Protests Nos. 2720-2016-101371 and 2720-2016-101318; Defective Merchandise; 19 C.F.R. § 158.11

HQ H293883 May 29, 2018 OT:RR:CTF:VS H293883 JMV CATEGORY: Valuation Port Director U.S. Customs and Border Protection 301 E Ocean Blvd Long Beach, CA 90802 RE: Protests Nos. 2720-2016-101371 and 2720-2016-101318; Defective Merchandise; 19 C.F.R. § 158.11 Dear Port Director: This is in response to the Applications for Further Review (“AFR”) of Protest Nos. 2720-2016-101371 and 2720-2016-101318, timely filed by Grunfeld Desiderio Lebowitz Silverman & Klestadt, LLC (counsel) on November 23, 2016, on behalf of the importer, Providence Industries Inc. doing business as MyDyer ("Protestant"), concerning their request for an allowance in value for imported merchandise claimed to be defective. FACTS: The Protestant requests a full duty refund for defective merchandise entered on March 4, 2016. The AFR in question concerns two entries of a single style of women's leggings. Protestant initiated the manufacture of the leggings after receiving a purchase order from a U.S. based retailer, LulaRoe LLC ("LulaRoe"). Protestant and LulaRoe entered into a sourcing agreement whereby Protestant would manufacture merchandise at LulaRoe's request using various trademarks that LulaRoe registered with the U.S. Patent and Trademark Office. LulaRoe issued two purchase orders for 126,000 units of leggings in the subject style and various sizes (e.g., kids, tween, etc.) to Protestant on January 8, 2015. LulaRoe also provided Protestant with detailed design sketches depicting various specifications that LulaRoe expected in the leggings. The design sketches included a "measurement page" for each size of the subject leggings specifying that the leggings should be comprised of 92% polyester, 8% spandex fabric and be able to stretch at least 4.5 inches. Protestant contracted the manufacture of the leggings to a Korean trading company, Estilo Co., Ltd. ("Estilo") and included LulaRoe's design sketches with the order. Estilo had the leggings manufactured by a textile factory in Indonesia, Sein Global Indonesia ("Sein Global"). Sein Global manufactured the leggings at issue and shipped them directly to Protestant in the United States. Estilo then issued a corresponding invoice to Protestant at the agreed upon unit price. The invoice mentioned the subject style number and described the goods as “Women's printed tights - knit, 92% polyester 8% spandex.” Upon receiving the leggings, Protestant performed a quality control inspection and discovered that the leggings had been made with 100% polyester fabric rather than the requested 92% polyester and 8% spandex fabric. As a result, the leggings were only able to stretch 2.5 - 3 inches rather than the requested 4.5 inch specification. Protestant’s inspection report noted that 100% of the purchase order had a “bad stretch.” To confirm its inspection report, Protestant had fit models test the leggings and Protestant claims that the models were unable to fit into the leggings. Protestant provided Customs and Border Protection (“CBP”) with an affirmation letter from the LulaRoe Chief Merchandising Officer confirming that LulaRoe generally expects Protestant to inspect all goods prior to delivery to LulaRoe to ensure that all specifications are met. The letter further states that Protestant is expected to replace and destroy any non-conforming merchandise. The letter also mentions that the Protestant advised LulaRoe of the stretch issue via email, which was also provided to CBP. The letter concludes by stating LulaRoe considered the leggings to be unsaleable and required the Protestant to destroy them. Protestant retained a professional destruction firm, SafeShred, to pick-up and destroy the leggings. Protestant provided a copy of SafeShred's invoice to CBP along with a certificate of destruction, which specifically references LulaRoe and the shipments at issue. Protestant also provided CBP with photographs of the shredded leggings. Estilo then issued a credit to Protestant for the full invoice price. Protestant provided CBP with a copy of Estilo's credit note for each shipment along with email correspondence between the two companies discussing the defective goods. Protestant also provided CBP with its written sourcing agreement with LulaRoe, which Protestant claims prevented it from selling the leggings on a secondary market. The agreement, in relevant part, states: ...Supplier [i.e., MyDyer] shall not sell, market, distribute or use for any purpose or permit any third party to sell, market, distribute or use for any purpose any Products or promotional or packaging material relating to the Products which are damaged, seconds, defective, dated or out of style, fail to meet Customer's specifications or quality standards in the Agreement, or are otherwise rejected by Customer. Protestant claims that, given this prohibition, the leggings were commercially worthless and Protestant was left with no alternative other than to destroy the leggings. Protestant argues that because the merchandise did not meet the specifications outlined by LulaRoe, and because the agreement prohibited the Protestant from reselling the goods to any third party, Protestant had no choice but to destroy the leggings. Protestant argues that it is therefore entitled to a full refund of duties under 19 C.F.R. § 158.12. 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. Allowance under 19 C.F.R. § 158.12 CBP regulations allow for an allowance in duties for 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). 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”), 23 C.I.T. 2 (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). Here, Protestant claims that the imported merchandise was commercially worthless since LulaRoe rejected the merchandise and the Protestant was contractually barred from selling the merchandise to a third party. Protestant is therefore seeking a full duty refund. However, because Protestant is seeking a full duty refund and because Protestant claims that the imported merchandise is commercially worthless, the merchandise at issue does not meet the first requirement of being partially damaged. Thus, a duty refund cannot be granted under 19 C.F.R. 158.12. Allowance under 19 C.F.R. § 158.11 CBP regulations also provide for an allowance in duties for merchandise that is completely worthless at the time of importation in 19 C.F.R. 158.11. Section 158.11 (a) provides: When a shipment of nonperishable merchandise, or any portion thereof which shall have been segregated from the remainder of the shipment under Customs supervision at the expense of the importer, is found by the port director to be entirely without commercial value at the time of importation by reason of damage or deterioration, an allowance in duties on such merchandise on the grounds of nonimportation shall be made in the liquidation of the entry. It is the importer’s responsibility to establish by appropriate evidence that the goods at the time of importation were wholly worthless, not merely damaged. Wm. J. Jones and Co. v. United States, 38 C.C.P.A. 158, 162 (1951). In Headquarters’ Ruling Letter (“HQ”) H256777, dated June 5, 2015, CBP considered whether garments, which were discovered to have needle holes, multiple runs, puckering, holes along the seams, loose thread, and oil and grease stains qualified as defective merchandise under 19 C.F.R. 158.11. CBP found that the shipment did not qualify as defective because no evidence was presented that the material was completely worthless. CBP stated that the importer provided no evidence as to what actually happened to the merchandise after the defect was discovered, or any other evidence that it could not be resold to another party. Here, Protestant has produced evidence that the leggings at issue could not be sold to a third party, and that the goods were actually destroyed. Protestant provided email correspondence and an affirmation letter from LulaRoe’s Chief Merchandising Officer as evidence that LulaRoe does not accept goods that do not perfectly comply with the specifications in LulaRoe’s purchase orders. Additionally, Protestant submitted the contract between Protestant and LulaRoe stating that Protestant could not resell damaged goods or goods otherwise rejected by LulaRoe, which demonstrates that the goods could not be sold to another party. Protestant also produced evidence that the leggings were destroyed by a professional destruction firm, which shredded the leggings. Protestant provided CBP with the invoices for the shredding services, pictures of the shredded leggings, and a certificate of destruction, which specifically mentions LulaRoe and the shipments at issue. Since Protestant had no option but to destroy the imported leggings, we find that the leggings at issue were entirely without commercial value and the Protestant is entitled to a full duty refund under 19 C.F.R. § 158.11. HOLDING: Because Protestant has sufficiently demonstrated that the imported merchandise was completely without any commercial value, Protestant is entitled to a full refund of duties under 19 C.F.R. § 158.11 for the entries associated with Protest Nos. 2720-2016-101371 and 2720-2016-101318. The protest should be granted. In accordance with Sections IV and VI of the CBP Protest/Petition Processing Handbook (HB 3500-08A, December 2007, pp. 24 and 26), you are to mail this decision, together with the CBP Form 19, to the protestant, through its counsel, 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 Trade, Regulations and Rulings will make the decision available to CBP personnel, and to the public on the Customs Rulings Online Search System (“CROSS”) at https://rulings.cbp.gov/, which can be found on the CBP website at http://www.cbp.gov and other methods of public distribution. Sincerely, Myles B. Harmon, Director Commercial and Trade Facilitation Division