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SMEs Facing Customs Negligence Penalties may Benefit from SBREFA

 

Unlike many other federal laws, small and midsize enterprises (“SMEs”) that import into the U.S. are not exempt from compliance with customs laws. The cornerstone of customs law is the Customs Modernization Act of 1993 (the “Mod Act”) which introduced the principle of “reasonable care.” Under the Mod Act, importers must exercise “reasonable care” when introducing or entering merchandise into the commerce of the U.S. or are attempting to do so. “Reasonable care” is not defined in the Mod Act, but is connected to the customs penalty statute, codified at 19 U.S.C. § 1592 (“Section 592”).

In general, under Section 592, no person (individuals and entities) by fraud, gross negligence, or negligence may enter or introduce (or attempt to do so) merchandise into U.S. commerce by making a material, false statement or material omission, whether oral or written in a document or electronically transmitted. The law also prohibits aiding or abetting others in violating the first subpart of the law summarized above. Violations of Section 592 are subject to monetary penalties that, depending on the level of culpability, can range from a maximum of 2 times the loss of duty (negligence) to 4 times the loss of duties (gross negligence) to 2 times the domestic value of the imported merchandise (fraud). Like many of its sister agencies, U.S. Customs and Border Protection (“CBP”) has significantly increased its enforcement efforts and is oftentimes issuing penalties regardless of a company’s size, revenue, or ability to pay.

For SMEs, a significant Customs penalty (or proposed penalty) can be a “bet the company” event, threatening the company’s viability and the livelihood of its employees, many of who may not be involved in the company’s importing practices at all. For those SMEs, SBREFA may offer some relief.

In March 1996, the Small Business Regulatory Enforcement Fairness Act of 1996 (“SBREFA”) was enacted. A section of the law requires U.S. Government agencies, including CBP, to establish a policy or program that reduces or waives civil penalties for violations of law or regulation by a small business, under certain circumstances. In May 1997, CBP’s legacy agency, the U.S. Customs Service, issued its Policy Statement Regarding Violations of 19 U.S.C. § 1592 by Small Entities (T.D. 97 – 46), setting forth the circumstances and procedures to waive the assessment of a Section 592 civil penalty for violations committed by small entities. These guidelines provide for a reduction in the initial assessment of a Section 592 civil penalty and a reduction in the ultimate penalty amount found to be due when certain mitigating factors exist.

Potential relief under SBREFA is available to small businesses, as defined under the laws governing the U.S. Small Business Administration (“SBA”). Generally, businesses with up to 500 employees may be eligible. An alleged violator has the burden of establishing to CBP that it is a small entity and that all of the following facts exist: “(1) the small entity has taken corrective action within a reasonable correction period, including the payment of all duties, fees and taxes owed as a result of the violation within 30 days of the determination of the amount owed; (2) the small entity has not been subject to other enforcement actions by Customs; (3) the violation did not involve criminal or willful conduct, and did not involve fraud or gross negligence; (4) the violation did not pose a serious health, safety or environmental threat, and (5) the violation occurred despite the small entity’s good faith effort to comply with the law.”

SMEs that are alleged to have violated Section 592 must provide evidence that they are independently owned and operated; are not dominant in their field of operation; provide copies of tax returns for the past 3 years and a current audited financial statement; and show their average number of employees over the previous 12 months.

CBP states that its SBREFA policy does not limit the U.S. Government’s right to initiate a civil enforcement action in the U.S. Court of International Trade to collect all duties, penalties, fees, and taxes due, limit the penalty amount that the Government may seek in a de novo trial in the CIT, or confer any substantive rights on the alleged violator in such a penalty and duties payment enforcement action.

CBP’s policy under SBREFA is not a “free pass” for SMEs facing a Customs negligence level penalty under Section 592. The proper circumstances must exist and the evidence must establish each element under the policy. For instance a 5-person company and its owners facing a $1.3M fraud penalty for an alleged “double invoicing” scheme resulting in $54,000 in lost duties cannot rely on SBREFA for relief from a potential business-ending penalty in the Port of Cleveland, but a 50 employee company facing a $1.7M negligence level in the Port of Miami arising from failure to properly file entries as subject to and submitting payment of antidumping and countervailing duties totaling more than $1M may rely on SBREFA for potential relief. The circumstances of each Customs Section 592 penalty case must be evaluated on a case-by-case basis to determine whether an SME can benefit under SBREFA. SMEs and their customs counsel who are familiar with CBP’s policy under SBREFA for Section 592 penalties is certainly helpful, but SMEs exercising “reasonable care” when importing have the best defense against alleged violations.

For assistance with understanding and complying with U.S. Customs laws and regulations, as well as representation before CBP in investigations, civil penalties, prior disclosures and other matters, please contact Jon P. Yormick, Attorney and Counsellor at Law, jon@yormicklaw.com or by calling +1.866.967.6425 (Toll free in Canada & U.S.) or +1.216.928.3474. 

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Yes, U.S. Importers (and Transactional Attorneys), There can be Successor Liability for Customs Duties and Penalties

These days, U.S. exporters and transactional attorneys know (or should know) that there is successor liability for export violations, whether the violations occurred under the Export Administration Regulations (EAR) or the International Traffic in Arms Regulations (ITAR).  Press releases and publications of civil penalty settlements and consent agreements are issued almost daily by either or both of the agencies that administer and enforce these export control regimes and the related statutes – the U.S. Department of Commerce, Bureau of Industry and Security (BIS), and the U.S. Department of State, Directorate of Defense Trade Controls (DDTC), respectively.

The same is true for violations of the numerous comprehensive and targeted sanctions programs administered and enforced by the Department of Treasury, Office of Foreign Assets Control (OFAC).  In case you miss any of those publicly issued notices from the U.S. Government, law firms and consultants re-tell or provide a link to each announced settlement through client advisories, alerts, articles, blogs, and tweets.  And there are plenty of scary presentations given around the world daily, rightfully extolling compliance, avoiding criminal investigations and penalties, and the threat of denial of export privileges.  More than occasionally, the cases involve export violations that occurred at an acquired domestic or foreign subsidiary; yet, the successor company is “on the hook” for the violations.

But importers, both U.S.-based and non-resident importers, should not feel left out of the successor liability spotlight. U.S. Customs and Border Protection (Customs) does not routinely publish information about civil penalty cases that are resolved administratively. There are just too many and probably most are not as interesting to read as the export and sanctions penalty settlements tend to be. However, the U.S. Department of Justice (DOJ) regularly files cases to collect unpaid penalties and duties in the U.S. Court of International Trade. One such recently filed case is United States v. Adaptive Microsystems, LLC, et al., Court No. 12-00122, and this case involves a claim for successor liability.

In this case, CBP is pursuing a claim for unpaid duties and penalties under 19 U.S.C. § 1592 (“section 592”).  CBP is pursuing it claim against a defendant that it alleges is responsible for the debts of a now-defunct Wisconsin company. Both that defendant and the defunct company have the same name – Adaptive Microsystems, LLC.  Customs alleges that from 2005-10, the defunct company intentionally or negligently misclassified imports of LED panels from Malaysia, using duty-free tariff headings.

The facts show that 95% of the defunct company was owned by another Wisconsin, non-party company (of which a particular non-party individual owned a 15.8% share) and that the non-party individual served as executive vice president of the defunct company. In 2011, the defunct company’s bank initiated a receivership action against the company in state court, resulting in a receiver being appointed.  Interestingly, Customs acknowledged that the receiver provided notice of the receivership action, yet Customs did not intervene in the action, instead relying on its priority creditor status under federal law.

A month after the receivership was initiated, however, Customs issued a pre-penalty notice of unpaid duties to the defunct company and upon apparently not receiving a response from any party, in July, 2011, Customs issued a penalty notice to the defunct company, demanding payment of outstanding duties and penalties in the amount of approximately $6.8 million. Meanwhile, after an unsuccessful auction of assets in the receivership action, at direction of the state court, the receiver entered into a purchase agreement with a Wisconsin company named AMS Acquisition , LLC. The purchase agreement called for AMS Acquisition, LLC to operate the business of the defunct company and its affiliates, including hiring a substantial number of employees to continue in their positions, and retaining the executive vice president who held the same position in the defunct company and has an ownership interest in the company that ultimately had an ownership interest in the defunct company. The sale was approved by the state court, but the Customs penalty was not addressed.  Instead, the court approved the sale as free and clear of all claims and encumbrances, “or interests of any kind or nature.”

After the sale, company names were changed and the new company transferred shares of stock to the executive vice president. Less than a year later, Customs filed the lawsuit against the new entity, the defunct company, and the holding company that was organized for the underlying transaction, alleging that the new company defendant had purchased some portion of defunct company “out of receivership and it liable” for the defunct company’s debts.

Earlier this year, the defendant (“New AMS”) moved for summary judgment arguing that it did not succeed to the alleged unpaid duties and penalties of the defunct company and that its purchase of the defunct company’s assets did not assume these liabilities. Customs countered by arguing that there was a genuine issue of material fact as to whether one of four common law exceptions to Wisconsin’s general rule against successor liability applied.

Analyzing Wisconsin law, the Court of International Trade found that the de facto merger exception did not apply. There facts clearly showed that the executive vice president “did not receive his shares as consideration for the receivership sale” and the evidence also showed that at the time of the asset purchase, there was no plan that he was to become a shareholder. The court noted that under Wisconsin law, courts consistently refuse to apply the de facto merger exception when no shares changed hands in a sale. Accordingly, New AMS’s motion for summary judgment was granted as to this exception. The court then analyzed the mere continuation exception to the successor liability rule.

Under this exception, Customs argued that the new company was a mere continuation of the defunct company because there was “significant overlap” between the two companies. Customs pointed to the fact that New AMS hired substantially all of the defunct company’s employees and that the executive vice president was retained as an officer and owner the new company. Applying Wisconsin law, the court noted that the key element of mere continuation exception is a common identity of officers, directors, and shareholders in the purchasing and selling corporations and that the overlap of ownership and control, not merely the continuation of the same business operations, is the true test. The court also rejected New AMS’s argument that absolute identity of the officers and owners is required under the mere continuation exception and noted that the evidence presented by New AMS left open the possibility that other officers might have overlapped as well. For these reasons, the court found that a genuine issue of material fact existed and denied summary judgment on this exception.

This case illustrates that Customs is willing to pursue acquiring companies in asset purchase transactions for unpaid duties and penalties of the acquired company.  Significantly, despite notice of the receivership, Customs chose not to participate in those proceedings, but instead issued a pre-penalty notice to the defunct company to which the Receiver apparently did not respond. Presumably, New AMS had knowledge of that notice and the ensuing penalty notice, yet none of the parties involved in the sale addressed the unpaid duties and penalties liability, instead apparently deciding that the state court’s approval of the sale as “free and clear” and the general rule against successor liability in an asset purchase would shield New AMS.  While New AMS eventually may be relieved of liability for the defunct company’s unpaid duties and penalties, it is embroiled in litigation with the DOJ/Customs for more than a year now and little doubt has divulged details about the sale, company structure, and relationship of the parties that private companies tend to not have to provide to federal government lawyers and agencies.

Transactional attorneys should take particular note of this case and be sure to properly address outstanding Customs duty and penalty liabilities during due diligence or, as in this case, a receivership sale.  Counsel experienced with identifying and addressing the Customs issues in a transaction such as this could have provided necessary support prior to the sale being consummated and head off the current litigation.  Overlooking or ignoring unpaid duties and penalties can have unwelcomed and even dire consequences.

After ruling on the motion for summary judgment on April 10, 2013, the case has proceeded.  On July 15 the court granted a joint motion to extend the fact discovery cut-off to October 31 and ordered the parties to file a joint status report proposing further proceedings by November 14, 2013. We will have to wait and see whether further motions for summary judgment are filed later this year, whether the parties potentially settle the case, or if it will proceed to trial.

For assistance with understanding and complying with U.S. Customs laws and  regulations, due diligence support in merger and acquisitions and other strategic alliances, as well as representation before CBP in investigations, civil penalty, and prior disclosure matters, please contact Jon P. Yormick, Attorney and Counsellor at Law, jon@yormicklaw.com or by calling +1.866.967.6425 (Toll free in Canada & U.S.) or +1.216.928.3474.

CBP Announces Centers of Excellence and Expertise for Buffalo and 5 Other Ports

Last week, Customs and Border Protection (CBP) Deputy Commissioner, David V. Aguilar, announced that the Port of Buffalo and 5 others ports will become CBP Centers of Excellence and Expertise (CEE).  In Fiscal Year 2013, CBP will establish the CEE for Industrial & Manufacturing Materials in the Port of Buffalo.  The other centers to be created are:

1. Agriculture & Prepared Products: Miami

2. Apparel, Footwear & Textiles: San Francisco

3. Base Metals: Chicago

4. Consumer Products & Mass Merchandising: Atlanta

5. Machinery: Laredo

CBP already operates CEEs for Electronics in Long Beach; Pharmaceuticals, Health & Chemicals in New York City; Automotive & Aerospace in Detroit; and Petroleum, Natural Gas & Minerals in Houston.

CEEs are virtual centers aimed at providing “one-stop processing” to lower the importers costs of doing business, provide greater consistency and predictability.  Just as importantly, CEEs are designed to “enhance CBP enforcement efforts,” according to CBP’s press release.

Clearly, CEEs help provide a single point of contact for questions and concerns related to particular sectors, concentrating expertise and experience of CBP professionals to effectively facilitate trade.  Greater expertise and facilitation is much welcomed, but CBP’s establishment of CEEs should also be a reminder for companies to review, update, and improve upon current importing practices and ensure that import compliance efforts are robust.  In short, U.S. and non-U.S. resident importers should prepare to match the expertise of a CEE to avoid time-consuming and costly delays and potential penalties.

Court of International Trade Upholds Dismissal of Customs Negligence Penalty

This month the U.S. Court of International Trade denied the Government’s motion for reconsideration of the Court’s prior dismissal of a Customs penalty claim based on negligence.  The dismissal was based on failure to exhaust the administrative remedies.

As the doctrine indicates, before proceeding to court to recover on a penalty claim, Customs has to “perfect” each penalty claim that the Department of Justice pursues recovery on in the Court of International Trade.  If Customs fails to do so, the Court lacks jurisdiction over the claims that are not “perfected” administratively.

In U.S. v. Nitek Electronics, Inc., Case No. 11-00078, the Government argued in its motion for reconsideration that the Court clearly erred in its prior decision to dismiss the negligence penalty claim.  Prior to addressing the arguments, the Court noted that “mere repetition of unsuccessful arguments is an improper use of [a motion for reconsideration] and a needless delay to finality.”

The Court rejected the Government’s primary argument that because penalty actions are brought de novo, the fact that Customs did not impose a negligence level penalty in the administrative proceedings is not a bar to bringing the claim in court for the first time.  The Court immediately pointed out that the Government raised this same argument in its response to Nitek’s motion to dismiss.  The Court was no more receptive to the argument the second time around.

The Court explained that § 1592(e)(1) allows it to decide the appropriate remedy “without being tethered to the claim imposed below,” and that the statute merely “indicates the lack of deference the Court affords Customs’ penalty determinations.”  It went on to explain (again) “that § 1592 creates a cause of action for the government not to impose a penalty claim but to recover a penalty already imposed at the administrative level.”  This means that “[t]he precise penalty claim Customs imposed for one of these three levels of culpability is thus central to the Court’s review,” citing prior decisions that held the scope of de novo review is limited to those issues considered in the proceedings before Customs.

The Court reviewed a long line of Customs penalty decisions that showed exhaustion of administrative remedies is routinely required before proceeding in the Court of International Trade.  This led the Court to find the Government “is simply incorrect in asserting lack of any controlling law on the issue of exhaustion in de novo proceedings.”

The Court also rejected (for a second time) the Government’s “lesser included offense” argument.  The Government argued that it met the statutory requirements and that Nitek was on notice of a negligence penalty claim because the elements of that claim are included in the Government’s claim for gross negligence.  But the Court noted that the Government could still not cite to any authority “that demonstrates that the criminal doctrine of lesser-included culpability applies to the (vastly distinguishable) context of civil penalties imposed pursuant to § 1592.”

Finally, the Court rejected the argument that its decision to dismiss the negligence level claim encroached on the Department of Justice’s ability to “independently evaluate Customs’ penalty claim prior to instituting § 1592 actions.”  The Court’s response to this argument was predictably simple: “It seems, however, that the predicament DOJ faced could have been avoided had Customs imposed a claim for gross negligence and negligence, thereby perfecting each claim.  The Court has entertained § 1592 actions to recover penalties Customs imposed for alternative levels of culpability.”  In other words, Customs should have known better and asserted alternative culpability level claims administratively so the Justice Department could bring seek to recover on those claims.

This decision makes it almost certain that companies and other culpable parties for Customs penalty cases will see Fines, Penalty & Forfeiture asserting (“perfecting”) alternative culpability level claims administratively with more regularity.  While fraud and gross negligence penalty cases certainly have “shock and awe” value, Customs risks losing those claims altogether if the Justice Department determines the evidence is not sufficient to prove them.

Therefore, Customs will need to perfect a negligence level penalty claim administratively in nearly every case to avoid outcomes like Nitek.  In some instances, this could help importers facing Customs penalty liability because it brings into play a lower penalty level exposure which might be more attractive, at times, than having to defend against the risk of a higher level penalty even if the evidence does not appear to overwhelmingly favor Customs.  Interesting strategy scenarios may play out where FP&F does not assert a negligence level penalty administratively.  Does this open the possibility for the importer’s counsel to suggest or even negotiate the inclusion of a negligence level penalty?

 

 

CBP’s New Transfer Pricing Policy Goes into Effect

Last week, a new rule finalized U.S. Customs and Border Protection (“CBP” or “Customs”) went into effect regarding transfer pricing.  This marks a new policy for CBP and offers companies involved with related-party sales opportunities for post-importation adjustments to the price of the imported goods.

Historically, CBP allowed post-importation price reductions on the entered value only where the adjustments were made according to a formula in place prior to import and written transfer pricing policies and there was no “control” in the adjustments.  Under the new policy, CBP will accept an importer’s use of transaction value in related-party sales if a specific 5-factor test is met, summarized as follows:

1.  A written “Intercompany Transfer Pricing Determination Policy” must be in is in effect prior to importation that takes into account Internal Revenue Code § 482 (Allocation of income and deductions among taxpayers)

2.  The U.S. taxpayer importing company uses its transfer pricing policy in filing its income tax return, and  adjustments under the policy are reported in the income tax return; 

3.  The transfer pricing policy states specifically how the transfer price and adjustments are determined as to all products covered by the policy;

4.  The company maintains and provides accounting details in its books and financial statements to support the claimed adjustments in the U.S.; and 

5.  No other conditions exist that may affect the acceptance of the transfer price by CBP.

If these factors are met and it can be shown that the relationship between the importer and exporter influenced the “price actually paid or payable,” Customs will now allow importers to make both upward and downward post -importation adjustments into account to determine the “transaction value,” used for entry purposes.

Importers are reminded that under this new post-importation adjustment policy, CBP strongly recommends participating in its Reconciliation Prototype Program, although it is not required for use of the new policy.  

For companies engaged in a large volume of related-party import transactions, the new transfer pricing policy provides greater opportunities for duty savings and even duty refunds.

Tax advisors and companies needing assistance with this new Customs transfer pricing policy and any other U.S. Customs issues can contact Jon Yormick, jon@yormicklaw.com or calling Toll Free (Canada & U.S.), +1.866.967.6425, or +1.216.928.3474.