The DR-CAFTA Bind
[Tip of the hat to my partner David Forgue, who has been thinking about this issue out loud longer than me.]
At what point is compliance with a trade agreement so risky that it becomes unworkable? Do the powers that be know that the trade agreements they negotiate might be effectively nullified by the cost of compliance? These are questions raised by the Federal Register Notice Customs and Border Protection published today.
Nominally, the notice finalizes changes to the regulations implementing the Dominican Republic-Central America-United States free trade agreement. However, the response to one comment is particularly telling. Here is the relevant text:
Conceptually, "reasonable care" should be based upon the standard of care that would be exercised by a similarly situated importer acting reasonably. Unfortunately, we have no real idea what that means in everyday practice. In retrospect, it will be easy for Customs to say that the importer should not have trusted the supplier. See the unfortunate precedent of Golden Ship Trading and my prior discussion of this in the NAFTA context.
A corporate compliance manager is likely to see this as a dilemma. The manager has only a few choices and none of them are great. First, the manager might simply choose to rely on COs from suppliers based on an examination of the four-corners of the CO itself. If it looks good on its face, accept it. The problem with that is that it might expose the company to liability down the road for duties and penalties if the COs eventually turn out to be invalid.
To avoid that possibility, the manager might decide to only accept COs from suppliers willing to permit a thorough vetting of the supporting documents. While that is safe from liability, it adds complication and expense to the supply chain. Would most companies authorize travel to Guatemala to review production records at a supplier? In addition, it probably precludes the use of suppliers who will refuse the increased scrutiny, which is more likely if materials costs must be disclosed.
The middle ground is to strategically review suppliers based on the criteria relevant to the particular importer. High MFN duty rate products and high volume imports present greater risk and greater potential liability. Those should get greater scrutiny than low volume, low duty imports. Some goods engender more risk of unscrupulous supplier conduct and deserve more attention. A product with a complicated rule of origin should be the subject of a more searching review than a simple rule. For example, apparel is trickier and more subject to shenanigans than is coffee. This strategy might limit liability, but does not eliminate it.
Another approach is to include in purchase contracts language requiring that the goods be originating under the appropriate rules of origin and require indemnification for losses resulting from that being untrue. If the application of this clause is contested, it might require litigation or arbitration in the supplier's home jurisdiction. That may be expensive and impractical.
Credit should be given to Customs for pointing out in the Federal Register Notice, that an importer can avoid liability by voluntarily correcting an entry that asserted an incorrect claim. That is true and does provide a safety valve. But, it presupposes that the importer knows that the claim was invalid.
In the end, each importer needs to weigh the risks and rewards of compliance. Keep in mind that this issue runs throughout most of our preference programs including GSP.
It did not need to be this way. Look at NAFTA. Under that agreement, the importer is pretty clearly (note important hedge) permitted to rely on the certificate of origin from the exporter. The CO and the verification system put the burden of proof on the exporter, not the importer. Granted, the importer might be on the hook for additional duties if the exporter fails a verification. Further, if the importer's reliance on the document was unreasonable, it could be subject to penalties. But, the focus under NAFTA is clearly on the exporter.
For some reason, the US does not like the NAFTA verification model. The newer trade agreements shift the verification to the importer. And, Customs has made efforts (including the Ford litigation) to use reasonable care and record keeping to shift that burden to the importer. How successful they will be in that effort remains to be seen.
Regardless of what happens with NAFTA, the DR-CAFTA, GSP, AGOA, and other trade preference programs put importers in a bind. Reliance on the exporter is not likely to satisfy Customs and Border Protection as evidence of the exercise of reasonable care. Audits of suppliers are expensive and time consuming. If the duty avoidance is minimal or the potential penalty substantial, the cost of compliance might make the trade agreement a bad deal for importers.
That leads to the last question: Do the policy makers at USTR and in the White House know that the on-the-ground implementation of trade agreements might actually nullify the benefits they were intended to generate? Does it help Central America or Sub-Saharan Africa to have a trade preference program that is so risky that importers think twice about using it?
At what point is compliance with a trade agreement so risky that it becomes unworkable? Do the powers that be know that the trade agreements they negotiate might be effectively nullified by the cost of compliance? These are questions raised by the Federal Register Notice Customs and Border Protection published today.
Nominally, the notice finalizes changes to the regulations implementing the Dominican Republic-Central America-United States free trade agreement. However, the response to one comment is particularly telling. Here is the relevant text:
Comment: The commenter asserted that Sec. 10.585(a)(1) and (a)(2) impose impossible obligations on the importer. These provisions state that an importer who makes a claim for preferential tariff treatment under the CAFTA-DR (1) will be deemed to have ``certified'' that the good is eligible for such treatment; and (2) is responsible for the truthfulness of the claim and the information in the certification. According to the commenter, unless the importer has conducted an audit of the producer's books and records, it cannot ``certify'' that the good is eligible for preference or attest to the truthfulness of the claim and the information in the certification. In this regard, the commenter noted that some producers may be reluctant to open their books and records to their customers, including U.S. importers.
CBP's Response: CBP disagrees with the commenter's assertion that the importer should not be responsible for certifying that the goods are eligible for preference or for the truthfulness of the claim and the information in the certification. It is the responsibility of the U.S. importer of the goods for which preference is sought to file the appropriate entry with CBP and make the claim for preferential tariff treatment for the goods. In making this claim, the importer is responsible for exercising reasonable care to ensure that the goods are entitled to such treatment. CBP acknowledges that some producers may be reluctant to open their books to importers, but notes that an importer who has not acted fraudulently but nevertheless made an incorrect claim, is not subject to penalties if the importer promptly and voluntarily makes a corrected declaration and pays any duties owing. (19 CFR 10.585, 10.621, 10.623)Basically, this says that importers are on the hook for what their suppliers tell them. You can ask for a certificate of origin, but it remains the importer's responsibility to exercise reasonable care to ensure that the certificate you received is true. As the commenter suggests, this may be difficult. What is the importer to do if the supplier provides a CO and refuses to permit the importer to review backup documents? Does reasonable care dictate that the importer reject that CO?
Conceptually, "reasonable care" should be based upon the standard of care that would be exercised by a similarly situated importer acting reasonably. Unfortunately, we have no real idea what that means in everyday practice. In retrospect, it will be easy for Customs to say that the importer should not have trusted the supplier. See the unfortunate precedent of Golden Ship Trading and my prior discussion of this in the NAFTA context.
A corporate compliance manager is likely to see this as a dilemma. The manager has only a few choices and none of them are great. First, the manager might simply choose to rely on COs from suppliers based on an examination of the four-corners of the CO itself. If it looks good on its face, accept it. The problem with that is that it might expose the company to liability down the road for duties and penalties if the COs eventually turn out to be invalid.
To avoid that possibility, the manager might decide to only accept COs from suppliers willing to permit a thorough vetting of the supporting documents. While that is safe from liability, it adds complication and expense to the supply chain. Would most companies authorize travel to Guatemala to review production records at a supplier? In addition, it probably precludes the use of suppliers who will refuse the increased scrutiny, which is more likely if materials costs must be disclosed.
The middle ground is to strategically review suppliers based on the criteria relevant to the particular importer. High MFN duty rate products and high volume imports present greater risk and greater potential liability. Those should get greater scrutiny than low volume, low duty imports. Some goods engender more risk of unscrupulous supplier conduct and deserve more attention. A product with a complicated rule of origin should be the subject of a more searching review than a simple rule. For example, apparel is trickier and more subject to shenanigans than is coffee. This strategy might limit liability, but does not eliminate it.
Another approach is to include in purchase contracts language requiring that the goods be originating under the appropriate rules of origin and require indemnification for losses resulting from that being untrue. If the application of this clause is contested, it might require litigation or arbitration in the supplier's home jurisdiction. That may be expensive and impractical.
Credit should be given to Customs for pointing out in the Federal Register Notice, that an importer can avoid liability by voluntarily correcting an entry that asserted an incorrect claim. That is true and does provide a safety valve. But, it presupposes that the importer knows that the claim was invalid.
In the end, each importer needs to weigh the risks and rewards of compliance. Keep in mind that this issue runs throughout most of our preference programs including GSP.
It did not need to be this way. Look at NAFTA. Under that agreement, the importer is pretty clearly (note important hedge) permitted to rely on the certificate of origin from the exporter. The CO and the verification system put the burden of proof on the exporter, not the importer. Granted, the importer might be on the hook for additional duties if the exporter fails a verification. Further, if the importer's reliance on the document was unreasonable, it could be subject to penalties. But, the focus under NAFTA is clearly on the exporter.
For some reason, the US does not like the NAFTA verification model. The newer trade agreements shift the verification to the importer. And, Customs has made efforts (including the Ford litigation) to use reasonable care and record keeping to shift that burden to the importer. How successful they will be in that effort remains to be seen.
Regardless of what happens with NAFTA, the DR-CAFTA, GSP, AGOA, and other trade preference programs put importers in a bind. Reliance on the exporter is not likely to satisfy Customs and Border Protection as evidence of the exercise of reasonable care. Audits of suppliers are expensive and time consuming. If the duty avoidance is minimal or the potential penalty substantial, the cost of compliance might make the trade agreement a bad deal for importers.
That leads to the last question: Do the policy makers at USTR and in the White House know that the on-the-ground implementation of trade agreements might actually nullify the benefits they were intended to generate? Does it help Central America or Sub-Saharan Africa to have a trade preference program that is so risky that importers think twice about using it?
Comments
(b) This whole issue could be resolved if importers were only responsible for the "truthiness" of the certification. That would make the whole process easier.
(c) Finally, I don't like to admit it, but I get why they don't want to apply NAFTA verification to other countries. Discussing sovereignty issues inherent in Customs verifying in-country with Canada is one thing. The same discussion with Morocco, Chile, Singapore, the Dominican Republic etc. etc. starts to look a little burdensome.
I would like to have seen them take a novel approach that I think is win/win. If you reasonably relied on the supplier but the claim turns out to be in error, you ought to lose the benefit going forward, without owing back duties and interest. That would be fundamentally fair.