Emerging False Claims Act Risk In Trade: Recent False Claims Act Developments Increase Trade Exposure (Part III)

I. Heightened Risk of FCA Liability Relating to Section 301 and 232 Tariffs

In addition to an expected uptick in traditional trade-related FCA cases relating to antidumping/countervailing duties (AD/CVD) circumvention, misclassification, and undervaluation, importers should be attuned to an expanded risk of FCA exposure relating to the Section 301 and Section 232 tariffs.

In 2018, the Trump administration invoked Section 301 of the Trade Act of 1974¹ to institute additional tariffs up to 25% on certain Chinese origin goods, and Section 232 of the Trade Expansion Act of 1962² to impose a 25% tariff on steel articles and a 10% tariff on aluminum articles, from certain countries. Section 301 and Section 232 tariffs are duties owed for specific products from certain countries, in addition to the normal duty paid based on its tariff classification.

The impact of these tariffs should not be understated. As a result of the additional Section 301 and 232 duties, U.S. Customs and Border Protection (CBP) has assessed more than $500 million in Section 232 duties on aluminum, nearly $1.3 billion in Section 232 duties on steel, and a whopping $35.6 billion in Section 301 duties on applicable goods from China in fiscal year (FY) 2020 alone.³ Furthermore, from FY 2019 to FY 2020, there was a staggering 19% increase in Section 301 duty assessments.⁴ The increase can be attributed, in part, to CBP’s increased investigation into, and heightened awareness of, importers either knowingly or unknowingly circumventing these additional duties by misclassifying goods or declaring a country of origin other than China. Indeed, in FY 2020, CBP reported completing 466 audits in total and collecting more than $44.6 million in additional duties as a result — an increase of 75 audits and $3.5 million from FY 2019.⁵ 

As these additional tariffs are country-specific and applicable according to tariff classification, it is more important than ever that importers take care to declare correctly the country of origin and product classification. Moreover, these costly additional tariffs, which sometimes are applied in addition to AD/CVD, present a heightened risk in the FCA context where the financial consequences and incentives, as discussed in our previous Alerts, can be enormous.  

In view of the heightened risk, importers must not only properly declare the classification and country of origin of goods in entry declarations filed with the government but should also take reasonable steps to ensure that the country of origin is being appropriately determined. An importer that relies on its vendor for country of origin determinations should understand the manufacturing process and work with the vendor to determine the appropriate country of origin under the U.S. rules rather than simply declaring on import documents the vendor’s determination to satisfy its obligation of exercising reasonable care under 19 U.S.C. § 1484. 

Determining the country of origin for imported goods according to U.S. customs laws is a complex process. Unless a product is wholly grown, produced, or manufactured in one country exclusively from materials of that country, generally the origin of the good is determined according to the substantial transformation analysis. Where an article is manufactured in whole or in part of materials from more than one country, the origin of that good is determined by whether such components are substantially transformed into a new and different article of commerce with a name, character, or use distinct from which it was transformed. This substantial transformation test is a tortured, fact-specific analysis with no bright-line rules, which can be difficult to employ for even the most seasoned practitioner. Applying the substantial transformation test correctly involves analyzing a number of factors and following updates on relevant CBP rulings and decisions from the U.S. Court of International Trade, such as Energizer Battery v. United States.⁶  

Moreover, there are nuances as to the applicability of this non-preferential rule of origin. For example, textile products have specific country of origin rules provided for in 19 C.F.R. § 102.21, some of which involve tariff shifts. On top of that, for goods from Mexico or Canada, while a different test may exist for country of origin marking, substantial transformation still applies for determining the application of additional duties, such as Section 301 tariffs. Meaning, for the same product, the North America Free Trade Agreement (NAFTA) Marking Rules⁷ might be used to determine the country of origin for marking purposes, but the substantial transformation test is used to determine the country of origin for Section 301 duty purposes, and these tests could result in two different countries of origin: one for duty and one for marking.⁸ Thus, an importer of record might be, in good faith, relying on a country of origin analysis that is based on the wrong rule of origin. 

The Section 301 and Section 232 tariffs create greater incentive not only for fraudulent activity by participants in the supply chain, such as transshipment or knowingly applying the inappropriate origin analysis, but also for whistleblowers to expose such activity, and it is crucial that companies be on alert. 

II. Steps Companies Can Take to Mitigate Risk

Although importers might not see settlements of FCA cases concerning Section 301 or Section 232 tariffs for years ― for example, the conduct in the trade-related FCA cases discussed in our prior Alert occurred from 2007 to 2018 ― companies can be proactive in mitigating the risk by ensuring that a strong compliance program with internal controls is in place now. 

CBP has made its expectations clear as to what constitutes a satisfactory compliance program for importers. Specifically, a program that will reduce the risk of material noncompliance must have an internal control system, a process effected by management designed to provide reasonable assurance of compliance with applicable laws and regulations, which consists of five interrelated components: control environment; risk assessment; control activities; information and communication; and monitoring activities.⁹  Although the five pillars of a strong import compliance program are the same across the importing community, program designs should consider the importer’s size, organization, nature of business, complexity of operations, method of processing and maintaining information, and legal and regulatory requirements. We explain each expected internal control below in detail.

A. Control Environment

The control environment consists of the organization structure, assignment of responsibilities, and philosophy fostered by management. This control sets the tone of an organization and is the foundation for all other internal controls. CBP expects that importers have an organizational structure that contributes to effective internal controls for customs operations, which includes identifying key individuals responsible for customs compliance (i.e., a reporting chain of command) and promoting a climate of integrity and ethical behavior. Additionally, a strong control environment incorporates training for key personnel involved in customs-related activities to maintain and improve their competence.

B. Risk Assessment 

An importing entity should be able to identify and analyze relevant customs-related risks pertaining to the imported merchandise and to manage such risks by implementing a control mechanism such as a policy or procedure. Risk assessment also includes the ability to identify changes, such as new laws or regulations, engagement of a new supplier, and changes in personnel, which may affect customs compliance.

C. Control Activities

Control activities are the policies and procedures, or other mechanisms, implemented to ensure compliance with customs laws and regulations. Effective policies and procedures not only provide guidance as to day-to-day operations, including who performs the control activity, how often it is performed, and how information and documents should be recorded, but also mitigate risks identified in the risk assessment.

In view of the heightened Section 301 and Section 232 tariff risk discussed above, companies should take a close look at their classification and country of origin policies and procedures to ensure that products are being classified appropriately and to investigate how country of origin determinations are being made. If the company is relying on its supplier, for example, to determine the country of origin, diligence should be conducted on the supplier to verify its existence, production capacity, and location, and inquiries should be made as to how that supplier is analyzing the country of origin and what rules are being applied.

While reviewing its internal controls, importers should also be aware of other priority trade areas of increased enforcement such as forced labor,¹⁰ USMCA compliance, and import safety and consumer protection, including intellectual property rights enforcement and COVID-related enforcement of personal protective equipment products by CBP and other agencies such as the Environmental Protection Agency.

D. Information and Communication

Information and communication systems identify and record pertinent operational and financial information relevant to customs activities. This control ensures effective communication of relevant and reliable information in sufficient detail and at the appropriate time to internal and external sources responsible for customs activities. Such communication may be oral or written and often relates to transactions processed by the importer, procedures used to authorize, correct, or report transactions, and other events relevant to import activity.

E. Monitoring

Monitoring, the fifth and final internal control component, consists of not only evaluating the effectiveness and quality of operations over a period of time, such as conducting post entry reviews, but also separate evaluations of control activities, such as periodic audits of the compliance program. The findings of these reviews should be evaluated and actions taken to correct or otherwise resolve issues identified.

The above-discussed internal controls are intended to provide reasonable assurance of compliance ― not absolute compliance. Their effectiveness will be limited by human judgment and human error, which is why CBP has mechanisms such as post-summary corrections, protests, and prior disclosures for importers to correct errors identified. However, although customs laws may shield a company from penalties when an importer voluntarily discloses customs violations,¹¹ the FCA does not. At least one U.S. district court has held that a prior disclosure of customs violations made to CBP pursuant to 19 U.S.C. § 1592 does not bar an FCA action concerning the same allegations or transactions.¹² Therefore, it is critical that companies be on the lookout for, and take steps to mitigate, customs violations that might be the basis of an FCA claim.

III. Conclusion

Companies that import goods into the United States should take heed of the rise in enforcement in general, but especially as to Section 301 and Section 232 duties, and closely review their import-related compliance programs. The increased regulatory and FCA risks discussed in this series can be mitigated by a strong compliance program that includes a robust set of internal controls. Although import liability and any associated penalties may be considered a routine cost of business for some companies, the increased risk of FCA liability for customs violations in light of recent statutory changes and overall regulatory environment discussed in this series should not be underestimated.

Reverse false claims actions for customs violations are not an aberration and are becoming a meaningful and expanding area of FCA liability with potentially enormous financial and other collateral consequences. In assessing FCA liability and remedies, the Department of Justice may take into account a company’s preexisting compliance program, including the nature and effectiveness of such program.¹³ Corporate counsel would serve their companies well to take the actions discussed in this series now to mitigate trade-related FCA risk.

¹ 19 U.S.C. § 2411.

² 19 U.S.C. § 1862.

³ CBP Trade and Travel Report Fiscal Year 2020 (February 2021), available at https://www.cbp.gov/sites/default/files/assets/documents/2021-Feb/CBP-FY2020-Trade-and-Travel-Report.pdf.

4 Id.

⁵CBP Trade Statistics, available at https://www.cbp.gov/newsroom/stats/trade.

⁶ 190 F.Supp.3d 1308 (Ct. Int’l Trade 2016).

⁷ 19 C.F.R. Part 102. CBP has stated that the NAFTA Marking Rules will carry over for the United States-Mexico-Canada Agreement (USMCA), even though not referenced in the agreement. See United States-Mexico-Canada Agreement Implementing Instructions, June 30, 2020, p. 9, https://www.cbp.gov/sites/default/files/assets/documents/2020-Jun/USMCA%20Implementing%20Instructions%20-%202020%20Jun%2030%20%28Finalv1%29.pdf.

⁸ See, e.g., Headquarters Rulings Letter H301619 (November 6, 2018). 

⁹ See, e.g., U.S. Customs and Border Protection Office of Strategic Trade Regulatory Audit Division: Focused Assessment Program (October 2003); U.S. Customs and Border Protection Office of International Trade Regulatory Audit: Focused Assessment Pre-Assessment Survey Audit Program (October 1, 2014) available at https://www.cbp.gov/sites/default/files/assets/documents/2016-Dec/Exhibit%202C%20-%20FA%20PAS%20Audit%20Program%20%2810012014%29_1.pdf. 

¹⁰ Forced labor in particular had a dramatic increase in enforcement in FY 2020, which we expect to continue, if not expand, in 2021. For example, in FY 2019, CBP issued six new withhold release orders (WROs), and in FY 2020 the agency issued a record 13 WROs. See CBP Trade Statistics, available at https://www.cbp.gov/newsroom/stats/trade. Furthermore, the estimated value of cargo detained as a result of the WROs rose from approximately $1.2 million in FY 2019 to more than $55 million in FY 2020. Id.

¹¹19 U.S.C. § 1592(c)(4).

¹² See, e.g., United States ex rel. Chiba v. Guntersville Breathables, Inc., 421 F.Supp.3d 1241, 1256 (N.D. Alabama 2019) (“[a]lthough GBI’s 2016 prior disclosure reported the transactions containing the boot-wader undervaluation, it does not satisfy the government action bar because prior disclosures under the applicable statutory regime do not constitute administrative civil money penalty proceedings”). 

¹³ Justice Manual 4-4.112 Guidelines for Taking Disclosure, Cooperation, and Remediation Into Account in False Claims Act Matters.