Here are some things you don’t see very often: blue moons, hen’s teeth, unicorns and judicial decisions that address Federal procurement country of origin requirements. The recent Court of International Trade decision in Energizer Battery, Inc. v. United States marks the first time that court has evaluated the standard for substantial transformation under the Trade Agreements Act. It’s well worth a detailed reading.
Federal Government Procurements Are Limited to “Eligible Products”
Government contractors are well aware that the Federal Acquisition Regulation limits TAA-covered purchases to “eligible products” from the United States or from a “designated country” to which the U.S. has granted non-discriminatory procurement status. A product is eligible either if it is entirely produced in a qualifying country, or if any imported materials undergo a “substantial transformation” through the production process. A substantial transformation requires that a part or material undergo a change in name, character or use, and become a new and different article of commerce, through a production process. Origin determinations are issued by U.S. Customs and Border Protection.
The products in question were flashlights assembled in the United States from Chinese-origin components. Including fasteners, and depending on whether a major subassembly was counted as a separate item or divided into its parts, the number of distinct components ranged from 36 to 55. The assembly process did not entail any alterations to the components.
Energizer had submitted a ruling request to CBP, unsuccessfully arguing that the assembly process substantially transformed the Chinese-origin parts into a U.S.-origin flashlight. CBP disagreed. In its view, the assembly process was too simple to qualify. Accordingly, the flashlight’s country of origin was China, meaning it was ineligible for sale to the Federal government.
This unfavorable outcome was appealed to the CIT. That court applies a “de novo” standard of review, meaning it is not limited to the reasoning set out in the challenged CBP ruling, but instead can perform an independent evaluation based on the facts presented to it.
Mere Assembly Is Not a Substantial Transformation
The CIT noted that there is no statutory definition of the term “substantial transformation” nor judicial precedent for its application to government procurement eligibility. Consequently, it looked to the approaches taken cases involving other statutes using the term, such as “country-of-origin marking, duty drawback, transshipment, voluntary restraint agreements, and the generalized system of preferences.”
Drawing on those precedents, and its own analysis of when a change in name, character or use takes place, the court upheld CBP’s conclusion.
It downplayed the importance of the change in name criterion, while noting that “[t]he constitutive components of the . . . flashlight do not lose their individual names as a result [of] the post-importation assembly.” Since the name of a part did not change due to incorporation into a finished article, this factor weighed against finding a substantial transformation.
To meet the second “change in character” criterion, “there often needs to be a substantial alteration in the characteristics of the article or components.” Because “the post-importation assembly operations do not result in a change in the shape or material composition of any imported component . . . there is no change in character as a result of Energizer’s assembly operations.”
Finally, the change in use criterion was unfulfilled because the use of the imported components was the same before and after assembly into a finished flashlight. “The proper query for this case is not whether the components as imported have the form and function of the final product, but whether the components have a pre-determined end-use at the time of importation. When articles are imported in prefabricated form with a pre-determined use, the assembly of those articles into the final product, without more, may not rise to the level of substantial transformation.”
As none of the criteria were met, the court concluded that the U.S. assembly process did not constitute substantial transformation of the Chinese-origin components into a product eligible for sale to the Federal government.
All government contractors and subcontractors offering to sell supplies (i.e., merchandise) to the United States government pursuant to a contract covered by TAA origin requirements (for example, under a Federal Supply Schedule) should evaluate whether their products meet the substantial transformation standard adopted in Energizer Battery. While the case addressed an assembly process that occurred in the United States, it is equally applicable to items produced abroad. At a minimum, contractors should keep in mind that, just because a particular product may be “produced” in an eligible country, it does not mean it was “substantially transformed” there.
For government contractors, applying the Energizer Battery decision’s analysis is all the more important because procuring agencies, the Government Accountability Office and the General Services Administration all take CBP and CIT decisions into account in determining TAA eligibility. See Pacific Lock Co., Comp. Gen. B-309982 (Oct. 25, 2007), and Compuadd Corp., GSBCA B-120211 et al. (Dec. 23, 1992). GSA has undertaken a compliance program to ensure that only eligible articles are offered in procurements covered by TAA requirements. With the new CIT decision, both contractors and Federal agencies now have more specific guidelines to apply in making these determinations.