During the long-anticipated sixth round of talks in Montreal to update NAFTA, from January 23-29, negotiators made progress in some issue areas while avoiding any major clashes that might have led to U.S. withdrawal from the existing agreement. Officials advanced discussions on digital trade, sanitary and phytosanitary measures, and technical barriers to trade to near completion while closing a chapter on anti-corruption measures.

Following the round, U.S. Trade Representative (USTR) Robert Lighthizer acknowledged progress in these areas, while highlighting the importance of the need to make progress on the “core issues” of greatest interest to the United States. These core issues, which could include the rules of origin for automobiles as well as other difficult issues (i.e., investment, procurement, dispute settlement and the U.S. proposal for a five-year “sunset clause” in the agreement), are ultimately what the U.S. will judge as determining the success or failure of the talks.

Despite some initial constructive engagement, however, negotiators remain far from resolving these issues. Canada responded to a few U.S. proposals during the round:

  • On the rule of origin for autos, Canada reportedly proposed expanding the formula for calculating regional and national content values to include intellectual property and new technologies. Lighthizer rejected this approach in his closing remarks, finding it to be the “opposite” of U.S. interests because it would lead to less regional content than the status quo. The initial U.S. proposal would increase the regional value content for automobiles from the current 62.5 percent to 85 percent, with 50 percent reserved for U.S.-origin content.
  • On investor-state dispute settlement (ISDS), Canada proposed a mechanism that would exclude the U.S., while maintaining mutual protections only for Canada and Mexico. While it is unclear whether USTR will favor this approach, U.S. industry groups will likely be opposed.
  • On the “sunset clause,” Canada made a counterproposal of a five-year review process for the agreement, without the threat of automatic termination.

Canada also proposed departing from a proposed rule that would require the NAFTA parties to automatically extend to one another the same level of market access for services as each commits to in future trade agreements—the so-called “MFN-forward” rule that Canada had already agreed to in TPP. Lighthizer said in his closing remarks that the proposal was “unacceptable” and referred to it as a “poison pill.”

The Trump Administration overall appears to be signaling that negotiations are likely to proceed without disruption at least through the next round, which will take place in Mexico City from February 26-March 6.

While officials initially set a target date of concluding talks by March 31, there are hints that negotiations could last beyond that date, even perhaps after Mexico’s general election on July 1. President Trump said on January 11 that he could be flexible on the timetable, and U.S. Secretary of Agriculture Sonny Purdue testified to the House Agriculture Committee on February 6 that he expects talks to be extended beyond March but completed before the end of the year.

Members of Congress representing agricultural interests continue to press the Trump administration to conclude an agreement that will “do no harm” to the U.S. agricultural sector, which has benefitted from expanded access to Canada and Mexico under NAFTA. These Members would prefer to see the negotiations extended beyond March, provided that the overall result remains favorable for U.S. agribusiness.

If importers did not have enough to worry about in the new trade protectionist environment – higher duties from dumping, subsidy, section 201 and section 232 cases and increased enforcement – now they also may have to contend with the increased risks of whistleblower cases brought under the False Claims Act (FCA).  31 U.S.C. §§ 3729-33.  The FCA has been around for more than 150 years, but recently, has been successfully used to allege underpayment of duties.  Actions under the FCA can be brought directly by the Department of Justice (DOJ) or by a private party, known as a relator, seeking recovery on behalf of the U.S. government in a qui tam action. There are strong incentives for relators to file qui tam suits in light of the statute’s treble damages and penalties and its provision allowing relators to receive a share of up to 30 percent of any recovery. Qui tam actions are filed under seal, and before the case is unsealed to the public, the government is given an opportunity to investigate and determine whether or not it will intervene in the action.  In some cases, the government’s investigation can last not just months but years, often involving extensive one-sided discovery that DOJ is granted under the FCA.  And, even when the government declines to intervene, a relator can still independently proceed with the litigation.  Only if the government affirmatively moves to dismiss the qui tam could the relator not proceed, something that DOJ has historically been extremely reluctant to do.

Traditionally, FCA suits have been based on allegations that a party improperly received payment from the government, but importers must also be aware of the potential exposure associated with the “reverse” FCA provision of the statute, which imposes liability on any person who “knowingly conceals or knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the Government.”  31 U.S.C. § 3729(a)(1)(G).  Under the statute, the knowledge element can be established by (1) actual knowledge (2) deliberate ignorance; or (3) reckless disregard.  See § 3729(b)(1).

Importers have become targets of reverse FCA claims associated with duty evasion in part because a recent case from the Third Circuit.  United States ex rel. Customs Fraud Investigations, LLC v. Victaulic Co. The Third Circuit held that a failure to mark country of origin could be actionable under a reverse FCA theory of liability if a company knowingly imported unmarked products in an effort to evade custom duties.  839 F.3d 242 (3d Cir. 2016).  The court found that Victaulic had an established obligation under 19 U.S.C. § 1484(a)(1) to disclose to Customs and Border Protection (CBP) the fact that its goods were unmarked or improperly marked and if Victaulic knowingly failed to notify the CBP of its pipe fittings’ non-conforming status, this could give rise to reverse false claims liability for the unpaid marking duties.  In May 2017, Victaulic filed a petition for a writ of certiorari but the Supreme Court denied the petition this past October, leaving Victaulic to defend itself in the district court. While that case has not reached a judgment, the concern for importers is clear given the court of appeals’ validation of such a theory under the FCA.

Other recent cases have targeted companies importing goods that are subject to antidumping and countervailing duties. In 2016, Z Gallerie LLC paid $15 million to settle whistleblower FCA allegations that it masked the type of furniture it imported from China in order to avoid extra dumping duties. Basset Mirror Company paid $10.5 million to settle a similar case on furniture from China just this past month.  The rise in FCA cases related to import duties was highlighted in the recent Wall Street Journal article, in which it stated that the DOJ collected $4.7 billion in fiscal 2016 and $3.7 billion as a result of False Claims suits brought by whistleblowers in fiscal 2017.

These cases, combined with increased duties as a result of numerous unfair trade proceedings, create a perfect storm – encouraging both FCA plaintiffs’ lawyers and whistleblowers alike to cash in on a company’s failure to comply with import laws.  FCA claims are not limited to marking or dumping matters.  Cases may be brought if importers incorrectly value or classify imported goods, or make incorrect duty free claims based on a free trade agreement.

With all this troubling news, there are steps that importers may take to mitigate the risks or defend against an FCA claim. First, importers should establish strong internal compliance programs. Even if internal controls fall short of ensuring 100% compliance with import laws, a strong compliance program can be important evidence if an importer is forced to defend an FCA suit because the plaintiff (whether DOJ or a relator) must establish that an importer acted with the requisite knowledge—i.e., the plaintiff must show that the noncompliance occurred because the importer acted with actual knowledge or at least reckless disregard.  The existence of robust internal controls could be essential in helping an importer overcome a finding of reckless disregard.  Second, and related to having a strong compliance program, taking steps to investigate, identify, and disclose to the government any errors made could foreclose FCA liability in other ways, too.  For instance, if a company makes a disclosure concerning a potentially improper practice and the agency response is to take no formal action, that may show that the practice is not material to the government’s decision to pay or the potential obligation for the company to pay (in the case of import duties).

The materiality of alleged false statements or claims has been receiving enormous scrutiny recently in the wake of the Supreme Court’s landmark FCA decision in 2016 in Universal Health Services v. Escobar, 136 S. Ct. 1989 (2016), with agency approval or failure to disapprove of allegedly fraudulent conduct repeatedly being cited in dismissing actions for failing to show materiality.  Moreover, if a company discloses to the government their practices or interpretations with respect to regulations they are subject to, what is known as the government knowledge bar can also foreclose a finding of FCA liability.  In short, while there is often no sure-fire way to avoid mistakes in transactions involving government dollars, there are various proactive measures a company can take to help prevent mistakes from turning into a case of alleged fraud.

The Federal Circuit in Pleasure-Way Industries, Inc. v. United States, 2017-1190 (Fed. Cir. 2018), recently confirmed that importers of motorhomes may not receive duty reductions for vans exported to Canada that were converted to motorhomes and returned to the US. In this case, the importer (Pleasure-Way) claimed that the 2.5% duty applicable to motorhomes (HTS subheading 8703.33) should only be assessed on the costs of converting vans into motor homes in Canada, and should not be assessed on the entire cost of the motorhome according to Harmonized Tariff Schedule of the United States (HTSUS) subheading 9802.00.50 (goods re-entered into the US after repair or alteration in Canada or Mexico).

Pleasure-Way is a manufacturer and seller of Class B motorhomes. Between January 2008 and September 2009, Pleasure-way bought 144 Sprinter vans and exported them for conversion into motorhomes which included fully plumbed bathroom and kitchen fixtures, water heaters, sleeping quarters, kitchen countertops with propane burners, microwave ovens, wall-mounted televisions, and refrigerators. The conversion also included installation of exterior features such as picture windows, porch lights, awnings, and running boards.

Under US law, “[g]oods re-entered after repair or alteration in Canada or Mexico” are only assessed duty on the costs of the repairs or alterations performed in Canada or Mexico. HTS subheading 9802.00.50. However, CBP regulations limit what constitutes qualifying “repairs or alterations” under this provision and state that the foreign activities must “not . . . create a new or commercially different good from[] the good exported from the United States,” and that the foreign activities must “not destroy the essential characteristics of . . . the good exported from the United States.” 19 C.F.R. § 181.64(a). The regulations also state that goods are not eligible for reduced duty treatment if the goods “are not complete for their intended use” when exported from the US to Canada or Mexico. 19 C.F.R. § 181.64(b).

Pleasure-Way had requested a ruling from CBP that the converted Sprinter Vans be classified under HTS subheading 9802.00.50. CBP initially granted the company’s request, but then changed its position. Based on the regulations, CBP determined that this provision does not apply to the motorhomes that were converted from vans. Pleasure-Way protested CBP’s decision and brought a case before the US Court of International Trade (CIT). The CIT ruled that Pleasure-Way was not entitled to lower duties because the operations in Canada created a new article of commerce and destroyed the essential character of the exported vans. The CIT relied on “changes to the pricing, the applicable tariff heading, the use, and the name of the vans.” Pleasure–Way Indus., Inc. v. United States, 38 I.T.R.D. (BNA) 1889, 2016 WL 6081818, at *6 (Ct. Int’l Trade Oct. 18, 2016).

The Federal Circuit affirmed the CIT decision and determined that Pleasure-Way, in changing the vans into motorhomes, created a commercially different good. The Federal Circuit focused on the CIT’s decision regarding differentiation in the marketplace. It determined that the motorhomes “no longer resembled the exported cargo vans,” and were “no longer classifiable as motor vehicles for the transport of goods.” The court also determined that the motorhomes were sold at “different price points than the exported vehicles.” Id. Therefore, the likely use and consumer base for the Sprinter vans as exported were broadly different from those for the motorhomes imported into the U.S. after leaving the Canadian conversion facility. Accordingly, the Pleasure-Way motorhomes were determined to be commercially different.

Importers may not take pleasure in this result – especially considering the fact that CBP had issued an affirmative ruling. Before investing in foreign operations based on duty reduction strategies, importers should understand that CBP has less than sixty days to revoke any previously issued ruling without notice and such revocation may be applied retroactively, provided the person to whom the ruling was issued has not acted in accordance with its terms and conditions. See, 19 C.F.R. §177.9(c) and §177.12(b); See also, HQ 963543, dated April 16, 2002. After having been in effect for sixty or more days, rulings become binding and may only be revoked prospectively after notice and comment procedures. 19 C.F.R. §177.12(b)(1)-(2)

On December 20, 2017, the Court of Justice of the European Union (CJEU) decided that a company may not use transaction value for customs valuation purposes when a transfer price consisted of both an amount initially invoiced and declared, and a flat-rate adjustment made after the end of the accounting period.

The Community Customs Code (CCC) and its related jurisprudence provides that customs value must be determined primarily according to the transaction value method, with the price actually paid or payable for the goods to be adjusted where necessary to avoid establishing an arbitrary or fictitious customs value. The CJEU found that uncertainty regarding future adjustments at the end of the accounting period made it impossible for the transfer price to be used as the transaction value for imports into the EU.

Please click here for more on this decision, as well as a discussion on how the U.S. continues to allow importers to use the transaction value method of appraisement.

Blockchains and distributed ledger technology (‘DLT’) are becoming increasingly prevalent in industry. A recent Juniper Research survey found that 56% of companies with more than 20,000 employees were either considering deploying, or were in the process of deploying, blockchain solutions.

At its core, blockchain technology is essentially an engine for processing exchanges of information. It is not a static record. A blockchain is a type of distributed database that tracks transactions in assets and exchanges of information. It is a chronological sequence of verified transactions within a certain network. A ‘transaction’ can be the transfer of an asset, the creation of a new medical record, or the entry into a swap transaction. There is not just one blockchain, just like there is not one database. Different blockchains can be created for different needs, with different operating rules.

A distributed ledger is a distributed database that tracks transactions. Multiple participants have access to the same ‘golden record’ – there is no single official copy. The ledger automatically updates when new transactions take place, and so there is prompt verification of completed transactions across the system. Blockchain is an example of a distributed ledger, but distributed ledgers don’t have to be based on blockchain.

Application to Supply Chains

Supply chain management has long sought an efficient, accurate, and paperless process. A system that records each event, is transparent when it needs to be, confidential at other times, designed to meet the regulatory obligations around government filings, commercial demands, insurance claims, and on and on.

One of the touted merits of a DLT supply chain is that it would solve challenges such as provenance (diamonds), sourcing (origin claims), important admissibility issues (forced labor), and even emerging issues such as conflict minerals.

Role of DLT in Tackling Modern Slavery

Modern slavery is a complex crime and it is estimated that 46 million people worldwide are in some form of slavery. DLT could be a powerful tool to address gaps in supply chain data and increase the efficiency of data sharing helping to improve traceability and transparency of supply chain labor standards. For example, DLT could assist companies to verify the working conditions of people involved in production. Increased collection, analysis, and sharing of data would help companies to identify and prevent slavery and could assist law enforcement agencies in tackling this insidious crime.

In circumstances where there is greater focus than ever before on corporate transparency, tracking supply chains and ensuring human rights are protected is increasingly important. The UK Government released new guidance in October 2017 on the Modern Slavery Act 2015 (MSA) which suggests that even companies that do not reach the £36 million turnover threshold should consider voluntarily producing MSA statements and there has also been increased NGO oversight particularly of large UK companies. Blockchains and DLT could provide the traceability and trust that companies need to combat modern slavery while at the same time improving corporate transparency.

What’s next?

In 2018, you can expect to see more implementations, so now is the time to develop a blockchain strategy and to develop a risk profile so that you will be ready to take advantage of the benefits of this new technology.

Crowell & Moring Can Help

Exploring Blockchain

We provide in-house CLE programs and information sessions on blockchain and DLT, helping clients understand both the technology and the regulatory issues of implementing a blockchain or DLT solution, as well as promising use cases in specific industries.

Creating a Blockchain Strategy

We offer in-depth workshop sessions for companies considering implementing a blockchain or DLT network, including identifying regulatory hurdles to adoption, assisting with network diligence, negotiating network agreements, and addressing the full range of issues relating to joining a network.

Ready to Join a Network

And, once you are ready to join a network, our team works to negotiate the legal agreements and provide a deep-dive review of operating procedures, cybersecurity and privacy concerns, and regulatory issues that will impact your success.

On Friday, January 5, 2018, U.S. Customs and Border Protection (CBP), a component of the Department of Homeland Security, released the fiscal year (FY) 2017 statistics relating to warrantless searches of electronic devices at the border; they show a significant increase in border searches—30,200 in FY 2017, up from 19,051 in FY 2016 (which was itself up from 8,503 in FY 2015).

CBP also released a new policy directive governing such searches, replacing guidance from 2009. The updated policy clarifies the standard operating procedures for searching, reviewing, and retaining information found on electronic devices.

For more information on key components of this new policy, please see Crowell’s Client Alert.

Despite increased pressure from the U.S. and the UN Security Council, human rights groups estimate about 16 countries still host North Korean laborers. A recent estimate by the Korea Institute for National Unification in Seoul puts the number of North Korean workers overseas at around 147,000. Most work in China and Russia, but reports continue to surface of North Korean workers even in EU countries.

In Poland for instance, a recent New York Times report found North Korean workers in a number of industries, including agriculture, the manufacture of shipping containers, and even ship construction. The report also includes the names of companies – Armex (reportedly linked to a UN sanctioned company called Rungrado General Trading) and Wonye – that have allegedly been involved in supplying such workers.

It was not until October 2017 that the EU agreed to stop renewing work permits for North Korean labor. However, media reports indicate local governments in Poland continued to approve such permits after the EU’s decision. New legislation took effect in Poland on January 1, 2018, barring new foreign worker permits in Poland, but there is reportedly little coordination between provincial governments and the national government on these permits.

The increased focus on imports produced by North Korean labor in third countries – now subject to exclusion from the United States, as well as exposing U.S. persons to OFAC sanctions – creates a need for enhanced due diligence in supply chain operations. Reports like these can help companies identify such products and transactions, something that is generally very difficult to do.

CBP has revised its informed compliance publication regarding Reasonable Care to include a section regarding forced labor. Additionally, seafood and apparel industries appear to be recent targets of CBP Requests for Information CF28’s regarding forced labor in their supply chain. Although admittedly, the CF28s may also be as a consequence of the passage of the Countering America’s Adversaries through Sanctions Act (CAASA). P.L. 115-44. CAASA created a presumption that “significant goods, wares, articles, and merchandise mined, produced, or manufactured wholly or in part by the labor of North Korean nationals or citizens” are forced labor goods and prohibited from entry into the United States.

The seven fact sheets available on CBP’s website are:

Companies should evaluate their supply chains to insure that they are not at risk. For more information please contact Jeff Snyder or Frances Hadfield.

U.S. Customs and Border Protection has been running year-long investigations into forced and child labor. The agency publicly stated it has been acting on information concerning specific manufacturers/exporters and specific merchandise and was not targeting entire product lines or industries in suspect countries or regions.

However, in practice it has recently come to light that the agency has issued questionnaires to certain industries related to their production in countries named on the Department of Labor’s website as those that use child or forced labor in their production of certain goods.

As of September 30, 2016, the list of goods produced by child labor or forced labor comprises 139 goods from 75 countries. If there is forced labor in any portion of a company’s supply chain, these goods may be excluded from importation into the United States.

Companies should closely examine their supply chains to ensure that goods imported into the U.S. are not mined, produced or manufactured, wholly or in part, with prohibited forms of labor, i.e., slave, convict, forced child, or indentured labor.

For more information, contact: Frances Hadfield

On August 9, in the latest in a long-running battle between Ford and CBP over ‘tariff engineering’, Ford won a key victory at the Court of International Trade.

The CIT agreed with Ford that its Transit vehicles, imported with second-row passenger seats removed after importation, qualify for the lower tariff rate on passenger vehicles (2.5%), and are not subject to the higher “chicken tax” (25%) on cargo vehicles. The key facts as stated by the court include:

Ford manufactures the Transit Connect 6/7s in Turkey and imports them into the United States. Although these vehicles are made to order and are ordered as cargo vans, Ford imports them with a second row seat, declaring the vehicles as passenger vehicles . . . .  After clearing customs but before leaving the port, Ford (via a subcontractor) removes the second row seat and makes other changes, delivering the vehicle as a cargo van.

CBP took the position that the second row seat “is an improper artifice or disguise masking the true nature of the vehicle at importation,” instead of what Ford argued was legitimate tariff engineering. Customs defines ‘tariff engineering’ as “the longstanding principle that merchandise is classifiable in its condition as imported and that an importer has the right to fashion merchandise to obtain the lowest rate of duty and the most favorable treatment.”  In adopting Ford’s view, the court found that the vehicles, at the time of importation, are “principally designed for the transport of persons.”

The court’s analysis is a “must read” for anyone with more than a passing interest in customs classification. The case provides a robust articulation of an expansive and legitimate foundation for tariff engineering. Basing its analysis on important historical precedent, the court pins its finding for Ford in an 1891 Supreme Court ruling that classification must be made of the imported item “in the condition in which it is imported,” and an even earlier high court decision that ruled a manufacturer may purposely manufacture goods in such a manner as to “evade higher duties.” The court further analyzed more recent CIT decisions applying them to Ford’s extensive facts.

Given the long running nature of this dispute and the amount of difference in the two tariff rates, many observers expect Customs to appeal and so the last word may not yet be written on the Ford vehicles at issue or factual applications of ‘tariff engineering’.

In today’s trade debates, the historical background is worth remembering: the 25% duty on trucks (compared to 2.5% duty on cars) was imposed by the United States in the 1960s in retaliation against Europeans for imposing high tariffs on American chickens. It was later used against Japan as Japanese vehicles began to make serious inroads into American commerce.  That high duty remains in place 50 years later. Duties invoked in haste in trade wars can become permanent.

For more information, contact: John Brew, Jeff Snyder, Frances Hadfield; Barry Nemmers