Internal Advice Concerning Protests Nos. 4601-14-101146 and 4601-14-101147; Defective Merchandise; 19 C.F.R. § 158.11 and 19 C.F.R. § 158.12(a)

HQ H256777 June 5, 2015 OT:RR:CTF:VS H256777 RSD CATEGORY: Valuation Port Director U.S. Customs and Border Protection 1100 Raymond Boulevard Newark, New Jersey 07102 RE: Internal Advice Concerning Protests Nos. 4601-14-101146 and 4601-14-101147; Defective Merchandise; 19 C.F.R. § 158.11 and 19 C.F.R. § 158.12(a) Dear Port Director: This is in response to the Applications for Further Review (“AFR”) of Protest Nos. 4601-14-101146 and 4601-14-101147, timely filed by Grunfeld Desiderio Lebowitz Silverman & Klestadt, LLC (counsel) on July 16, 2014, on behalf of the importer M. Hidary and Company (Hidary) concerning their request for an allowance in value for imported merchandise claimed to be defective. After reviewing the AFR and the background materials, we concluded that Hidary provided insufficient grounds to grant AFR. Although Hidary states on Customs Form 19 (CF 19) that the protest denial is inconsistent with previous Customs rulings, it did not indicate which specific rulings would be inconsistent with the denial. However, as requested, we are providing internal advice to consider whether the shipments under consideration were entitled to value allowances. Hidary sent several samples of the merchandise from the second shipment for our review. FACTS: According to the information provided in the records of the two protest claims, Hidary is making two separate, but related defective merchandise claims under 19 C.F.R. § 158.11 and 19 C.F.R. § 158.12. The first claim under Protest 4601-14-101146 concerns two entries of boys’ shirts and shorts sold and shipped to the retailer, Sears Holding Corp. (Sears). During the fall/winter season of 2012, Sears placed several orders with Hidary for athletic apparel for delivery during the spring of 2013. To fulfill the order, Hidary contracted with W. Brothers, a manufacturer located in Pakistan, for the production of the merchandise. The merchandise was boys’ knit crew neck tops, featuring a self-fabric crew neck, a contrast color back neck taping printed front, side piping, set-in sleeves, a logo heat seal at the center front, hemmed sleeve opening and bottom with double needle stitching. The merchandise was made of 100 percent polyester micro interlock fabric, 10 GM/SM with wicking. Hidary submitted an invoice from W. Brothers dated February 1, 2013. This invoice shows that W. Brothers shipped 17,916 pieces of men’s tops style E84723 at a C&F unit price of $2.25 per piece plus an additional 20 cents each for hangers. On March 5, 2013, Hidary paid W. Brothers the full amount indicated on the invoice. Part of this payment was for the 17,916 pieces. The subject entry was made on March 15, 2013. Counsel indicates that the tops were properly classified in subheading 6103.43.15 of the Harmonized Tariff Schedule of the United State (“HTSUS”), and duty was paid. We note that the entry also included a line item under subheading 6110.30.30, HTSUS, and we assume that the tops actually are classified here and that counsel has made an error. Upon receipt of the shipments, Sears noticed that the merchandise contained a number of defects. Sears found that the garments had dirt, grease, oil stains, needle holes in the fabric, multiple runs, puckering, holes along the seams, and loose threads hanging around the hems. Sears notified Hidary of the defects and indicated that it felt the merchandise did not have any commercial value. As a follow up, the Sears’ quality assurance team also examined the merchandise in Sears’ stores and concluded that it was unacceptable to sell to its customers. Additionally, Sears commissioned an independent examiner to inspect the merchandise, who concluded that the merchandise failed in quality. The independent examiner report noted that the garments had open seams, holes or cuts in the fabric, pulls or runs, puckering, roping, and various stains on the merchandise. Counsel states that Sears contacted Hidary to notify them of the defects and informed Hidary that 33,578 pieces of the merchandise would be returned to the vendor due to the extensive damage to the clothing. Your office indicates that the two entries covering Protest 4601-14-101146 involved 49,692 pieces sold to Sears. Hidary sent its representative to the Sears’ facilities to conduct its own visual examination of the merchandise and determined that Sears was correct. Sears offered to return the merchandise, but because Hidary felt the merchandise had no commercial value and it did not want to incur any shipping costs, it informed Sears that it did not want the defective merchandise returned. Hidary issued Sears a credit in the amount of $160,000 for boys damaged goods for the period of March 3, 2013-June 1, 2013, allegedly encompassing the relevant merchandise on the entries at issue. The second protest, 4601-14-101147 concerns shipments of athletic tops and bottoms that were also ordered by Sears during the same time period and from the same manufacturer, W. Brothers. One of the styles was a boy’s muscle top. It featured a self-fabric crew neck, a contrast color back neck taping, and side piecing with printed front that wrapped to the back. The fabric was made of 100 percent polyester micro interlock 140 GM/SM with wicking. The trim fabric was made of 100 percent polyester micro mesh 140 GM/SM with wicking. W. Brothers shipped 23,916 tops (style number E833903) under an invoice dated March 5, 2013. Hidary paid W. Brothers in full for the merchandise shown on this W. Brother’s commercial invoice. The merchandise was entered into the United States on April 3, 2013, and was classified in subheading 6110.30.30, HTSUS, with duty paid. The record for protest 4601-14-101147 also indicates that on March 26, 2013, Hidary entered another shipment of merchandise into the U.S. which contained 1265 dozen sweaters (style number E846823) classified in subheading 6110.30.30, HTSUS and 1566 dozen pairs of boys shorts (style number E817573) classified in subheading 6103.43.15, HTSUS. As with the prior shipments, the Sears quality assurance team evaluated the merchandise in the shipments and concluded that its quality was unacceptable. The garments had holes in the fabric, puckering on the seams, stains on the clothing, as well as other extensive damage. An independent examiner reported that the merchandise failed inspection because there was dirt, oil and grease stains on the clothing, pulls or runs in the seams and needle holes and cuts in the fabric. Consequently, Sears contacted Hidary to inform them that due to extensive damage found by a visual inspection, the merchandise in selected styles would be returned to Hidary. Counsel has submitted photographs of various garments that look like they are of style number E833903 and of E817573 (shorts). The photographs show garments had various defects including poor stitching, misaligned seems, loose threads, stains, etc. Hidary agreed that Sears was correct and permitted the cancellation of the orders. After the cancellation of the Sears’ order, Hidary mitigated it losses by selling the rejected merchandise to secondhand discount stores at a fraction of the original price it had paid. Hidary determined that it received about 48.5 percent of the invoice price, when it resold the merchandise to the secondhand discount stores. In other words, the resale invoice value was only 48.5 percent of the compensation that Hidary received for the merchandise from Sears due to its defective nature. Subsequently, Hidary made a claim against W. Brothers seeking compensation for the loss from the defective merchandise. W. Brothers made a series of payments to Hidary for the same amount Hidary requested. According to Hidary’s counsel, the vendor initially had difficulty refunding all of the payments to Hidary for the defective merchandise because of its precarious financial condition. However, the vendor eventually did make refund payments to Hidary, which were indicated by a series of bank records showing that Hidary received $130,000 in payments from W. Brothers. A Post Entry Amendment dated November 25, 2013, was filed requesting a refund of $12,541.88 in duties. ISSUE: Whether the subject merchandise qualifies for a defective merchandise allowance pursuant to 19 C.F.R. § 158.11 or 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 U.S. 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. Section 158.12(a) Customs Regulations (19 C.F.R. § 158.12(a)) states in pertinent part that merchandise which is subject to ad valorem or compound duties and found by the district 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 damage. With respect to merchandise that is partially damaged at the time of importation, the CBP regulations provide, in pertinent part: 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). In Samsung III, in addition to the above-mentioned requirements, the court articulated three requirements that an importer must satisfy in order to claim an allowance under 19 CFR § 158.12. First, the importer must show that it contracted for “defect-free” merchandise. See Samsung III, 35 F. Supp. 2d at 945. Second, the importer must be able to link the defective merchandise to specific entries. Id. at 945-46. Third, the importer must prove the amount of the allowance value for entry. Id. 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 Cust. Bul. 849 (1984) (Headquarters Ruling (HQ) 543106, dated June 29, 1983) (An “importer must provide…evidence 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 HQ 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 that…regulation [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. HQ 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 the merchandise ordered and its condition at the time of importation. With respect to the shipments of wearing apparel in the first protest claim for which a full refund is requested, there is no evidence that the imported merchandise was entirely without commercial value. In Wm. J. Jones and Co. v. United States, 38 C.C.P.A. 158, 162 (1951), the court held that in order to have merchandise treated as a non-importation, "it is incumbent upon the importer to establish by appropriate evidence that the goods at the time of importation were wholly worthless, not merely damaged." Photographs of the merchandise showing the alleged defects were presented along with emails from the consignee, Sears, indicating that the merchandise had serious defects that rendered it unsuitable for sale in its stores. Counsel states that the costs involved in packing and re-shipping the merchandise would have been greater than any revenue that could have been obtained from another buyer of the defective merchandise, so it let Sears dispose of the merchandise. However, no samples of the actual merchandise were presented. In addition to the absence of physical samples, no evidence was presented as to what actually happened to the merchandise and that it could not resold to another party. In other words, the importer has not substantiated its claim that the shipping costs of the defective merchandise would be more than could be obtained from reselling it. More significantly the importer has not presented evidence that the imported merchandise was completely worthless. At a minimum, we believe that the merchandise would have at least some value as scrap materials. Based on the foregoing because of a lack of evidence, we find that the importer is not entitled to an allowance in duties on the grounds of non-importation, or an allowance of duties for damage, under 19 C.F.R. § 158.11. In regard to obtaining a partial allowance in value for the imported merchandise under 19 C.F.R. § 158.12, we note that the importer furnished samples of the imported merchandise. In inspecting this sample merchandise, we note that there are a number of serious defects in the garments, such as poor sewing and stitching, loose threads, puckering in the seams, grease on the fabric, etc. We acknowledge that the defects in the garments would clearly make the garments less than first quality merchandise, and these defects could make the garments difficult to sell at a full price retailer. We also recognize that the defects in the garments could also damage the reputation of the merchandise’s brand so that the brand name owner would be reluctant to have the defective merchandise sold under its brand name. Although the garments were seriously damaged, counsel concedes they were not completely worthless, because the damaged merchandise was resold to a discounter at about 48.5 percent of the price that Sears had paid for it. Therefore, counsel had sought an allowance equal to 48.5 percent of the value it declared to CBP when it was imported. Under the circumstances presented, we find that Hidary has established the merchandise had serious defects at the time it was imported. The nature of the defects in the garments makes it highly unlikely that the damage to the garments occurred after they were imported into the United States. In determining the amount of the allowance in the valuation that should be granted under 19 C.F.R. § 158.12 to the damaged merchandise, we note that the facts of this case are similar to the facts of HQ 547062 dated May 7, 1999. In that case, the subject merchandise was purchased from an overseas vendor and the Protestant resold the imported merchandise to J.C. Penney Company, Inc., (JCP). However, after inspecting the merchandise, JCP rejected the merchandise due to a high number of defects. Protestant then entered into negotiations with its overseas vendor seeking a price reduction. A reduction in price was agreed upon in the amount of $238,872.65. Protestant submitted a copy of its claims letter to the vendors concerning the defective goods requesting an adjustment in the amount of $238,872.65. Thereafter, vendor issued a check in that amount. In its protest, the Protestant submitted proof of payment from the vendor to the Protestant for CBP’s examination. We reviewed the documentation submitted and found that the Protestant's notice to the vendor of the defects and the vendor’s adjustment of the price, together with evidence of the defects, was sufficient to permit an allowance in the value of the imported merchandise. Thus, we held that the imported merchandise should be appraised pursuant to transaction value with an allowance granted pursuant to 19 C.F.R. § 158.12 in the amount that the vendor had granted to the Protestant as a price adjustment because of the defects in the merchandise. In this case, counsel has submitted a proof of payment document from a bank showing that W. Brothers did refund $130,000 to Hidary. The correspondence contained in the record indicates that W. Brothers reimbursed Hidary on account of the defects in the imported merchandise. In other words, the refunds that W. Brothers provided to Hidary constituted a mutually agreed upon price reduction of the imported merchandise because it was defective. Therefore, consistent with HQ 547062, we find that under 19 C.F.R. § 158.12, the shipments of defective merchandise that Hidary imported should be entitled to an allowance in their value, in the amount of the price reduction that W. Brothers gave to Hidary due to the defects in the imported merchandise. Counsel alleges that Hidary is seeking additional refunds from W. Brothers because it believes that it is entitled to further reimbursements for the defective merchandise. However, at this time any future additional refunds that Hidary may get from W. Brothers is entirely speculative. Thus, we find that the amount of the allowance for defective merchandise under 19 C.F.R. § 158.12 must be limited only to the actual amount of the refund that Hidary has received from W. Brothers due to the defects in the imported merchandise, which in this case is $130,000 for both protests. So the amount of the $130,000 should be allocated proportionately over all entries at issue. According to the information presented, the amount of the refund that W. Brothers provided to Hidary attributable to the entries involved in Protest 4601-14-101147 was $70,292.46, and thus this is the amount of the allowance granted for the defective merchandise. HOLDING: Because the importer has not met the requirements of showing that the imported merchandise under consideration was completely without any commercial value, it is not entitled to any of the provisions for refunds of duties due to destroyed, abandoned or non-imported merchandise, under 19 C.F.R. § 158.11 for the entries involved in Protest Number 4601-14-101146, and thus the protest should be denied. However, for the entries covered by Protest Number 4601-14-101147, the importer has established that the merchandise was damaged and contained numerous defects at the time it was imported into the United States. Because the merchandise imported into the United States was of a lesser quality than the merchandise which was ordered and paid for by the importer, an allowance in the value of the merchandise based on the extent of that damage in the shipments in accordance with 19 C.F.R. § 158.12(a) is to be allowed. Therefore, Protest Number 4601-14-101147 should be granted. The amount of the valuation allowance is equal to the refund that Hidary received from its overseas vendor, W. Brothers, because of the defects in the imported merchandise. Therefore, the appraisement of the imported merchandise is to be adjusted by an allowance subtracting amount of the refund attributable to the shipments in that protest from its original entered value as explained above. This decision should be mailed by your office to the party requesting Internal Advice no later than 60 days from the date of this letter. On that date, 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. Please do not hesitate to contact us at (202) 325-0132, if you have any questions or concerns. Sincerely, Monika R. Brenner, Chief Valuation and Special Programs Branch