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 Thus, the bind ruling was revoked and declared void.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.