Trade Agreements Act Enforcement Loses a Couple More Teeth

Merle M. DeLancey Jr.

Two recent judicial decisions involving the Trade Agreements Act (“TAA”) build on a trend reflecting a more favorable enforcement climate for contractors grappling with domestic preference regimes. Earlier this year, the U.S. District Court for the District of Columbia dismissed a qui tam action that alleged fraud in connection with country of origin requirements imposed by the TAA. United States ex rel. Folliard v. Comstor Corp., 308 F.Supp.3d 56 (D.D.C. 2018) (finding the relator failed to adequately plead that the alleged TAA noncompliance was “material” to the Government’s payment decision). The decision marked a welcome early defeat of a False Claims Act case based on the enhanced materiality and scienter requirements of the Escobar decision (as we wrote about here).

Two recent federal court decisions appear to extend the trend of taking some of the bite out of TAA enforcement, and potential exposure for alleged noncompliance. Despite this welcome news, domestic preference programs remain a key legal obligation for government contractors (and an area likely to remain under scrutiny with the Administration’s professed focus on Buy American and Hire American initiatives).

The Clause vs. the Act

On July 16, 2018, the U.S. Court of Federal Claims (“COFC”) held that, under the Federal Acquisition Regulation’s (“FAR”) Trade Agreements Clause, 48 CFR § 52.225-5, the Government is authorized to purchase products manufactured in the United States regardless of the product’s country of origin under the Trade Agreements Act. Acetris Health, LLC v. United States, No. 18-433C, 2018 WL 3425071 (Fed.Cl. July 16, 2018).

Acetris filed a bid protest after the Department of Veterans Affairs (“VA”) refused to renew its contract to continue selling its Hepatitis B drug to the VA and Department of Defense (“DoD”). The VA based its denial on a Customs and Border Protection (“CBP”) decision that the country of origin for Acetris’ drug was India. The CFP found that the drug’s active pharmaceutical ingredient (“API”) was sourced from India and was not substantially transformed during the manufacturing process that took place in the United States. For more than 25 years, in determining the country of origin under the TAA, the CBP has held that a drug’s country of origin is based on the location where the drug’s API is manufactured. As a result, absent an agency waiver, generic drugs with APIs manufactured, for example, in India and China could not be sold to the VA or DoD.

The COFC held that because Acetris’ drug was manufactured at a facility in New Jersey, the TAA’s “substantial transformation” test did not apply—the Act’s substantial transformation test only comes into play if a product is manufactured outside of the United States. Thus, regardless that certain API for Acetris’ drug was sourced from India, the drug was manufactured in the U.S.

In reaching this decision, the COFC wrestled with the confusing terminology in the TAA and the Trade Agreements Clause—specifically, the definitions of “domestic end product” and “U.S.-made end product.” Under the TAA, the Government “may acquire only U.S.-made or designated country end products.” The COFC held that “U.S.-made end products” include “domestic end products.” Thus, an end product manufactured in the United States from materials sourced from multiple countries and which qualifies as a “domestic end product” complies with the TAA and is eligible for sale even in the absence of substantial transformation in the U.S. The same reasoning would also apply to the Buy American Act.

Further, the court said the VA was required to make its own assessment of whether a product qualified as a “U.S.-made end product.” It could not simply rely on the CBP’s country of origin determination. Nothing in the Trade Agreements Act provides that CBP, rather than the procuring agency, is responsible for determining whether an offered product qualifies as a U.S.-made end product under the Trade Agreements Clause. Finally, COFC noted that, unlike other matters, the FAR does not direct a procuring agency to refer TAA compliance issues to CBP.

Non-TAA Compliant Products Sold under Federal Supply Schedule Contracts Not False Claims

On July 25, 2018, the United States Court of Appeals for the Seventh Circuit unanimously affirmed a district court’s dismissal of a False Claims Act (“FCA”) case because the relator failed to allege sufficient details to support his fraud claim. United States ex rel. Berkowitz v. Automation Aids, Inc., No. 17-2562, 2018 WL 3567836 (7th Cir. July 25, 2018). Berkowitz and his competitors held GSA Federal Supply Schedule contracts and made sales to the Government through the GSA Advantage website. Berkowitz alleged his competitors/defendants sold non-TAA products to the Government and that they impliedly certified TAA compliance when invoicing the Government—i.e., submitted false claims.

Berkowitz discovered his competitors’ alleged non-TAA compliance by comparing their sales information available on GSA Advantage with product lists obtained in the normal course of business that identified the country of origin for certain products. Based upon this comparison, Berkowitz concluded his competitors must have sold non-TAA-compliant end products to the Government.

The Seventh Circuit held the relator’s allegations did not rise to the level of fraud. Relying on the Supreme Court’s Escobar decision, the court began by discussing how and why Rule 9(b) protects defendants from conclusory and broad FCA claims based on an implied certification theory. The court found the relator’s general allegations that, based upon the sales data and product lists, the defendants sold non-TAA-compliant end products to the Government failed to satisfy the particularity requirements under Rule 9(b). Such allegations did not demonstrate what occurred “at an individualized transactional level” for each defendant. The court reasoned that the defendants’ sale of alleged noncompliant products during one time period did “not equate to the defendants making a knowingly false statement in order to receive money from the government.” Rather, at most, the relator’s allegations amounted to claims that the defendants “made mistakes or were negligent” regarding their TAA compliance.

Even though the court recognized the difficulty a non-insider relator may have alleging what occurs inside a competitor’s business, this “difficulty” does not relieve the relator of his obligation to adequately plead all of the elements of an FCA claim or to fully investigate his claim before filing a complaint.” Finally, the Seventh Circuit also noted that, because the government allegedly had paid millions of dollars for the noncompliant products, the relator could not satisfy the materiality prong of the implied certification theory.

What does all of this mean?

Notwithstanding the Administration’s desire to strengthen the preference for American products through, for example, the Buy America Act and President Trump’s Buy American Hire American Executive Order, the Federal Judiciary is interpreting the laws as written. As a result, products that traditionally could not be sold to the Government are now available. Further, courts continue to strike down FCA claims based on alleged TAA violations. One would hope this will deter the qui tam bar and the Department of Justice (“DOJ”) from pursuing speculative claims based on complex regulatory schemes.

One has to think the Administration and Congress will not take lightly what appears to be federal courts easing Buy American restrictions or allowing companies to skirt false claims act exposure. Look for regulatory changes seeking to make TAA compliance to be a “material” requirement for Government payment and to close the loophole exposed by the Acetris decision.

In the meantime, do not delete TAA and other domestic preference compliance from your compliance programs. DOJ and the qui tam bar will continue to enforce and pursue recoveries in this area. Factual scenarios may arise in the future where TAA compliance is material to the Government’s decision to pay. Be proactive with your contracting officers regarding potential sourcing issues/concerns because an open dialogue may help support a materiality defense.

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