Court Decision May Affect Ability to Sell Products Assembled from Imported Components to U.S. Government Agencies

In a development that may have important implications for companies selling products to the U.S. government, on December 7, 2016, the Court of International Trade (CIT) issued a decision holding that the assembly in the United States of a flashlight using imported components did not qualify as “U.S. origin” under the Trade Agreements Act. The court’s decision potentially may alter the manner in which government agencies determine whether a product with foreign content is eligible to be purchased.

To understand the implications of the court’s decision, some background is necessary. The Buy American Act requires that federal agencies give a “price preference” to bids from companies offering U.S. origin products.  However, where procurements are above certain threshold values, the Trade Agreements Act overrides the Buy American Act. Products from countries that are members of the WTO Government Procurement Agreement and/or free trade agreements with the United States are entitled to non-discriminatory treatment. At the same time, federal agencies may not purchase products from countries that are not members of the Government Procurement Agreement or free trade agreements (unless there are no alternatives from an eligible country). Thus, for example, the federal government may not purchase Chinese-origin products, because China is not a member of the WTO Government Procurement Agreement and does not have a free trade agreement with the United States.

The Trade Agreements Act provides that the origin of an article not wholly the product or manufacture of a single country is determined by the rule of “substantial transformation.” An article is a product of a country if it has been substantially transformed there into a new and different article of commerce with a name, character or use different from that of the article or articles from which it was transformed.

“Substantial transformation” is a customs law concept, and Customs and Border Protection (CBP) is authorized to issue advance determinations on the application of the substantial transformation test for purposes of federal government procurement. The substantial transformation concept is used by CBP to determine origin in other contexts as well, including for purposes of deciding which country of origin must be marked on a product and determining which tariff rate applies at the time of importation.  There is a substantial body of CBP rulings that serve as precedents in evaluating whether imported components have undergone substantial transformation and therefore lost their foreign origin.

The case Energizer Battery v. United States involved a situation in which Energizer had sought a ruling from CBP on whether its assembly of military flashlights in the United States from imported components was sufficient to constitute a substantial transformation of the components.  CBP ruled that the assembly operations were insufficient, noting that all of the components, including the LED that was the key part of the product, were imported from China and that the assembly operations were relatively simple. CBP did not find significant that the LED wafers were grown in the United States before being exported to China for further processing there.  As a result, the flashlight did not qualify as U.S. origin.

Energizer appealed this ruling to the CIT. In analyzing the issues, the Court relied exclusively on the limited number of prior judicial decisions on substantial transformation, and not the full body of CBP precedents addressing a wider range of factual situations. Possibly as a result, the Court formulated a narrow test that appears to require that imported components be modified in some manner prior to assembly into the finished product before they can be considered substantially transformed. Specifically, the Court found that the flashlight components’ names did not change after assembly and that they had a “pre-determined use” at the time of importation. It further stated that the assembly operations did not “result in a change in the shape or material composition of any imported component.”

If this test were applied in other situations, it could disqualify a broad range of assembly operations that in the past have been considered to result in a substantial transformation. At the same time, however, the Court acknowledged that each situation has to be examined on an individual basis, and that other court decisions had relied on other factors. Accordingly, it does not appear that the Court intended to preclude CBP from applying its traditional tests.

Nonetheless, it will be important to monitor future CBP rulings on substantial transformation to see how CBP views the CIT’s decision.