Since late 2012, there has been a standing prediction amongst trade and customs lawyers that a wave of whistleblower cases alleging false claims in customs and trade transactions would eventually overwhelm importers[1]. This prediction seemed reasonable in the wake of a $45 million settlement between the Government and Toyo Ink SC Holdings Co., Ltd., from which the whistleblower in that case received nearly $8 million as a bounty[2]. Indeed, allegations by private parties made in the name of the government (qui tam cases) have grown substantially each year since the False Claims Act was amended in 1986 to encourage such whistleblower cases[3].
During fiscal year 2020, the government recovered $2.2 billion under the False Claims Act, of which $1.6 billion resulted from 672 qui tam cases—an average of 13 new cases each week[4]. Amongst the recoveries made by the government last year was another significant settlement resulting from false claims made on customs declarations with Linde GmbH agreeing to pay over $22 million following a qui tam action as a result of which the whistleblower received a $3.7 million reward[5].
These large customs-related FCA recoveries notwithstanding, and despite the substantial rewards received by the relators in those cases, there truly hasn’t been a wave of trade and customs qui tam actions as previously expected. While the volume of trade-related qui tam actions has been underwhelming, particularly in relation to the expectations, that trend could well reverse itself in the wake of the US-China trade war.
Why Section 301 Duties on Chinese Imports?
The Section 301 tariffs assess an additional 25% tariff on approximately $250 billion of imports from China and 15% on another $300 billion[6]. The section 301 tariffs are assessed upon import based on the country of origin of the imported merchandise and the tariff heading under which the merchandise is classified[7]. Provided that China is identified as the country of origin on the customs declaration and the tariff heading falls within one of the 5 operative lists or tranches maintained by the USTR, the imported merchandise is assessed an additional duty in accordance with the rate applicable to the list on which the tariff heading appears, unless an exclusion has been granted[8]. More than $88 billion has been collected as of May 2021 under Section 301 trade remedies against China[9]. This perhaps could have been even higher.
International trade statistics are fastidiously maintained by both exporting countries and importing countries[10]. Those data are often referred to as a predicate to the US-China trade war specifically citing the substantial trade surplus China maintains with the United States[11]. In examining these statistics, it has been consistently the case over the years that US trade data on imports from China generally exceed the statistics reported by China on exports to the United States. This is nearly perfectly explained by imports from China into the United States that transit through Hong Kong, which imports would continue to be reported as originating in China regardless of their last port of export to the United States. These shipments would likewise be properly reported as exports to Hong Kong under the Chinese statistics rather than exports to the United States.
In the later part of 2020, however, those statics flipped. China’s exports to the United States far exceeded the US data on imports from China by more than 20%. Relocating a part of the manufacturing process could explain a large part of this data discrepancy (more on that later) or simple fraud could explain some of this discrepancy. The additional tariffs on Chinese imports are staggeringly high in the context of customs tariff rates. Thus, the motivation and the stakes could not be higher. Regardless of the underlying rationale of individual importers, we are likely dealing with claims of origin on US Customs declarations that may not be properly justified by the importers making the claims. As a result, there has never been a more lucrative pool of potential duty recoveries as there has been since 2018 when USTR Robert Lighthizer announced punitive tariffs on certain Chinese imports under Section 301 of the Tariff Act[12].
So, will we see that wave of trade qui tam cases we have all been expecting for the past 8 years? Certainly, whistleblowers will be incentivized to grab a piece of the multi-billion-dollar pie. Moreover, the public opinion of Chinese imports has likely not been lower than it has been since the inception of the Section 301 trade remedy action on China, going lower still in light of the political and human rights developments in Hong Kong and Xinjiang[13]. Given these factors, Chinese imports are a juicy target for would-be whistleblowers.
Two principal influences could, however, continue to limit the volume of trade-related qui tam cases: (1) the arcane, complex and subjective nature of the customs regulations as they relate to the rules of origin and tariff classification; and (2) many of the would-be whistleblowers may be outside of the United States making reaching them and adequately protecting them significantly more difficult. This short piece will focus on the former. International whistleblowers present unique challenges in customs fraud, which may not afford anonymity along with other practical difficulties necessitating a separate discussion.
False Claims Act and Customs Fraud
The False Claims Act[14] , first enacted during the civil war to combat fraud by government suppliers and amended several times over the subsequent years, prohibits: (1) presenting a false claim; (2) making or using a false record or statement material to a false claim; (3) possessing property or money of the U.S. and delivering less than all of it; (4) delivering a certified receipt with intent to defraud the U.S.; (5) buying public property from a federal officer or employee, who may not lawfully sell it; (6) using a false record or statement material to an obligation to pay or transmit money or property to the U.S., or concealing or improperly avoiding or decreasing an obligation to pay or transmit money or property to the U.S.; or (7) conspiring to commit any such offense[15]. Violations of the False Claims Act may result in liabilities for the payment of costs, expenses, attorneys’ fees, damages, and perhaps triple damages in a civil action brought either by the U.S. or by a relator in the name of the U.S[16]. Additional liability may flow from any retaliatory action taken against a False Claims Act whistleblower.
While the Act was created, and remains most often used, for fraudulently attempting to obtain money or property from the government, it has been expanded over the years to provide for a so-called “reverse false claim” provision appropriate for use in customs fraud cases. A reverse false claim is one where, “the fraud flows in the opposite of the usual direction.[17]” Rather than fraudulently attempting to obtain money or property from the government, the misconduct is designed to fraudulently avoid remitting money or property to the government. A reverse false claim provision gives raise to liability where the defendant: (1) made or used a false statement or record material to an obligation to provide the government with money or property, and (2) knowingly concealed or improperly avoided or decreased an obligation to provide the government with money or property[18].
As such, in order to sustain an allegation of a reverse false claim, the defendant must have made: (1) a record or statement that was false, (2) the defendant had knowledge of the falsity, (3) the defendant made or used (or caused to be made or used) the false record or statement, (4) the defendant’s purpose was to conceal, avoid, or decrease an obligation to pay the government, and (5) the false record or statement was material[19]. As for the second prong in a reverse false claim case, a violation may be established where the defendant (1) concealed or improperly avoided or decreased an obligation to pay the government and (2) did so knowingly[20]. There is no requirement under the second prong to show that the defendant used a false record or statement or that a record or statement was material[21].
It is clear that Congressional intent is to remain expansive in defining the elements of a false claim under the statute. In fact, with respect to whether or not a record or statement is false, the statute itself provides no definition. Congress has, however, stated that “false” in this context includes more than conduct intended to defraud but also includes information presented blindly or in reckless disregard to its veracity[22]. Moreover, where the courts have taken a more limited view of the term “obligation” and whether it must include only fixed amounts, the 2009 amendment clarified Congressional intent that the obligation “includes fixed and contingent duties owed to the Government – including fixed liquidated obligations such as judgments, and fixed, unliquidated obligations such as tariffs on imported goods.[23]” (emphasis added). Not only would a customs fraud matter appear to meet the basic statutory elements of a reverse false claim, but Congress has explicitly provided for customs fraud cases in amending the language of the statute.
The statutory standards for falsity under the False Claims Act fit precisely with the standard of care to which US importers are held under the customs laws, which is discussed more below. Thus, where an importer has provided inaccurate and misleading information in connection with an import declaration submitted to US Customs and Border Protection (CBP) and thereby failed to live up to its statutory burden of reasonable care under the customs laws, so too would the importer have run afoul of the False Claims Act where such an error or omission resulted in the loss of revenue to CBP.
Reasonable Care and Knowing Avoidance: Navigating the rules of origin in a False Claim Action
While US Customs and Border Protection (CBP) is the primary enforcement agency of US customs laws and related border controls, the burden of proactive compliance with these rules has been placed upon the importers themselves under the Customs Modernization Act (“Mod Act”)[24]. Under the Mod Act, an importer … shall, using “reasonable care”: (1) make entry …filing … information as necessary for CBP to determine whether the merchandise may be released from custody; (2) by filing … the declared value, classification and rate of duty applicable to the merchandise, and other documentation or information necessary to enable CBP to: (i) properly assess duties; (ii) collect accurate statistics; and (iii) determine whether any other applicable requirement of law (other than a requirement relating to release from customs custody) is met[25]. A violation of this provision is determined to be negligent if it results from an act (or omission) done through either: the failure to exercise the degree of reasonable care and competence expected from a person in the same circumstances in ascertaining the facts or in drawing inferences therefrom, in ascertaining the offender’s obligations under the statute, or in communicating information so that it may be understood by the recipient. … a violation is determined to be negligent if it results from the offender’s failure to exercise reasonable care and competence to ensure that a statement made is correct[26].
Declarations of origin, particularly inaccurate declarations such as claiming Vietnam origin rather than China, could likely avoid the payment of substantial additional duties that are otherwise due under the Section 301 trade remedies. This inaccurate declaration may be made with the intention to defraud the government of these additional duties, but it could also be made blindly, or with reckless disregard for the veracity of the declaration such as relying entirely upon an exporter-seller’s statement[27]. Under such circumstances, it is relatively easy to demonstrate that not only would an importer have violated its burden of reasonable care under the customs law, but also likely satisfied the elements of a violation of the False Claims Act.
Rules of origin (ROO) as an unintended shield for customs fraud
Inaccurate declaration as to the origin of imported merchandise is much easier to make than one may otherwise believe. There is no specific statutory provision for customs “rules of origin” or “country of origin” under US law[28]. Rather, CBP looks to court precedent, CBP regulations, and agency interpretations to determine origin of an imported product where necessary[29]. The country of origin of an imported product is broadly defined as the country of manufacture, production, or growth of any article of foreign origin entering the customs territory of the United States[30]. In the modern supply chain, this definition is not particularly helpful.
There are two operative sets of rules of origin (ROO): (1) Non-preferential ROO; and (2) preferential ROO, which are used to determine eligibility for tariff preferences under trade agreements to which the US is a party. For the purposes of this discussion, and the Section 301 duties in particular, the focus primarily will be on non-preferential ROO, which are used to determine the origin of goods imported from countries with which the United States has most-favored-nation (MFN) status (i.e., WTO member-states). These non-preferential ROO are the primary basis of the assessment of tariffs on imports, addressing country of origin labeling issues, and determining admissibility of merchandise.
Under non-preferential rules of origin, two major criteria apply. First, goods that are wholly the growth, product, or manufacture of one particular country are attributed to that country. This is known as the wholly obtained principle and is quite straight forward. Second, and by far the most common scenario in the modern supply chain, where an imported product consists of components from more than one country, a principle known as substantial transformation is used to determine origin. In most cases, the origin of the good is determined to be the last place in which it was substantially transformed into a new and distinct article of commerce based on a change in name, character, or use[31]. It is plain to see that this standard is subjective and not intuitive for the layman in making their own determination about what constitutes a change sufficient for conferring origin. Origin determinations are fact-specific and even CBP acknowledges that there can be considerable uncertainty about what is deemed to be substantial transformation due to the “inherently subjective nature” that may be involved in CBP interpretations of these facts[32].
Global trade and manufacturing are increasingly cross border, involving design, production, marketing, distribution, support, and delivery to the final consumer, with each of these steps potentially occurring within different jurisdictions. Moreover, there is an increasing reliance on outsourcing parts of the production to sub-contractors that may themselves be located in a third country. Even where an importer seeks the clarity of a ruling from CBP, the issuance of the ruling is often exceedingly complex for CBP themselves where questions as to which processes or procedures are sufficient for a product to be “substantially transformed” must be answered, often based upon abstract descriptions[33]. The global trade community have criticized CBP and other customs authorities on this very point, highlighting that determinations are subjective, inconsistent, and lack transparency[34]. In a 2018 survey by consulting firm Ernst & Young, a majority of trade professionals indicated origin rulings are inconsistent across customs authorities and cited a need for ROO harmonization[35].
When it comes to claims of origin and the resultant liability for duties that attach as a consequence, even would-be whistleblowers are unclear or entirely unaware as to whether there have been inaccurate declarations made to CBP. What is clear is that where an importer is complacent, willfully ignorant, or simply negligent in their duty to exercise reasonable care, it can be easy to claim a country of origin that may not be in line with CBP’s view of the facts under the substantial transformation standard. Would-be whistleblowers must be familiar enough the corporate supply chain to identify potentially problematic origin claims. While this may have been a barrier to many trade-related qui tam cases to date, the impact to the bottom line of Section 301 duties are likely significant enough to be now visible to a broader spectrum of corporate employees including finance, tax, merchandising, sourcing, and distribution staff at US importers. In short, the payment of Section 301 duties—or the avoidance of such duties—has likely made customs issues more top of mind at all levels of a company.
Defenses Potentially Available to Defendant Importers
Another potential barrier to larger volumes of trade-related qui tam cases are unique defenses that may present themselves in customs fraud cases. These defenses may have rendered many customs fraud cases more speculative than experienced whistleblower attorneys could accept up to this point. However, a deep understanding of the customs laws and how they may be impacted by a whistleblower allegation can overcome nearly all such defenses provided the appropriate facts have been collected. Below is a brief discussion of the more substantial defenses.
Original Source Requirement
In order for a qui tam case to proceed, three key questions must be answered: “(1) Have the allegations made by the plaintiff been ‘publicly disclosed’? (2) If so, is the lawsuit ‘based upon’ that publicly disclosed information? (3) If so, is the plaintiff an ‘original source’ of the information?[36]” In a customs case, there may indeed often be publicly disclosed information taken from cargo manifests and compiled and made available by third-party data aggregators. Notwithstanding this potential issue, if the relator has knowledge that is independent of and materially adds to the publicly disclosed allegations or transactions, and they have voluntarily provided the information to the Government before filing suit, the qui tam action may nonetheless proceed. As such, where a realtor is in possession of detailed facts regarding customs malfeasance that is supported by, rather than identified as a result of, publicly available information such as manifest data, a case may be sustained.
However, several of the largest customs cases in recent years may not have survived if not for settlements. Cases filed by competitors and based almost entirely on publicly available information. In reviewing a qui tam case brough in connection with fraudulent claims by a defense contractor, the U.S. Supreme Court examined whether a qui tam complaint based on information derived from a Freedom of Information Act request was based on publicly disclosed information and thus barred under 31 U.S.C. § 3130(e)(4). In that case, Schindler Elevator Corp. v. United States ex rel. Kirk, the Court held that a broad interpretation of the public disclosure bar was appropriate and held that the relator’s efforts in that case, which involved his own personal experiences in the industry and public FOIA requests, were a clear example of opportunistic litigation, anyone could have made the FOIA requests and filed the claims at issue in that case. Thus, a relator must possess actual knowledge and detailed facts, rather than industry experience and publicly available information notwithstanding large settlements.
First to File Bar
Importers often utilize a safe-harbor mechanism under US customs law where mistake or error has been self-detected in previous import transactions. A prior disclosure, when properly prepared and timely filed, protects the importer and can significantly reduce the amount of any penalties that would have been imposed had Customs initiated an administrative penalty action[37]. In a case involving negligence or gross negligence, Customs is limited to collecting interest on the liquidated amount found owing[38]. While this particular issue has not been specifically addressed by the courts, it would stand to reason that a properly filed and timely prior disclosure made by an importer to CBP would likely be a successful defense against a qui tam action alleging false information declared that resulted in the underpayment of duties. Nevertheless, as a practical matter, the availability of such a defense would be expected to be relatively rare.
Reasonable Care Defense?
Under the Mod Act, CBP has been asked to ensure members of the trade community are better informed of customs laws and regulations in order to assist them in meeting their burdens of informed compliance and reasonable care[39]. In this regard, CBP has published a list of some basic questions that in its view may establish reasonable care in claiming a country origin upon import. While not exhaustive, this list may serve as a road map for importers to assist them in establishing that, indeed they have exercised reasonable care and have therefore met their burden of compliance under the customs laws. Even where a substantive determination from CBP or the court may find hold otherwise, affirmative answers to these questions may well be affirmative defenses against a determination of negligence (or worse) under the customs regulations. Those questions, are as follows:
Have you taken reliable measures to ascertain the correct country of origin for the imported merchandise?
- Have you established reliable procedures to ensure that you report the correct country of origin on customs entry documents?
- Have you established reliable procedures to verify or ensure that the merchandise is properly marked upon entry with the correct country of origin (if required)?
- Have you obtained a “ruling” from CBP regarding the proper marking and country of origin of the merchandise (see 19 C.F.R. Part 177), and if so, have you established reliable procedures to ensure that you followed the ruling and brought it to CBP’s attention?
- Have you consulted with a customs “expert” (e.g., an attorney, licensed customs broker, or a customs consultant) regarding the correct country of origin/proper marking of your merchandise?
- Have you taken reliable and adequate measures to communicate customs country of origin marking requirements to your foreign supplier prior to importation of your merchandise?
- If you are claiming a change in the origin of the merchandise or claiming that the goods are of U.S. origin, have you taken required measures to substantiate your claim (e.g., do you have U.S. milling certificates or manufacturer’s affidavits attesting to the production in the United States)?
- If you are importing textiles or apparel, have you developed reliable procedures to ensure that you have ascertained the correct country of origin in accordance with 19 U.S.C. § 3592 (Section 334, Pub. Law 103-465) and assured yourself that no illegal transshipment or false or fraudulent practices were involved?
- Do you know how your goods are made, from raw materials to finished goods, by whom and where?
- Have you established a reliable document maintenance program or procedure to ensure you can produce any required entry documentation and supporting information, including any required certificates of origin or certifications?
While maintaining robust internal compliance programs, and seeking professional advice are often successful defenses against CBP’s allegations of negligence against importers, it remains to be seen if such a defense could overcome a qui tam action. Although the customs penalty provisions[40] and the False Claims Act are entirely separate provisions, it stands to reason that a successful allegation of false claims made in a customs transaction would be unlikely where customs themselves have defined the conduct to not even be negligent, let alone “knowingly false”, however that term may be defined.
Conclusion
Although long expected, a wave of customs fraud whistleblower cases may well come to fruition as a result of Section 301 tariffs on certain imports from China. While the arcane and complex nature of the rules of origin and well as certain customs-specific idiosyncrasies may have operated as a barrier to such action thus far, none of these factors are insurmountable. The dollar values at stake and the plainly obvious circumvention taking place are likely to be sufficiently strong motivators to overcome these issues.
[1] See e.g. The Rise of Reverse FCA Cases Amidst ‘America First’ Trade Policies (available at https://www.crowell.com/NewsEvents/AlertsNewsletters/all/Rise-in-Reverse-FCA-Cases-Amidst-America-First-Trade-Policies); “Expanding the Use of the Federal False Claims Act to Police Trade and Export Comopliance (available at , https://www.arentfox.com/perspectives/alerts/the-expanding-use-the-federal-false-claims-act-police-trade-and-export); The Rise of Private Party-Initiated Trade Enforcement Action (available at https://www.bakermckenzie.co.jp/e/material/dl/supportingyourbusiness/newsletter/internationaltrade/ClientAlert_20130107_InternationalTrade_E.pdf); et seq.
[2] See Dept of Justice press release announcing settlement with Toyo Ink in False Claims Act case (available at https://www.justice.gov/opa/pr/japanese-based-toyo-ink-and-affiliates-new-jersey-and-illinois-settle-false-claims-allegation)
[3] See Dept. of Justice press release on fiscal year 2020 False Claims Actions (available at https://www.justice.gov/opa/pr/justice-department-recovers-over-22-billion-false-claims-act-cases-fiscal-year-2020)
[4] Id.
[5] See U.S. Dept. of Justice press release on Linde GmbH settlement under the False Claims Act (available at https://www.justice.gov/opa/pr/multinational-industrial-engineering-company-pay-22-million-settle-false-claims-act).
[6] Notice of Determination and Request for Public Comment Concerning Proposed Determination of Action Pursuant to Section 301: China’s Acts, Policies, and Practices Related to Technology Transfer, Intellectual Property, and Innovation (United States Trade Representative) 83 Fed Reg 14906 – 14954 (April 6, 2018); see also, USTR China Section 301 Tariff Action (available at https://ustr.gov/issue-areas/enforcement/section-301-investigations/section-301-china/investigation).
[7] See USTR China Tariff Action at https://ustr.gov/issue-areas/enforcement/section-301-investigations/section-301-china/investigation.
[8] Id.
[9] See CBP Trade Statistics https://www.cbp.gov/newsroom/stats/trade
[10] United Nations Merchandise Trade Statistics Concepts and Definitions available at https://unstats.un.org/unsd/publication/SeriesM/SeriesM_52rev2E.pdf
[11] United States Trade Representative, US-China Trade Facts available at https://ustr.gov/countries-regions/china-mongolia-taiwan/peoples-republic-china#:~:text=The%20United%20States%20had%20a,%2C%20down%204.1%25%20from%202018).
[12] USTR Sec. 301 Determination 83 Fed Reg at 14906.
[13] Pew Research Report: U.S. Views of China Turn Sharply Negative Amid Trade Tensions (available at https://www.pewresearch.org/global/2019/08/13/u-s-views-of-china-turn-sharply-negative-amid-trade-tensions/ ).
[14] 31 U.S.C. §§ 3729 – 3733
[15] Id.
[16] Ibid.
[17] United States ex rel. Ramadoss v. Caremark, Inc., 586 F.Supp.2d 668, 692 (W.D. Tex. 2008) (quoting United States ex rel. Bahrani v. Conagra, 465 F.3d 1189, 1195 (10th Cir. 2006))
[18] United States ex rel. Ormsby v. Sutter Health, 444 F. Supp. 3d 1010, 1055 (N.D. Cal. 2020)
[19] Id at 1055-1056
[20] Id.
[21] Id.
[22] S. Rpt. 31 U.S.C. § 3729(b)(1)(B) (“(1) the terms “knowing” and “knowingly” – … (B) require no proof of specific intent to defraud”).
[23] S. Rpt. 111-10 at 14 (2009).
[24] Title VI of P.L. 103-182
[25] 19 C.F.R. s. 141.61
[26] U.S. Customs and Border Protection Informed Compliance Publication: What Every Member of the Trade Community Should Know: Reasonable Care, Sept. 2017 (available at https://www.cbp.gov/sites/default/files/assets/documents/2018-Mar/icprescare2017revision.pdf)
[27] 6 Press Release of the US Attorney’s Office for the Southern District of New York, “Manhattan U.S. Attorney Sues Garment Wholesaler, Garment Importers, and Executive for Scheme to Avoid Paying Millions in Import Duties on Garments” (23 September 2016);
[28] CBP Informed Compliance Publication: What Every Member of the Trade Community Should Know: Reasonable Care, Sept. 2017.
[29] U.S. Customs and Border Protection Informed Compliance Publication: What Every Member of the Trade Community Should Know: U.S. Rules of Origin, m, May 2004.
[30] 19 C.F.R. §134.1
[31] Anheuser-Busch Brewing Association v. United States, 207 U.S.556. See also U.S. Customs and Border Protection, What Every Member of the Trade Community Should Know about U.S. Rules of Origin, Informed Compliance Series, May 2004, p. 9
[32] U.S. Customs and Border Protection Informed Compliance Publication: What Every Member of the Trade Community Should Know: U.S. Rules of Origin, May 2004
[33] Congressional Research Office, International Trade: Rules of Origin, May 2020 (available at https://fas.org/sgp/crs/row/RL34524.pdf)
[34] EY Report, Managing the pace of change,” Making sense of a world in motion – a global trade perspective, 2016 at p. 10.
[35] Id.
[36] See 31 U.S.C. s. 3730 (e)(4)(A)
[37] See, 19 C.F.R. s 162.74
[38] Id.
[39] United States Customs Modernization Act (Pub.L. 103–182, 107 Stat. 2057, December 8, 1993),
[40] See 19 U.S.C. section 1592