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.


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