U.S. Trade Court: Flashlight for U.S. Military Is Chinese-Origin Under Buy American Act

The White House has announced its “America First” agenda, including its intent to pursue trade policies that are consistent with that agenda. With early statements regarding trade with China and an announcement to “identify all trade violations and to use every tool at the federal government’s disposal to end these abuses[,]”[1] government contractors would be wise to note a seminal decision of the U.S. Court of International Trade issued last month involving the Trade Agreements Act of 1979, as amended, (“TAA”).[2] The decision in Energizer Battery, Inc. v. United States, 3 marked the first time in which the U.S. Court of International Trade (“CIT”) construed the meaning of “substantial transformation” as used in the TAA.

Background: The TAA, Generation II Flashlight, and CBP’s Country of Origin Ruling

In general, the TAA is an exception to the Buy American Act[4] (“BAA”) and opens U.S. Government procurement to certain products originating from “designated countries.” Under certain procurement requirements, the TAA authorizes the President to waive BAA requirements for end-items originating from designated countries. Countries are designated through various programs and agreements, such as the World Trade Organization Government Procurement

Agreement (“WTO GPA”) and include allied countries in Western, Central, and Eastern Europe, Africa, the Americas, and elsewhere. Most recently, Moldova and Ukraine became designated countries in November 2016. In addition, designated countries are those with which the U.S. has Free Trade Agreements, such as Australia, Canada, Mexico, Israel, Morocco, Singapore, and others.

The TAA prohibits procurement of end-items from non-designated countries, which notably includes China, India, Russia, and Vietnam. For procurement purposes, the TAA is implemented in Federal Acquisition Regulation (“FAR”) 52.225-5 Trade Agreements, which lists all “designated countries.”

Under its regulations that implement the TAA, U.S. Customs and Border Protection (“CBP”) has authority to issue “country of origin advisory rulings and final determinations as to whether an article is or would be a product of a designated country or instrumentality for the purpose of granting waivers of certain ‘Buy American’ restrictions in U.S. law or practice for products offered for sale to the U.S. Government.”[5]

In 2012, after receiving an advisory opinion from CBP that China was the country of origin of its second generation military flashlight, the Generation II, Energizer Battery, Inc. (“Energizer”) requested a final determination from CBP regarding the country of origin.[6] Energizer intended to sell the Generation II flashlight to the U.S. military. The item was described as designed to be extremely rugged, providing longlasting LED and infrared lighting that is not visible to the naked eye, but useful for signaling in military situations. The Generation II flashlight was further described to be more technologically advanced than a prior version, using a microprocessor and programming control that require sophisticated hardware and software programming. The flashlight also includes an IFF Mode, described as an infrared strobe mode used to “Identify Friend or Foe.”[7]

Applying its regulations[8] that are consistent with the FAR, CBP noted that the FAR “restrict the U.S. Government’s purchase of products to U.S.-made or designated country end products for acquisitions subject to the TAA[,]” and that the FAR define “‘U.S.-made end product’ as:

…an article that is mined, produced, or manufactured in the United States or that is substantially transformed in the United States into a new and different article of commerce with a name, character, or use distinct from that of the article or articles from which it was transformed.”[9]

In its analysis, CBP followed its reasoning in prior rulings on the issue of “substantial transformation,” explaining that the question depends on issues of the country of origin of an item’s components, the extent of processing that occurs within a country, and whether that processing results in a product with a new name, character, and use.[10] CBP further explained that while no single factor is determinative, “the key issue is the extent of operations performed and whether the parts lose their identity and become an integral part of the new article.”[11] CBP outlined the production process in its ruling.

In issuing its final determination, CBP confirmed its earlier conclusion in its advisory ruling, finding that the foreign-origin components did not undergo a substantial transformation when assumed in the U.S.[12] CBP noted that nearly all of the Generation II components were of Chinese origin, including the LED, which was stated to be the “most important” and found to give the flashlight its essential character – generating light.[13]

U.S. Court of International Trade Decision

In its decision, the CIT reviewed the “substantial transformation” question de novo, based on the record created before the court, without regard to CBP’s underlying final determination.[14]

The court noted that the Generation II flashlight is composed of approximately fifty (50) components, almost all of which are specifically designed for the item.[15] Prior to importation into the U.S. electrical wires are cut to length in China and one of the LEDs is soldered to the flashlight’s printed circuit board.[16] Additionally, the lens head subassembly is partially assembled in China.[17] Final assembly, testing, and packaging occur at an Energizer facility in Vermont, a process that “takes approximately seven minutes and ten seconds.”[18]

The court granted the defendant’s motion for summary judgment and found that Energizer’s U.S. assembly operation did not constitute a “substantial transformation” under the TAA and, therefore, the Generation II flashlight was not of U.S. origin. While the court found that CBP “d[id] not apply the substantial transformation test with clarity[,]” in part because it included “essential character” in its analysis, a concept borrowed from customs classification, but not applicable under the relevant statute and regulations.[19] The court found that the statute and regulations require only that for a product to undergo a substantial transformation, “it must become a ‘new and different article of commerce with a name, character, or use distinct from that of the article or articles from which it was so transformed.’”[20]

Nonetheless, under the totality of circumstances, the court likewise found that Energizer’s imported components did not undergo a change in name, character, or use as a result of post-importation assembly in the U.S. and, therefore, the Generation II flashlight country of origin was China.[21] The court found the post-importation processing were not sufficiently complex to support a finding that a substantial transformation existed.[22]

To reach its conclusion, the court looked to many prior decisions in which “substantial transformation” was decided in different contexts in customs cases. The court also noted that those courts generally agreed that each case must be decided on its own facts, that the name criterion is the least compelling factor in the analysis, and that the courts have mainly focused on 19 Id. at 12-13. 20 Id. at 12-13 (quoting 19 U.S.C. § 2518(4)(B)). 21 Id. at 33. 22 Id. changes in use or character.[23] In its analysis, the court noted that a change in use occurs “when the end-use of the imported product was no longer interchangeable with the end-use of the product after post-importation processing[,]” but that “when the end-use was predetermined at the time of importation, courts have generally not found a change in use.”[24] The court also noted the use of “subsidiary or additional factors,” including the extent and nature of the post-importation processing, value added by such processing, and other factors.[25] Finally, the court observed that in cases involving post-importation assembly, “courts have considered the nature of the assembly together with the name, character, and use test” to determine whether a substantial transformation exists.[26]

In its analysis, the court found that both parties agreed that Energizer’s post-importation assembly operations did not result in a change in the “shape or material composition” of any of the imported components and, therefore, no change in character.[27] The court also determined that the flashlight’s constitutive components did not lose their individual names as a result of postimportation assembly.[28] In addition, the court held that the relevant inquiry regarding change in use is “whether the components have a pre-determined end-use at the time of importation[,]” not whether the components have the form and function of the end-item.[29]

Finally, the court found that Energizer’s “postimportation processing is or [was] not sufficiently complex as to constitute a substantial transformation[,]” rejecting Energizer’s argument that the assembly process was “complex, meaningful and transformative[,]” where the record only offered proof of the assembly, testing, and packaging time and number of components assembled.[30]

Accordingly, the court effectively upheld the decision of CBP in finding that a substantial transformation did not exist under the TAA. The time to appeal the decision has not yet expired, but given that CBP (twice), and now the CIT, have consistently found against Energizer on the issue, it would seem that chances of a successful appeal are limited, at best.

In addition to providing guidance to contractors, subcontractors, and suppliers on meeting the substantial transformation test under the TAA, the Energizer 30 Id. at 27 (citation omitted). decision is important in light of the new trade priorities set by the Trump Administration. As of this writing, the President has signed an Executive Order to withdraw the U.S. from the Trans-Pacific Partnership (TPP) and another is to be signed regarding renegotiation of the North American Free Trade Agreement (NAFTA). Companies already in the U.S. Government supply chain, and those considering, should promptly review whether the end-items being supplied comply with the TAA, and pay careful attention to the Administration’s efforts to implement the “America First” agenda and how those efforts could impact TAA-designated countries and compliance.

[1] See Trade Deals Working For All Americans, https://www.whitehouse. gov/trade-deals-working-all-americans, (last viewed January 23, 2017).

[2] 19 U.S.C. §§ 2511-2518 (2016).

[3] No. 13-00215, slip op. 16-116 (CIT Dec. 7, 2016).

[4] 41 U.S.C. §§ 8301-8305 (2016)

[5] See HQ H215657 at 5, dated April 29, 2013.

[6] Id.

[7] Id. at 2.

[9] HQ H215657 at 4 (quoting 48 C.F.R. 25. 003).

[10] Id.

[11] Id. at 4.

[12] Id.

[13] Id. at 7.

[14] Energizer, at 11-12.

[15] Id. at 3-5.

[16] Id. at 5.

[17] Id.

[18] Id. at 6.

[19] Id. at 12-13.

[20] Id. at 12-13 (quoting 19 U.S.C. § 2518(4)(B)).

[21] Id. at 33.

[22] Id.

[23] Id. at 16-17.

[24] Id. at 19.

[25] Id. at 20.

[26] Id. at 21.

[27] Id. at 23.

[28] Id. at 25.

[29] Id. at 26.

[30] Id. at 27 (citation omitted).

 

Additional Assistance

For assistance with TAA, country of origin, and other U.S. Customs and International Trade matters, please contact Jon P. Yormick, Special Counsel at jyormick@phillipslytle.com or (716) 847-7006.