrests, "comfort wires," a tumble lock mechanism and labels. Finally, the rear seats are made of a "cost reduced fabric." There are two trim levels, so the details vary somewhat, but this should be enough detail to convey the point.

Shortly after customs clearance, but while still within the legal confines of the port of entry, the rear seats, rear door windows, and other passenger amenities are removed to convert the vehicles to the small cargo vans you probably see every day. They look like this:

There are passenger wagon versions of the Transit, but the case only involves vehicles that are ultimately delivered as cargo vans.

Why would Ford go to all this effort? Because in the 1960's, the US got into a spat with Europe over its duties on chicken imports from the US. In retaliation, the US imposed a 25% duty on trucks. That duty remains on the books today and is called "the Chicken Tax." The duty on cars for the transport of persons is, on the other hand, just 2.5%. That difference makes it worthwhile for Ford to import tall passenger cars and, after importation, convert them to trucks, saving 22.5%. That, ladies and gentlemen, is an example of tariff engineering. Or, as the government contends in this case, it is an impermissible "artifice or disguise" to avoid the correct assessment of customs duties.

Think about all the Transit Connect vehicles you see in the course of a day. I see lots. This is obviously a big deal case for Ford and for Customs and Border Protection. It is also a big deal in general because this case might set the parameters for legally acceptable tariff engineering. That's why it has been closely watched.

The starting point for this analysis is that the classification of an article must be ascertained by examining it in the condition in which it was imported. Processing subsequent to importation is generally not relevant. However, an importer cannot "resort to disguise or artifice" to avoid an applicable duty. That means that if the imported article "is not the article described as dutiable at a specific rate, it does not become dutiable under the description because it has been manufactured or prepared for the express purpose of being imported at a lower rate." The Court of International Trade expressed this as a "bright line test" of "does the article, as imported, fall within the description sought to be applied?"

Thus, if the imported Transit, with reduced cost seats and rear windows is, in fact, classifiable as a passenger car, then it will be classified as such regardless of subsequent modification. That is the important legal conclusion at this point of this case. What the Court is saying is that Ford's motive of reducing duty liability and subsequent processing does not dictate the classification. Rather, if the imported Transit vehicles, which are described as passenger cars, are passenger cars when imported, then Ford will win this case. That is a big deal, if it holds.

To determine whether the Transits are passenger cars, the Court of International Trade started to appy the analysis of a 1994 Federal Circuit case involving early sport-utility vehicles, Marubeni Am. Corp. v. United States. That case set out lots of features that indicate that a vehicle is designed primarily for passenger use or primarily for cargo use.

According to the Court, it has a lot of details about the vehicle as imported and post-conversion. But, it lacks some necessary information about the cost reduced rear seats. The Court believes that the missing information is necessary for it to apply Marubeni and make a final determination in this case. Consequently, the Court denied motions for summary judgment filed by both parties. That means that the parties will have to either present additional evidence, possibly in the form of an agreed set of facts, or the case will have to be decided following a trial on the open questions of fact.

Either way, we don't know the result yet. It appears that if (and I don't know this to be true) the rear seats installed in imported Transits are not adequate for passenger use, Ford may have a a problem. But, it might be that the seats are just awful and at the same time perfectly adequate for passenger use. Although some other facts may be at issue, this seems to be the sticking point. So, we need to wait for a complete result. Obviously, I will keep watching.

Shameless Search for Validation

I received an email telling me that this blog is in the running for some kind of recognition among legal blogs in niche or specialty practices. To win, I need readers to vote. So, please do me a solid by visiting this site and voting for my blog. You'll need to navigate down the page to find The Customs Law Blog. Then click the image of the blog. That will take you to the voting page.


And, watch this space for a review of a case from the Supreme Court of Canada and some developments involving the False Claims Act.