Interest and Disclosures

The Court of International Trade decision in Otter Products, LLC addresses a novel question about how loss of revenue is calculated in the context of a prior disclosure. Grab a snack, this is complicated. 

First, for anyone who needs a reminder: An importer that makes a material false statement or omission in connection with the entry of merchandise as a result of negligence, gross negligence, or fraud has violated 19 U.S.C. 1592 and is, therefore, susceptible to penalties. Penalties can be severe, up to two times any unpaid duties when the violation results from negligence and four times the unpaid duties when the violation results from gross negligence. Plus, the importer must pay the duties. In the case of fraud, the penalty is up to the domestic value of the merchandise, which is the entered value plus duties and other adjustments to try to get an approximate retail value in the United States. Given that the statute of limitations is five years, this can add up very quickly. Oddly, the penalties for negligence and gross negligence can be even higher if the violation did not result in a loss of revenue, but that is a quirk of the math that is best considered a technical possibility. 

Photo by Lilian Dibbern on Unsplash

An importer (or other person) that discovers a violation has the option to limit its potential liability by filing a "prior disclosure" with Customs and Border Protection. When there is a successful prior disclosure, the importer must tender any unpaid duties and the maximum the interest owed on the duties. This can be a very significant reduction in risk. Consequently, disclosures are fairly routine. And yet, they can be messy. 

Otter had two overlapping customs issues to address in the 2010's. First, it discovered that it had failed to declare assists as part of the value of certain imports. That omission affected the value Otter reported and the collection of duty, making it a material omission. There was also an issue regarding the classification of the merchandise products. The duty difference in the classification was from 5.3% as entered to 20% as far as CBP was concerned. That is also material. The classification dispute also sparked litigation. Eventually, the Federal Circuit resolved the matter in favor of Otter. That means Otter actually overpaid duties when it disclosed what was initially believed to an underpayment due to the classification when, in reality, Otter had been correct, and the disclosure resulted in an overpayment. 

After the Court decision confirmed the correct classification, Customs closed out the disclosures. As part of that process, Customs refunded the overpayments to Otter. The refund did not include interest, which is the issue before the Court in this case.

Before we get to the decision, we should look at the refunds themselves. Historically, a prior disclosure had been seen as a voluntary act by the disclosing party and, therefore, not subject to protests as a "charge or exaction" or a decision of Customs. In a case called Carlingswitch, the importer made a voluntary disclosure and tendered duties to Customs. Later, it was determined that the importer owed much more money. After that, the whole thing fell apart when someone noticed that the statute of limitations had passed, and Customs had no means to force the importer to pay. At that point, Carlingswitch sued to get its tender back. The Court of International Trade and the Court of Appeals both held that the voluntary tender of duties and potential penalties (presumably the interest), was not a charge or exaction giving rise to a right to a protestable decision. That appeared to make getting a refund of truly voluntary tenders impossible. If Customs makes a demand for payment, the situation is different and there may be a protestable event (see Brother Int'l Corp.)

After that, lawyers and importers adopted two strategies. Sometimes, they refuse to tender any money until the disclosure is complete and Customs confirms the amount due in writing to the disclosing party. This is permitted under the regulations. The downside to this approach is that interest keeps running and if the disclosure takes a long time (as they can do), it adds up. It also does not include a mechanism for contesting the amount owed.

The second approach is to make the tender early and request that it be deposited into a "suspense account," meaning it was held in accounting limbo until the disclosure was complete. That mechanism also allows Customs to refund the money. But it was not a regulatory process and, therefore, potentially subject to CBP discretion. That process also lacks a means of contesting the loss of revenue calculation (which sets the penalty caps).

Then in 1993, Congress passed The North American Free Trade Agreement Implementation Act, which included The Customs Modernization Act. The "Mod Act" made changes to the penalty statute that required amendments to the corresponding regulations. On September 26, 1996, Customs proposed amending the regulations relating to prior disclosures. As proposed, the section on tender read as follows:

(c) Tender of Actual Loss of Revenue. A person who discloses the circumstances of the violation shall tender any actual loss of revenue either at the time of disclosure or within 30 days after a Customs officer notifies the person in writing of the calculation of the actual loss of revenue. The Fines, Penalties & Forfeitures Officer may extend the 30 day period if it is determined there is good cause to do so. Failure to tender the actual loss of revenue finally calculated by Customs shall result in denial of the prior disclosure benefits.

Note that there is no reference in that proposed regulation to challenging the loss of revenue calculation. In the Notice and Comment phase, someone suggested that the proposal be amended to include a requirement that Customs refund any portion of the tender found to be in excess of the actual loss of revenue. Other comments suggested that the proposal be amended to provide a means of challenging or protesting Customs' calculation of the loss of revenue. 

Customs agreed that there should be a mechanism to resolve a "legitimate dispute" between Customs and the disclosing party regarding the loss of revenue. As a result, Customs amended the proposal and published the current 19 CFR 162.74(c). Under that regulation, Headquarters review of the loss of revenue is allowed in limited circumstances and with significant strings attached. The disclosing party can seek HQ review of the loss of revenue where:

1. The claimed loss exceeds $100,000
2. The disclosing party tenders the claimed loss of revenue
3. Greater than one year remains on the statute of limitations
4. HQ review is limited to the basis for the loss of revenue calculation 

If those circumstances apply, Customs Headquarters may review the calculation. If it finds there was an overpayment, Customs will refund the excess paid. However, the regulation also states that "Such Headquarters review decisions are final and not subject to appeal. Further, disclosing parties requesting and obtaining such a review waive their right to contest either administratively or judicially the actual loss of duties, taxes and fees or actual loss of revenue finally calculated by CBP under this procedure."

This raises a lot of question about whether it ever makes sense to contest the amount of the calculation administratively. If the importer does and Customs does not reduce the calculation, Customs may say that the importer has exhausted its rights to appeal; essentially, setting the loss of revenue calculation in stone (as far as Customs is concerned). Under Carlingswitch, the tendered amount might still be considered voluntary and not protestable. On the other hand, if the importer tendered as a means of qualifying for administrative review or following a demand from Customs, it might be protestable. Either way, it seems reasonable to assume Customs might cite the regulation in an effort to foreclose protests as an administrative challenge to the calculation. 

Any effort to seek judicial review would also run counter to this regulation. But it looks to me to be a stretch for a customs regulation to foreclose judicial review. On its face, it seems to violate the principle of separation of powers. An administrative agency cannot tell a federal court what it can and cannot decide. More specifically, no agency regulation can change the statutory jurisdiction of the Court of International Trade. Thus, this regulation seems to be there to discourage judicial because it creates an apparent obstacle that disclosing parties might want to avoid. As a result, the better practice may still be to withhold payment until the amount is resolved or to request that the tender be deposited into a suspense account to facilitate refunds of overpayments. 

With that background, what is happening in the Otter decision?

While the classification litigation was happening, CBP held Otter's disclosures in abeyance. After the litigation was complete, Customs closed out the disclosures and refunded the overpayments. That refund caused the extended background discussion above. I assume the refund was granted because CBP had not acted on the disclosures so there was no final determination of the amount owed to be challenged and, therefore, no alleged waiver of and rights to judicial review. 

All of that explains, I hope, how Otter got a refund of its voluntary tender. What Otter did not get was interest on the refund and that is what this case is about.

Since this case does not concern a denied valid protest, the plaintiff brought the case to the Court on its residual jurisdiction under 28 USC 1581(i). While subsection (i) gives the CIT exclusive jurisdiction over final agency actions relating to customs duties, taxes, and fees collected on imports (and other matters), it does not create a cause of action. To successfully bring a case, the plaintiff has to assert a cause of action for which the United States has agreed to be sued, that is, a waiver of sovereign immunity. In (i) cases, the waiver is usually the Administrative Procedure Act, which waives sovereign immunity where a final agency action has adversely affected or aggrieved the plaintiff. 

On the other hand, there is a "no-interest rule," which precludes suits for interest against government agencies in the absence of a specific waiver of sovereign immunity. The Court noted that a waiver with respect to interest exists, for example, with respect to reliquidation to refund overpaid duties. 19 USC 1505(c). The Court then examined the law relating to prior disclosures and found that a disclosure does not result in a reliquidation. Given the lack of reliquidation and the failure of Congress to include a mechanism for including interest in the judgment in the context of an APA challenge to the calculation of the loss of revenue in a disclosure, the Court could find no waiver of sovereign immunity. As a result, it dismissed the case for lack of subject matter jurisdiction.