United States International Trade Commision Rulings And Harmonized Tariff Schedule

faqs.org  Rulings By Number  Rulings By Category  Tariff Numbers

faqs.org > Rulings and Tariffs Home > Rulings By Number > 2008 HQ Rulings > HQ 560274 - HQ H015873 > HQ H014663

Previous Ruling Next Ruling
HQ H014663

---

February 13, 2008

OT:RR:CTF:VS H014663 HEF

CATEGORY: VALUATION

Port Director
U.S. Customs and Border Protection
555 Battery Street
San Francisco, California 94111

RE: Application for Further Review of Protest No. 2809-07-100418; Defective Merchandise; 19 C.F.R. § 158.12(a)

Dear Port Director:

This is in reply to an application for further review (“AFR”) of Protest No. 2809-07-100418, dated June 20, 2007, timely filed by protestant and importer of record, Keeco, LLC (“Keeco”), concerning an allowance in value for imported merchandise claimed to be defective. Business proprietary information furnished in connection with the AFR has been accorded confidential treatment. Such information is designated by brackets and has been redacted from the public version of this letter.

FACTS:

The eleven protested entries concern merchandise that Keeco imported in 2006. The merchandise primarily consists of bed linens, such as comforters, bed skirts, pillow cases and shams. Keeco states that it did not inspect the merchandise at the time of importation, as the merchandise was shipped directly to the U.S. retailer. In August 2006, the U.S. retailer notified Keeco that the merchandise did not meet the retailer’s quality requirements, citing, among other things, that the items did not possess the thread count that the retailer had ordered. According to Keeco, the retailer returned the entire product line to Keeco and refused to accept any of the products not yet received.

Keeco asserts that it ordered defect-free merchandise from the foreign manufacturer. In support of this claim, Keeco submitted with its protest nine production sheets issued by Keeco to direct the manufacturer’s production of the subject merchandise. The production sheets are primarily in Chinese, but Keeco also submitted English translations. The production sheets specify that quality should be in accordance with “Keeco Product Performance Standards, ‘product handicraft Sheet [sic],’ and the customer’s requirements.” The production sheets also provide that the processing party should arrange production and quality inspection complying with these standards and that if a dispute concerning product quality arises between Keeco and the manufacturer, a final inspection will be performed by a specified lab.

In connection with this protest, Keeco also provided copies of the following documents: Keeco’s Product Performance Standards, representative samples of the product handicraft sheets, and the U.S. retailer’s product performance standards. A representative of Keeco explained that the Keeco Product Performance Standards are internal standards that are followed when no customer specific performance standards are supplied. The product handicraft sheets define general product standards for the merchandise and provide technical product specifications for each component of a product. The specifications define the design layouts, fabrics, measurements, allowances, and techniques that should be used in the production of the product or component. According to Keeco’s representative, in instances where the customer provides its own performance standards, these standards are followed by the manufacturer instead of Keeco’s Product Performance Standards. In the instant case, the U.S. retailer provided its own performance standards. Therefore, the foreign manufacturer was required to comply with the product handicraft sheets for each product and the U.S. retailer’s performance standards.

The U.S. retailer’s performance standards specify the requirements for the merchandise and the test methods for determining whether the merchandise is compliant with these standards. The standards require that the merchandise have “no major defects, such as stains, holes, slub yarns, mis-stitches, etc.” The standards further prohibit the merchandise from having open seams, broken stitches, unraveled seams, excessive piling, needle damage, and loose threads. The standards require uniform color within a sample and between samples, and the hems on the merchandise must be straight, uniform, and consistent. The standards also set forth, among other things, requirements for fabric weight, thread count, and shrinkage performance.

The U.S. retailer ordered a lab to test the imported merchandise for quality defects. Copies of three of the resulting lab reports were submitted to Customs and Border Protection (“CBP”). The reports note defects such as poor fabric qualities with weaving irregularities, needle holes, unraveled trim, and noticeable shading differences between the components of a comforter set. Upon receipt of the returned merchandise from the U.S. retailer, Keeco sent samples of the unopened merchandise to another third party inspection service for testing. The inspection service confirmed defects in the products tested and issued a report on the defects, which includes photos. A copy of the report was submitted with Keeco’s protest. In this report, some of the defects are described as: no stuffing in the corner, poor top stitching, defective trim, fabric defects, open seams, and puckering. Keeco notes that its in house quality team tested additional stock keeping units (“SKUs”), which were also found to be defective. Keeco submitted a copy of its internal testing report, which notes material and workmanship defects and includes photographs.

Keeco eventually sold the imported merchandise in a secondary market. As a result of the alleged defects, Keeco claims that it suffered a [ ] percent loss due to the write down to the secondary market. In addition, Keeco was charged a [ ] percent freight charge by the U.S. retailer to return the defective merchandise and a [ ] percent handling charge. Keeco also claims that it incurred an additional [ ] percent in storage costs and another [ ] percent for handling the defective merchandise and preparing it for the secondary market.

In May 2007, the foreign manufacturer and Keeco executed a written compensation agreement for the allegedly defective merchandise. A copy of the agreement was submitted with Keeco’s protest. The agreement states that both parties agree that the merchandise contained manufacturing defects and that the defects resulted in a product that did not meet Keeco’s specifications. The agreement also provides that the foreign manufacturer will credit Keeco [ ], an amount that the parties agree represents the fair cost of the defects. The agreement allows the foreign manufacturer to deduct this amount from future payments that it receives from Keeco.

Keeco states that the total value of the merchandise subject to the alleged defects is [ ]. Keeco asserts that it is entitled to an allowance in the appraised value of the imported merchandise because of the defects. Keeco provides three alternative methods for calculating the allowance in the appraised value of the imported merchandise. The first is based upon the amount specified in the compensation agreement with the foreign manufacturer. Keeco calculates the allowance in duty by dividing the total compensation amount by the total value of the imported merchandise alleged to be defective. The resulting [ ] percent is apportioned over the total number of items entered that are alleged to be defective. Therefore, Keeco claims that it is entitled to an allowance in duty of [ ].

The second alternative Keeco advances is for an allowance of [ ] percent of the appraised value of the imported merchandise. This figure is based on the [ ] percent loss Keeco incurred as a result of the write down to the secondary market, the [ ] percent for freight and handling charges imposed by the U.S. retailer, and the [ ] percent for storage and handling costs Keeco incurred in preparing the merchandise for the secondary market. As a third alternative, Keeco submits that it is entitled to a duty allowance based on a modified deductive value approach. Under this theory, Keeco again claims that it is entitled to an allowance of [ ] percent of the appraised value of the imported merchandise. To calculate the claimed allowance, Keeco takes the price that it sold the merchandise for in the secondary market and subtracts from this amount its handling costs. Keeco then subtracts the resulting difference from the price at which the product was originally sold to the U.S. retailer.

ISSUE:

Whether the subject merchandise qualifies for a defective merchandise allowance pursuant to 19 C.F.R. § 158.12.

LAW AND ANALYSIS:

Merchandise imported into the United States is appraised in accordance with section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (“TAA”) (19 U.S.C. § 1401a). The primary basis of appraisement under the TAA is transaction value, which is defined as “the price actually paid or payable for the merchandise when sold for exportation to the United States,” plus certain enumerated additions to the extent they are not otherwise included in the price actually paid or payable. 19 U.S.C. § 1401a(b)(1). In order for imported merchandise to be appraised under transaction value, it must be the subject of a bona fide sale between the buyer and seller and it must be a sale for exportation to the United States.

The Statement of Administrative Action to the TAA, as adopted by Congress provides: “Where it is discovered subsequent to importation that the merchandise being appraised is defective, allowances will be made.” Statement of Administrative Action, H.R. Doc. No. 153, 96 Cong., 1st Sess., pt 2, reprinted in Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (1981), at 47.

With respect to merchandise that is partially damaged at the time of importation, the CBP regulations provide, in pertinent part:

Allowance in value. Merchandise which is subject to ad valorem or compound duties and found by the port director to be partially damaged at the time of importation shall be appraised in its condition as imported, with an allowance made in the value to the extent of the damage.

19 C.F.R. § 158.12(a).

At the time of entry, the subject merchandise was classified in subheadings of the Harmonized Tariff Schedule of the United States (“HTSUS”) that were subject to ad valorem duties. Therefore, the merchandise is eligible for an allowance in value under 19 C.F.R. § 158.12(a), provided that the other criteria of the regulation are satisfied.

In interpreting section 158.12, the courts have held that an importer qualifies for an allowance in dutiable value where (1) imported goods are determined to be partially damaged at the time of importation, and (2) the allowance sought is commensurate to the diminution in the value of the merchandise caused by the defect. See Samsung Electronics Am., Inc. v. United States (“Samsung III”), 35 F.Supp. 2d 942, 946 (Ct. Int’l Trade 1999), aff’d, 195 F.3d 1367 (Fed. Cir. 1999); see also Fabil Mfg. Co. v. United States, 237 F.3d 1335, 1337 (Fed. Cir. 2001).

CBP has granted an allowance under 19 C.F.R. § 158.12 for merchandise alleged to be defective where it can be shown that the imported merchandise under consideration was of a lesser quality than that which was ordered and paid for by the importer. See, e.g., C.S.D. 84-11, 18 Cus. Bull. 849 (1984) (HRL 543106, dated June 29, 1983) (An “importer must provideevidence to support a claim that merchandise purchased and appraised as one quality was in fact of a lesser quality, thus warranting an allowance in duties.”); and HRL 547060, dated March 8, 2000. See also, Samsung Electronics Am., Inc. v. United States (“Samsung II”), 106 F.3d 376, 378 (Fed. Cir. 1997) (“Customs has asserted thatregulation [19 C.F.R. § 158.12] applies only to defective merchandise that is lesser merchandise than that which was ordered[W]e defer to Customs’ interpretation and hold that 19 C.F.R. § 158.12 applies when the merchandise received is worth less than the merchandise that was ordered.”)

When making a claim under section 158.12, the importer must prove that it is entitled to an allowance in value by a preponderance of the evidence. See Fabil Mfg. Co., 237 F.3d at 1339.

An importer may establish that the merchandise appraised was damaged or defective at the time of importation through the submission of documentary evidence. HRL 548390, dated January 12, 2004, provides the following illustrative list of pertinent documentation: (1) purchase contracts; (2) purchase orders; (3) specifications; (4) quality control reports; (5) internal and external correspondence addressing the relevant merchandise; (6) photographs; (7) samples; (8) affidavits; and (9) any other documentation that individually or cumulatively establishes that the merchandise was ordered and the condition of the merchandise at the time of importation.

In support of its claim that it ordered defect-free merchandise from the foreign manufacturer, Keeco has provided nine production sheets that it issued to the manufacturer to direct production of the subject merchandise. The production sheets specify that the quality of the merchandise should be in accordance with “Keeco Product Performance Standards, ‘product handicraft Sheet [sic],’ and the customer’s requirements.” The production sheets also provide that the processing party should arrange production and quality inspection complying with these standards and that if a dispute concerning product quality arises between Keeco and the manufacturer, a final inspection will be performed by a specified lab. The subject merchandise was also required to meet the U.S. retailer’s performance standards, which specified certain types of defects that were unacceptable. On the basis of the evidence provided, we are satisfied that Keeco contracted for merchandise of a specified quality.

As the court set forth in Samsung III, an importer must provide objective and verifiable evidence with some semblance of specificity with respect to the alleged defect in the merchandise. See Samsung III, 35 F.Supp. 2d at 947. Merely asserting that the importer of the imported garments was not satisfied with the quality of the garments or found the garments to be of inferior quality does not constitute “objective and verifiable evidence with some semblance of specificity.” HRL 548635, dated April 7, 2005. In the instant case, Keeco sent samples of the returned, unopened merchandise to an independent third party inspection service for testing. The report issued by the independent inspection service confirms that defects existed in the products tested and describes the defects. The report also includes photos of the defects. Keeco also had its in house quality team test additional SKUs, which were also determined to be defective. In support of its protest, Keeco provided a copy of its internal testing report, which includes photos of the defects and a sample of the subject merchandise. The sample submitted to CBP is a panel of drapery, which has broken stitching, untrimmed threads, and puckering. Keeco also provided copies of three lab reports ordered by the U.S. retailer.

In addition, Keeco submitted a copy of its compensation agreement with the foreign manufacturer, which states that the parties agree that the merchandise contained manufacturing defects and that the defects resulted in a product that did not meet Keeco’s specifications. The parties also agreed that [ ] represents the fair cost of the defects and that the foreign manufacturer will credit this amount on future payments it receives from Keeco.

CBP has examined agreements by the seller to compensate the buyer for allegedly defective merchandise on numerous occasions. In HRL 545231, dated November 5, 1993, CBP determined that the evidence presented, which consisted of an exchange of detailed correspondence between the importer and the manufacturer regarding the defective merchandise and evidence that the manufacturer compensated the importer for the defect, warranted an adjustment to the appraised value of the imported merchandise. See also, HRL 547062, dated May 7, 1999. However, CBP has cautioned that the fact that a vendor agrees to credit a buyer or reduce the price of the imported merchandise does not, by itself, evidence or establish that the merchandise was defective at the time of importation. See HRL 547060, supra. In another case, HRL 548507, dated January 25, 2005, CBP noted that it is not uncommon for a seller to make an adjustment to the price of the goods in order to retain the buyer of the goods as a future customer for whatever reason the buyer may not be completely satisfied with the goods. See also, HRL 548635, supra.

In the instant case, the language of the compensation agreement indicates that both parties acknowledge that the merchandise contained manufacturing defects and that the foreign seller agreed to compensate the importer for what the parties agree represents the fair cost of the defects. Based on the language of the compensation agreement and the other evidence presented, which includes the U.S. retailer’s lab reports, Keeco’s independent inspection report, Keeco’s in house report, the drapery panel sample, and the U.S. retailer’s lab reports, we find that Keeco has established by a preponderance of the evidence that the imported merchandise was defective.

Application of section 158.12 mandates that in order to be entitled to a value allowance, the importer must establish a correlation between the allowance sought and the damage or defect in the goods. Keeco proposes three methods to calculate the value of the allowance. The first method is based on the amount credited to Keeco in the compensation agreement. The compensation amount, which the agreement states represents the fair cost of the defects, would be apportioned over the entries of the imported merchandise.

In HRL 545231, supra, CBP noted that although price rebates do not form the basis of an adjusted appraised value in situations where an adjustment due to defects is requested, they can serve as a means of determining the bona fides of a defective merchandise claim when the claimed defects or their extent are in question. On the basis of the evidence presented in HRL 547062, supra, CBP held that an allowance in value for imported merchandise that was found to be defective should be based on the price adjustment agreed to by the importer and foreign seller. Based on the evidence presented in the instant case, we similarly believe that an allowance in value for the defective merchandise should be granted on the basis of the amount to be credited to Keeco under the parties’ compensation agreement. We note that Keeco and the manufacturer have agreed that this amount represents the fair cost of the defects. In addition, the compensation amount does not appear to include other non-allowable costs such as charges associated with the storage, handling, and preparation of the merchandise for sale to the secondary market.

Keeco has proposed two alternative methods for determining the allowance in value. Keeco’s second method is based on the alleged [ ] percent loss Keeco incurred as a result of the write down to the secondary market, plus amounts for freight, handling, and storage charges associated with the rejection of the merchandise by the U.S. retailer and its preparation for a secondary market. Under this method, the total allowance in value equals [ ] percent of the appraised value of the imported merchandise. Under the third method, Keeco claims that it is entitled to an allowance of [ ] percent of the appraised value of the imported merchandise using a modified deductive value approach to determine the value of the defects. To arrive at this amount, Keeco subtracts its handling costs from the price that the merchandise was sold for in the secondary market. The resulting difference is then subtracted from the price at which the product was originally sold to the U.S. retailer.

As we noted in HRL 548390, supra, the Customs Regulations are not intended to make an importer whole for damaged or defective merchandise, but rather are designed to address an inaccuracy in the appraised value that results from the importer receiving damaged or defective goods. In HRL 548390, CBP held that the importer was not entitled to recover the cost of transporting the imported merchandise to the repair facility, the cost of transporting the repaired merchandise from the repair facility to its customers, nor the “chargebacks” or “return authorizations” that amounted to the retail value of the merchandise and were incurred because the merchandise, even after repair, was not suitable for sale. See also, HRL 547042, dated June 17, 1999 (holding that costs associated with oversight and examination of repair work, transportation of the importer’s employees to and from the repair facility, and cartage of the merchandise between the importer’s facility and the repair facility were not part of the actual repair costs and therefore could not be included in calculating the allowance in value). Similarly, in the instant case, the freight, handling, and storage charges that Keeco incurred in connection with the rejection of the merchandise, as well as the costs associated with preparation of the merchandise for the secondary market, are not measures of the extent of the defects in the merchandise.

In HRL 545534, dated May 15, 1995, the importer of defective shorts proposed that the resale price of the shorts, less all costs associated with the importation, reconditioning, distribution and resale, be the basis of the value allowance calculation. Alternatively, the importer proposed that the difference between the actual resale price of the shorts and the original resale price to the retailer, less the costs of the repairs and sales allowance, be the basis of the value allowance. The buyer also proposed that a $2 million payment it made to cover the retailer’s lost profits, loss of customer goodwill, and the cost of recalling and returning the merchandise, be included in the value allowance calculation. CBP rejected the use of the resale price under both proposals, because no evidence was presented to show that the reduced price at which the shorts were sold reflected the extent of the defects. CBP also held that no legal authority existed for including the $2 million payment in the value allowance. See also, HRL 546761, dated September 23, 1999 (rejecting the difference between the imported value and the importer’s resale prices less its U.S. expenses as the basis of the value allowance); and HRL 548390, supra, (holding that the importer was not entitled to an allowance equal to the price reduction that it negotiated with the U.S. retailer, because that price was not related to the entered value, but rather it was related to the retail value between the importer and its U.S. customer and did not accurately reflect the extent of the damage of the imported merchandise). In the instant case, Keeco has not presented any evidence correlating the U.S. resale price in the secondary market to the extent of the defects in the merchandise.

Based on the foregoing analysis and the rulings cited above, the allowance in value may not be based on the calculations proposed by Keeco under methods two and three.

HOLDING:

An allowance in the value of the imported merchandise equal to the amount agreed to by Keeco and the foreign manufacturer in the compensation agreement as the fair cost of the defects may be granted. Keeco is not entitled to recover the freight, handling, and storage charges that Keeco incurred in connection with the rejection of the merchandise, as well as the costs associated with preparation of the merchandise for the secondary market. In addition, the allowance in value may not be based on the resale price of the merchandise in the secondary market, less Keeco’s expenses.

In accordance with the Protest/Petition Processing Handbook (CIS HB, January 2002, pp. 18 and 21), you are to mail this decision, together with the CBP Form 19, to the protestant no later than 60 days from the date of this letter. Any reliquidation of the entry in accordance with the decision must be accomplished prior to mailing of the decision. Sixty days from the date of the decision the Office of Regulations and Rulings will make the decision available to CBP personnel, and to the public on the CBP Home Page on the World Wide Web at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution.

Sincerely,

Myles B. Harmon, Director
Commercial and Trade Facilitation Division

Previous Ruling Next Ruling