Neville Peterson LLP: Customs and International Trade Law

May 7, 1997
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: Customs' Draft Drawback Penalty Regulations ---------------------------------------------------------------------------------
I. INTRODUCTION
The United States Customs Service has posted for public comment a "draft" of its proposed regulations implementing Section 593A of the Tariff Act of 1930, as amended [19 U.S.C. Section 1593a], which authorizes the agency to impose civil penalties for the filing of false or fraudulent duty-drawback claims. Under Section 622 of the Customs Informed Compliance and Modernization Act, the new penalty law and regulations will become effective once Customs implements an automated drawback selectivity program. This Memorandum summarizes the draft regulations.

II. SIMILARITY TO CIVIL CUSTOMS PENALTY PROCEDURES

Customs' proposed procedures for civil drawback penalties largely parallel those which govern the imposition of civil Customs penalties under Section 592 of the Tariff Act of 1930, as amended [19 U.S.C. Section 1592]. Accordingly, drawback claimants suspected of having filed false (negligent or fraudulent) claims will be issued prepenalty and penalty notices, and will have the ability to petition for remission or mitigation of those penalties in accordance with 19 U.S.C. Section 1618. A "prior disclosure" option, to limit penalty liability, would also be available.

III. SUMMARY OF THE DRAFT REGULATIONS
Key aspects of the draft regulations can be summarized as follows:

Loss of Revenue Under Section 593A

Customs proposes to define the term "Loss of Revenue" for drawback penalty purposes as "the amount of drawback which is claimed and to which the claimant is not entitled". This term would be further refined to embrace "actual loss of revenue", which is defined as drawback which has been claimed and paid to the claimant, as well as "potential loss of revenue", which is defined as the amount of drawback which has been claimed but not paid. Penalties could be based on either actual or potential losses of revenue.1
Presumably, a "potential loss of revenue" could occur as soon as a drawback claim is filed, while an "actual loss of revenue" could not occur until accelerated duty drawback is paid, or a drawback claim is liquidated.

"Repetitive Violations"

Under Customs' proposed regulations, "repetitive" violations of Section 593A carry higher penalties, and less possibility of administrative mitigation by Customs. The proposed rule would define a "repetitive" violation as "a violation by a person that involves the same issue as a prior violation by that person". Thus, a drawback claimant is not guilty of a "repetitive" violation if it had a prior violation involving a different issue.

Maximum Penalties

Customs' proposed regulation would restate the maximum drawback penalties allowed by statute. These vary according to the culpability of the offender, and according to whether the drawback claimant is a participant in Customs' voluntary Drawback Compliance Program, as follows:

MAXIMUM DRAWBACK PENALTIES -- DRAWBACK COMPLIANCE PROGRAM NON-PARTICIPANT

Culpability	Maximum Penalty
Fraud	300% loss of revenue
Negligence:
First violation	20% loss of revenue
First repetitive violation	50% loss of revenue
Second and subsequent repetitive violations	100% loss of revenue

MAXIMUM DRAWBACK PENALTIES - DRAWBACK COMPLIANCE PROGRAM PARTICIPANTS

Culpability	Maximum Penalty
Fraud	300% loss of revenue
Negligence
First violation	Warning letter
First repetitive violation	20% loss of revenue
Second repetitive violation	50% loss of revenue
Third and subsequent repetitive violations	100% loss of revenue

"Repetitive" violations would be measured within a three-year time period. Where an earlier violation occurs more than three years prior to a subsequent violation, the latter violation is not considered "repetitive".

Prior Disclosure

When a drawback claimant makes a "prior disclosure" of a violation to Customs, that is, a written disclosure made before a formal investigation is commenced, or without knowledge that a formal investigation has been commenced -- the maximum penalty for a fraudulent violation shall be 100% of the loss or revenue. For "prior disclosed" negligent violation, the maximum penalty will be an amount equal to the interest accruing on any actual loss of revenue during the period from the date a claim was paid/overpaid to the date on which the overpayment was tendered to Customs.

Prepenalty and Penalty Notices.

The proposed drawback penalty regulations mirror those for 19 U.S.C. Section 1592 by providing for the issuance of a written prepenalty notice to an alleged violator, and granting the alleged violator the opportunity to show why no penalty should be assessed. The prepenalty notice must:

In cases of alleged fraud, a prepenalty notice may not be issued without Customs Headquarters approval. A drawback claimant will be allowed to petition for remission or mitigation of a drawback penalty claim in accordance with 19 U.S.C. Section 1618.

Recovery of Actual Loss of Revenue>

Whether or not a monetary penalty is assessed for a false drawback claim, the draft regulations would empower Customs to recover any actual loss of revenue resulting from the claim. Customs may demand restitution of excess drawback payments by means of a written notice; the recipient may challenge the loss of revenue determination by written application to the Commissioner of Customs.

Mitigation Guidelines

        Customs' proposal would also add a new Appendix D to part 171 of the Customs Regulations, providing administrative guidelines for the imposition and mitigation of civil drawback penalties. These guidelines would define the two degrees of culpability - "negligence" and "fraud" -- using the same definitions that are used for 19 U.S.C. Section 1592 penalties.
        The guidelines restate some of the statutory and regulatory requirements pertaining to the issuance of prepenalty and penalty notices, and the submission of responses thereto. They also provide that a "prior disclosure" will be accepted by Customs only if the drawback claimant tenders the amount of drawback overpayment either at the time of disclosure or within 30 days after written notice by Customs.
        The guidelines also set forth ranges of mitigation for various types of violations, as follows:

Culpability	Range of Mitigation of Penalty
Negligent-nonrepetitive	10-20% loss of revenue
Negligent-first repetitive violation	25-50% loss of revenue
Negligent-second/subsequent repetitive violations	50-100% loss of revenue
Fraud	150-300% loss of revenue

Drawback Compliance Program Participants

Where a violation of 19 U.S.C. Section 1593 is committed by a participant in Customs' voluntary Drawback Compliance Program, the guidelines provide the following mitigation ranges based on culpability:

Culpability	Range of Mitigation
Negligent-nonrepetitive	Warning letter
Negligent-first repetitive violation	10-20% loss of revenue
Negligent-second repetitive violation	25-50% loss of revenue
Third and subsequent repetitive violations	50-100% loss of revenue

Drawback program participants do not receive any special dispensation in the case of fraudulent violations.

Mitigating Factors

The proposed guidelines identify several "mitigating factors" which Customs may consider in setting the amount of a drawback penalty. These include contributory Customs error, extraordinary cooperation with the investigation, immediate remedial action, and a prior good record. In addition, the government's inability to obtain personal jurisdiction over the alleged violator, the violator's inability to pay the penalty, and Customs' failure to notify a drawback claimant of a known violation, are all listed as factors justifying mitigation.

Aggravating Factors

        Customs' proposed guidelines would also identify various "aggravating" factors which would justify the denial of mitigation, or the imposition of a harsher penalty than might otherwise be the case. These factors include obstruction of an investigation or audit, withholding evidence, providing misleading information to Customs and prior substantive violations of 19 U.S.C. Section 1593a for which an administrative finding of culpability has been finalized. In addition, a claimant's failure to comply with a Customs Summons or other lawful demand for records will be deemed an "aggravating" factor 2.

IV. ISSUES PRESENTED BY CUSTOMS' PROPOSAL
        The statute authorizing Customs to impose civil drawback penalties was a controversial one. It raises considerably the financial risks attendant to filing claims for duty drawback; an exporter who files an erroneous drawback claim not only risks the denial of its claim, but also a steep civil penalty. At the same time, Section 593A of the Tariff Act gives Customs an effective civil remedy to address drawback law violations 3.
        However, there are a number of issues presented by civil drawback penalties which are not addressed in Customs' proposal. Some of these may be clarified in final regulations, but others likely will require litigation. These include:

Attempt Offenses

attempt

Persons Liable for Penalties: It is unclear who, other than the drawback claimant, can be liable for Section 593A penalty claims. Arguably, the definition of persons "seeking, inducing or affecting" a drawback claim could be construed broadly to include persons assigning drawback rights to others, drawback brokers, persons issuing certificates of delivery, and even publishers and licensors of drawback software.

Personal Liability of Businesspersons: The United States Court of International Trade has recently issued several decisions holding that individual business owners or executives can be liable for 19 U.S.C. Section 1592 penalties, even where the importing entity is a corporation. It is likely that Customs will attempt to extend liability for drawback penalties to individuals, particularly where the claim is filed by a closely-held corporation.

Clerical Errors, Inadvertences: While the statute authorizes the imposition of penalties in cases of "negligence", the regulations do not make it clear that mere clerical errors and inadvertences are not grounds for imposition of such a penalty. Given Customs' "hard line" position on drawback issues in recent years, there is certainly reason for drawback claimants to be concerned that the agency will be tempted to seek penalties each time a drawback claim is denied, or each time a drawback audit results in a recommendation that drawbacks be recovered.

V. CUSTOMS' REQUEST FOR COMMENTS
Customs is seeking comments from the public concerning the draft drawback penalty regulations in the next 30 days. The agency will consider comments publish a formal proposal in the Federal Register later this year.
We stand ready to furnish any additional information or assistance which may be needed in addressing these interesting proposed regulations. ____________________________
1In contrast to civil Customs penalties under 19 U.S.C. Section 1592, there are no "nonrevenue violations" of the drawback penalty statute.
2We note that failure to comply with a Customs demand for information could by itself result in a claim for a recordkeeping penalty, under CustomsÕ proposed regulations.
3Lacking authority to impose civil penalties for false drawback claims, Customs has often been forced to resort to criminal prosecutions under 18 U.S.C. Section 550, which makes it a felony to file false claims for duty drawback. Customs has also pursued prosecutions under civil and criminal provisions of the False Claims Act. However, the legislative history to Section 622 of the Customs Informed Compliance and Modernization Act indicates that Section 593A civil penalties are to be CustomsÕ "exclusive" civil remedy for false drawback claims.

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