Neville Peterson LLP: Customs and International Trade Law

January 27, 1999
Our File: 2700-01
M E M O R A N D U M
TO: Clients and Friends of the Firm
FROM: John M. Peterson
Neville Peterson LLP
RE: Country of Origin Marking Requirements: New Federal Circuit Decision
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     The United States Court of Appeals for the Federal Circuit (CAFC) has issued a major new decision affecting country of origin marking requirements. The new decision, in Bestfoods (f/k/a CPC International Inc. v. United States, is perhaps the most significant marking decision of the last half-century, but is not a favorable decision for business. It has the effect of bifurcating the United States country of origin marking law [19 U.S.C. Section 1304(a)] -- applying different standards to different goods -- and subjecting previously-exempt goods to country of origin marking requirements. It is likely to have a particularly harsh impact on United States food and beverage processors.

Synopsis of the Decision

     In Bestfoods, a United States manufacturer produced peanut butter at a plant in Arkansas, using a small quantity (less than 10 ) Canadian-origin peanut slurry. Customs ruled that the finished peanut butter was required to be marked "Product of Canada", on the ground that the small quantity of Canadian slurry used in its manufacture did not undergo a change in tariff classification of the kind specified in the NAFTA Marking Rules, 19 C.F.R. Part 102.

     The United States Court of International Trade ruled that Customs was not entitled to substitute its NAFTA Marking Rules for the traditional "substantial transformation" test, in determining whether goods produced in the United States with imported (NAFTA country) origin materials were subject to marking. Rather, upholding the standard enunciated by the courts in United States v. Gibson-Thomsen Co., Inc., 27 CCPA 267 (1940), the CIT held that, so long as goods are produced in the United States by a process of "substantial transformation", they are not "articles of foreign origin", and are not subject to marking.

     In Bestfoods, The Federal Circuit reversed the earlier decisions of the CIT, and ruled that Congress, in passing the NAFTA Implementation Act, intended to delegate to the Treasury Department the power to redefine the term "articles of foreign origin", as used in the country of origin marking statute, with respect to goods made in the United States from NAFTA-origin materials.

     As a result of the Federal Circuit's decision, the country of origin marking statute, 19 U.S.C. Section 1304(a), has effectively been bifurcated. Articles manufactured in the United States with non-NAFTA inputs are exempt from marking (i.e., are not "articles of foreign origin") if they are the product of a "substantial transformation" in this country. By contrast, articles made in the United States in whole or in part from NAFTA-origin inputs, however, are only exempt from marking if the foreign inputs undergo a change in tariff classification of a kind specified in the NAFTA Marking Rules, 19 C.F.R. Part 102.

     The Federal Circuit has remanded the case to the CIT so that Bestfoods may present "any other arguments it may have as to why it should not be required to mark its product under the applicable regulations." The Federal Circuit declined to consider Bestfoods' cross-appeal, which argued that the lower court had erroneously applied the "substantial transformation" test to the company's domestically-made peanut butter.

     The Federal Circuit's decision, written by Judge Bryson, holds that Congress, in enacting NAFTA, intended to delegate to the Treasury Department the power to issue NAFTA Marking Rules, and further, that Congress intended that these rules would be used to change the definition of the term "article of foreign origin" as it appears in Section 304 of the Tariff Act of 1930, as amended, [19 U.S.C. Section 1304]. In the Court's view, the NAFTA Implementation Act and the accompanying Statement of Administrative Action authorized the promulgation of such regulations "as necessary or appropriate to implement immediately applicable U.S. obligations under NAFTA." The Court further concluded that, because NAFTA Annex 311 contemplates the issuance of NAFTA Marking Rules which were to operate on "tariff shift" principles, Congress must have intended that these rules would be applied for purposes of administering the country of origin marking law.

     Furthermore, the Court noted that NAFTA Annex 311 provided that goods of a NAFTA party which were processed in the United States in a manner effecting a "tariff shift" under the NAFTA Marking Rules would be exempt from country of origin marking requirements under Section 304. While the CIT held this to be an additional exemption from marking, the Federal Circuit reasoned that it changed the entire scope of the marking statunte. If NAFTA goods which underwent a specified tariff-shift in the United States were exempt from marking as an "article of foreign origin", the Court reasoned, then the converse must be true, that is, NAFTA goods which do not undergo such processing remain "articles of foreign origin", subject to marking, even if they undergo a "substantial transformation". Specifically, the Court held that:

The effect of the adoption of NAFTA is that the term "article of foreign origin" in the Federal marking statute must be construed to exclude NAFTA goods that undergo a tariff shift after importation, regardless of whether they would be considered "articles of foreign origin" under the Gibson-Thomsen test [of "substantial transformation"]. In the case of NAFTA goods, Congress has thus authorized the Secretary of the Treasury to promulgate regulations that define the term "article of foreign origin" for NAFTA goods according to the tariff-shift methodology. Of course, the consequence of altering the definition of "article of foreign origin" is not only to change the scope of the goods that are exempted under the marking statute, but also to change the scope of goods that are subject to the statutory marking requirement. Thus, the effect of Congress's authorizing the Secretary of the Treasury to promulgate regulations necessary or appropriate" to make the United States marking rules comply with the requirements of Annex 311 . . . was to empower the Secretary to adopt a construction of the Federal marking statute, for NAFTA goods, that was based on the tariff- shift approach instead of the Gibson-Thomsen approach.

The Decision's Impact on Business

     As a result of the Bestfoods decision, United States manufacturers must apply two different rules to determine whether goods produced in this country with foreign-origin inputs are subject to marking to show a foreign country of origin. If the goods are made with non-NAFTA inputs, they are exempt from marking if they are the product of a "substantial transformation" in the United States -- that is, a process which results in creation of a new and different article of commerce, having a name, character or use different from its components.

     On the other hand, if the goods are made in whole or in part of Canadian or Mexican inputs, they will be subject to marking as a foreign article unless the foreign components undergo a change in tariff classification as specified in the NAFTA Marking Rules. In this regard, it is important to note that, under the NAFTA Marking Rules, Customs' position is that the origin of a good is the country of origin of those materials which do not undergo a required tariff shift. Moreover, Customs' view is that, under the NAFTA Marking Rules, an article may be determined to have more than one foreign country of origin.

     Thus, all United States manufacturers who use Canadian- or Mexican-origin inputs and components will be required to conduct a NAFTA Marking Rules analysis to determine whether their products must be marked as having foreign origin.

Analysis

     In our judgment, the Federal Circuit's Bestfoods decision is based on faulty statutory interpretation, and, if left unchallenged, will place United States manufacturers who utilize Canadian and/or Mexican ingredients at an extreme competitive disadvantage. We have recommended that United States manufacturers consider organizing political and financial support to seek review of this decision, either in Congress or before the United States Supreme Court.

     The Bestfoods decision obviously works a major change in the scope and application of the country of origin marking statute. Indeed, the Federal Circuit's sweeping decision goes farther in shifting power over the marking statute to the Executive Branch of government than the government's own arguments in the case had urged.

     What is most remarkable about the Federal Circuit's decision is that the Court found an implied intent on Congress' part to amend the marking statute, and shift power over the statute to the Treasury Department, notwithstanding (1) the legislative history which shows that Congress had specifically amended the statute, in 1938, to deny Treasury that power, and (2) the provision in the NAFTA Implementation Act specifying that no amendment or repeal of any Federal statute was to be implied. The Court responded to these concerns by stating:

We likewise reject the Bestfoods argument that the fact that Congress amended 19 U.S.C. Section 1304 in one respect, not pertinent here, indicates that it did not intend to change, or permit the Secretary of the Treasury to change the operation of the statute in other respects. The NAFTA Implementation Act added a new subsection to 19 U.S.C. Section 1304, which is now codified at 19 U.S.C. Section 1304(j). That subsection made a variety of changes in the statute as it applies to NAFTA goods. Bestfoods argues that because Congress did not include abrogation of the Gibson-Thompson test among the provisions of Subsection (j) it must not have intended to allow that change to be made. The problem with that argument is that the new subsection contained matters for which the marking statute needed to be amended or supplemented. It did not include matters that were not expected to be addressed through regulation, such as the content of the marking rules. Significantly, the new subsection did not include any reference to the exemption from marking that was required by Annex 311 for goods that underwent a tariff shift after importation. That subject was not addressed in the new subsection, presumably because it was regarded as unnecessary to amend the statute to put that provision of Annex 311 into effect. The same reasoning applies to the adoption of the tariff shift methodology to define those goods falling within the marking requirement: because a statutory amendment was not necessary to effect that change, it is not surprising or significant that the statute was not amended for that purpose.

     The effect of the Federal Circuit decision is to return Bestfoods, and the rest of United States manufacturers, back to "square one", as it existed after Customs published its NAFTA Marking Rules. Goods produced in the United States with NAFTA-country inputs will be exempt from marking only if those inputs undergo a change in tariff classification of the kind specified in the NAFTA Marking Rules. This may pose a problem for the food processing and beverage industries in particular, since the NAFTA Marking Rules for food products are strict, and contain no "de minimis" exceptions. Thus, in the case of Bestfoods' Skippy peanut butter, the presence of even minute traces of Canadian-origin peanut slurry (which do not undergo a tariff shift during processing) is sufficient to cause the product to be labeled "Product of Canada". Products for which no "de minimis" exemption exists to the tariff shift NAFTA Marking Rules include all goods classified in Chapters 1, 2, 3, 4, 7, 8, 11, 12, 15, 17 or 20 of the Harmonized Tariff Schedule. See 19 C.F.R. Section 102.13(b)

     Even where the "de minimis" rule applies to goods, application of the "tariff shift" requirements of the NAFTA Marking Rules may produce absurd or anomalous results. For example, if a photocopier document handler (HTS subheading 9009.90) is assembled in the United States using NAFTA-origin components (also subheading 9009.90), and the foreign components account for more than 7% of the product's total cost, the rules would treat the finished document handler as an "article of foreign origin", which must be marked to indicate the countr(ies) of origin of the parts which do not undergo a tariff shift. The fact that the assembly of the document handler might have been a major assembly operation which effects a "substantial transformation" would be irrelevant to the marking requirements.

     While the Court has remanded this case to the CIT, with instructions to allow Bestfoods to raise any other objections to marking it may have, our judgment is that this is not likely to be a very meaningful avenue secure further review of the regulations. This is because Congress did not promulgate any intelligible standards against which the regulations might be judged. The Federal Circuit seems to have lost sight of the fact that Congress did not have any particular NAFTA Marking Rules before it when it passed the NAFTA Implementation Act, and the NAFTA itself did not specify any standard for the rules. The rules are whatever the three NAFTA governments could mutually negotiate; they are obviously affected by political considerations, with "trade sensitive" goods being assigned rules of origin which are more difficult to meet. This is evident in the lack of a "de minimis" rule for agricultural and food products.

     The lack of standards suggests to us that the Federal Circuit is simply wrong in interpreting NAFTA and its implementing Act to suggest that Congress intended to give Treasury carte blanche to revise the marking rules.

Next Steps

     We have recommended that Bestfoods consider asking the Federal Circuit to rehear this case, in the process making a suggestion for an en banc reconsideration, and consider seeking industry support, if need be, for a petition asking the United States Supreme Court to hear the case. While the Supreme Court rarely hears international trade appeals (it has, however, taken one such appeal in each of its last two sessions), the Bestfoods case raises unique issues concerning the relationship between NAFTA and United States law. To our knowledge, it is the first Circuit court case construing NAFTA's impact on domestic law. Since all trade appeals come through the Federal Circuit, there is no opportunity for a conflict between circuits, suggesting that the Supreme Court should render the final determination on this matter.

     There is also a strong possibility that Congress will call hearings to discuss the Bestfoods decision and its impact on administration of the marking law. Congress has long asserted that Treasury did not have power to define the scope of operation of the marking statute. The Court's ruling to the contrary may prompt Congress to amend the marking law in order to take back control over the marking law.

     We stand ready to discuss the decision [available at www.fedcir.gov] in further detail at your convenience, and to explore the decision's impact on your company's operations.

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