Q & A: Customs Bonds
March 19, 2024
In this Surety Today: The Blog post we will discuss Customs Bonds. The format of this post will be in a Q & A form taken from an interview with Mr. John J. Sheppard, II, V.P. with C.A. Shea & Company, Inc., the premier authority in customs bonds. In this post we will discuss what customs bonds are, how the customs process works, the potential exposure for the surety, what are some of the defenses, the issue of stacking, resolving claims with customs and limitations concerns.
Mr. Sheppard is a vice president with C.A Shea & Company and has been with the company for over 27 years. He has actively been involved in the placement, administration and filing of custom bonds since 1996. He oversees the day-to-day operations of the bond department at Shea, and is responsible for underwriting and dealing with customs on both the local and executive levels. He’s a licensed insurance producer and broker. Mr. Sheppard is part of the liaison Customs Surety Executive Committee of the National Association of Surety Bond Producers, which is an ad hoc committee of different surety associations in the surety industry that acts as an official conduit with the executive level of the US Customs Management team. This committee works on improving communications between customs and the surety industry and works hand in hand with customs in developing policy and regulations when it concerns the bond process.
C.A. Shea & Company, has been a leader in the customs trade related bond space for more than 75 years. Shea services both insurance and surety brokers and agents, as well as other trade professionals seeking US Customs, Federal Maritime Commission, and other related bonds for their clients who interact with the federal government importing and exporting.
Q: Let’s get started with an overview of the U.S. Customs process?
A: Okay. Well, primarily I think we will be talking about our importer bonds. There are maybe 15 different kinds of customs bonds, but importer bonds are by far the most common, and in my opinion, probably the most interesting. The way the import process works in the United States, which is really unique in the world, and is really the gold standard, is that you import your goods, you tell customs how much duty you think is due, you get your goods, and then 10 to maybe 30 days later, depending on your arrangement with customs, you pay to customs the duties, taxes and fees that you told them you thought was going to be due. Customs then has a somewhat undefined period of time, but usually it takes about 314 days from the day of that transaction where customs determines what the true duty taxes and fees due to customs are by going through all the rules and regulations to try to figure out did you pay them the right amount of money, did you estimate it correctly, or did you do something “wrong”? And after that process takes place, then the importer either gets a notice that they owe more money or that they get a refund or that everything was done correctly. So, that is a really, really high level overview of how that process works.
Q: One of the unique aspects of Customs bonds that I discovered in a case that I had was that they can actually stack liability. What does that mean? Walk us through that.
A: So, what that means is that when you have a continuous bond, and that is probably the most common type of customs bond that most of us will run into, what happens is say the bond is in the amount of one hundred thousand dollars. That means that the penal sum of the bond is one hundred thousand dollars for each period the continuous bond exists. The issue of course, is that if that one hundred thousand dollars bond exists for 10 years, the surety could potentially have a million dollars in liability because what happens is that the bond makes the guarantee that all the rightful duties and taxes will be paid up to the bond amount for each period where the bond exists. And, because Customs does not give you a release, you have to be very careful about that aggregation or potential aggregation of liability.
Stover: That is consistent with what we discovered in our case. The Customs bond was a million dollars, and so every year, over a period of five years, the surety had accumulated exposure of $5 million, and I do not think the surety underwriters were aware that continuous Customs bonds can stack liability.
Q: Of course you will have the principal and maybe multiple principals on a bond with the surety, is Customs required to go after the principals first, or can they just go straight to the surety?
Customs must make demand first. They have to make demand on principal, even if they know the demand is not going to go anywhere. So, in the case of a bankrupt entity or an entity that just does not exist anymore, they first make their demand there. The principal has 60 days to resolve the issue, and then, if in 60 days, it is not resolved, Customs makes demand on the surety.
Q: What are the types of claims that are typically asserted by Customs on these Customs bonds?
A: I would say the most common type of claim will be something like an increased duty bill. So, for instance, you are importing shirts and you say the shirts are 70% cotton, 30% silk, and you classify them that way. Then you pay your duty based on that classification. Well, then Customs looks at it and discovers, after taking a sample, that the reverse was true, the shirt was 30% cotton and 70% silk. As a result, you, the importer actually owe more duty now. And, so what will happen is after the review period, which is referred to in the trade as “liquidation,” after that period, Customs will send the importer a bill and say, you paid a hundred dollars in duty, but you actually owe $300, so you must pay Customs the difference.
Another common issue is a late filing of Customs paperwork. So, for instance, you import your goods and you have to pay Customs within 10 days. Well, in addition to paying Customs, you have to also deliver all of your backup documents that justify the duty rate that you established when you paid the duty. So, if you fail to deliver those documents timely, maybe instead of 10 days, you take 11 days to do it, Customs will fine you for that. That typically would be a thousand dollars fine for something like that. So that is another very common issue.
Q: What are some other sorts of uncommon or other types of exposure that the sureties face under these bonds?
A: Some uncommon exposure. Again, I mean, I guess common enough for Customs, but another exposure would be failure to “redeliver.” So, what that means is – let’s say you are a poppy seed importer. You import your poppy seeds, and now FDA needs to review that entry because they would need to make sure the poppy seeds are fit for human consumption. Well, the poppy seeds do not sit around waiting to be inspected. A sample sticks around and then the rest of the poppy seeds go out into the population after 30 days. After 30 days, if the goods do not pass inspection, the FDA could issue a demand to customs that the poppy seeds be recalled and redelivered back to Customs. Well, at this point, the importer is looking at FDA and Customs saying, well, there is nothing I can do, the seeds are on everybody’s bagels already, they are gone. So, in that circumstance, Customs issues a demand equal to three times the entered value of the goods that were failed to be redelivered, not the duty, but the actual cost of the goods. So, that can really quickly eat through capacity on your bond amount.
Q: How long is this in the process that that could happen?
A: I would say, again, you are going to see those redeliver demands within 45 days of entry, because it is like they will issue the redelivery notice within 30 days, typically. So, I mean, I’d say anywhere from 30 to 60 days, you are going to see those notices of redelivery. Now, I’m not in the claims department, so it may be more or less than that, but I mean that is typically, you are not going to see a redelivery notice three years later or anything like that. It is going to be relatively quick. So that would be something that I think underwriters may not be aware of. That is the kind of a potential loss on the bond, a redelivery issue. That exposure exists really at any time you have other government agencies involved in whatever it is that is being imported, but particularly FDA has the ability to demand that redelivery.
Q: I assume the law is clear that the surety’s exposure onto these bonds is limited to the penal sum. Is that correct?
A: Yeah, definitely. I mean, surety liability is definitely limited to the bond amount for the period where that occurred.
Q: We just talked about what the potential claims are against these bonds. What are the potential defenses that could be asserted by the sureties if they get hit with these claims?
A: Well, defense can be very difficult. I mean, because what you need to do is essentially prove that Customs was wrong. You will need to provide the justification and basis for why the importer declared the amount of duty in order to be able to dispute Customs’ assessment. Sometimes there can be very legitimate reasons. I think the easiest one is, for example, like a Snuggy. That is the classic example. See How the Case of the ‘Snuggy’ Impacts Tariffs and Trade. Is a Snuggy a piece of wearing apparel or is it a blanket? Blankets might have a duty rate of 5%, but wearing apparel may have a duty rate of 30%. Obviously if you are the importer, it is a blanket. Obviously, if you are Customs, it is wearing apparel. Both could be legitimate classifications depending on how you are looking at that. So, what happens is you really need to be able to go through and make a strong case as to why Customs has the incorrect assessment. So, that is one way, that is one defense i.e.: being able to contest. Other than that though, I mean, if it is just a matter of failure to deliver documents timely, it can be very difficult to find a defense on those types of issues.
Q: So it is my understanding that if the surety does have to get involved, that there are things like a protest process that is in place that could be utilized by the surety. There is something called reconciliation or drawbacks. Can you talk about those things?
A: Sure. So, the best sort of example for a drawback is like let us say a leather jacket manufacturer, you import all your leather and you make all your jackets in the United States, and then you sweep up all the leather scraps off the floor and you export them to India to make soccer balls. Well, you paid duty on all those scraps, but since the scraps did not get entered into the United States for consumption in the United States, you should not have had to pay duty on that. So, you can drawback or basically get a tax refund on the aggregate of those scraps. And you can either do that with no bond, where you have to basically, you put in your claim and your wait around for three or four years for Customs to cut you the check, or you can take advantage of what they call an accelerated drawback process where you post the bond equal to the amount of tax refund that you want, and you get that check within two months.
So that is what a drawback would be. An example of a reconciliation on the other hand, is like when you import goods into the United States, you need to be able to declare what the “entered value” is. But, entered value can be a made up number. It is like a legal term. It has nothing to do with what you are selling the goods for really, or what you purchased them for. It is a complicated calculation for figuring out just to satisfy Customs. And what reconciliation does is it says, hey, look, I don’t know. I cannot at the time of entry determine what the entered value truly is. So, I’m going to give you my best guess Customs, I’m going to pay you duty, and then within 21 months, I’ll tell you what the actual entered value is. So, you may ask yourself, now, why? How is it that somebody could not know what the entered value is on importing goods? Well, let’s say you are a bikini manufacturer, and so you have all your bikinis made in Thailand, or wherever they are made, and you ship them to the United States for sale. Well, you may say while all the material was sourced overseas and the labor was sourced overseas, the plans, the intellectual property for that bikini for the design is US made. So, you cannot tax US goods, the goods being the intellectual property. So, the importer needs to figure out how it can take the value of the intellectual property out of the cost of producing the goods in order to declare the correct entered value. Because that process is complicated and can be rather confusing. That is where a reconciliation takes place.
Q: So, as you are going through this in your examples that you are giving, it sounds really complicated as to each individual item, and I know I have looked at it, and the issues can relate to something like what percentage of thread is something made of, where did the thread come from, and then it could be do we have a treaty with that country? Is there an exception for that country and duties there? I mean, it is really complicated, but there is a database and a website that people can go to and other than calling C.A. Shea, of course, but there are Customs bulletins and decisions. You can request advanced ruling letters and things like that from Customs, correct?
A: Oh yeah. I mean, the problem with Customs is that there are so many layers. If you go and you look at the tariff, you look at the harmonized tariff, it’s probably 2000 pages long. It has got every possible iteration of any kind of commodity that you could think of and tons of rules and regulations. So, it is super complicated. You really need to, if you have an issue like that where you are really trying to determine what is the entry value or how much duty do I need to pay, that is something that you really do need to engage competent counsel on or have a really good Customs broker involved who can help you sort through all that, because that is all really complicated.
Q: Yeah, yeah. No, I agree. But the reason we are talking about it is because if a surety has all this dumped in its lap and it gets a big bill, that there is at least a possibility that there are ways to attack that bill and maybe get some things knocked down or taken off through these various processes.
A: 100%. I mean, your example of a trade agreement is a great example. You could say, oh, hey, this shirt, if 15% of this shirt was produced in the Caribbean basin, it is duty free by law, the law being a trade agreement with the (the countries party to that treaty in) Caribbean basin. And so that is a big deal. I mean, that takes the duty rate of that shirt from 30%, down to zero. So, if the surety, knowing that that potentially exists, needs to be able to know to go through the supply chain and be able to bring that sort of issue to the forefront.
Q: Okay. So you and I talked earlier and you mentioned that Customs is taking an interesting position with respect to limitations on claims, and in fact, you guys are involved with an amicus brief that is being filed. Why don’t you talk to us about that real quick?
A: Oh, sure. So, typically what we look at is we will say liquidation of the entry plus 90 or 180 Days, whatever the case may be, is the reasonable end for surety liability. And the way you get the liquidation is that Customs has taken their time to be able to either notice the principle that there’s some delinquency or notice the surety that there’s delinquency. And typically takes place within six years of the transaction. Now, Customs is asserting a position where they are saying that, well, no, actually it could be forever. We can take as long as we want. Because while there is regulatory language that says how long Customs has to take in order to make a demand notice on the principal, there is no regulatory language that says how long Customs has to take to make a demand against the surety. So, after X number of days or whatever it happens to be where Customs discover something went sideways, they have to tell the principal, you need to make this right. If the principal fails to answer that or determines that they are just not going to pay it, normally you would imagine that Customs would rather quickly make notice to the surety and say, you have to pay. But, what Customs is asserting is that, well no, we can take our time. We can take as long as we want between when the principal says they are not going to pay until we notice the surety that payment is due, and when we make notice that the payment is due, that is when the clock starts. So, obviously that is a problem because Customs could potentially wait forever in some of these cases before they make demand. So, as you were saying, when these cases came to our attention, we engaged with the Surety and Fidelity Association of America and a number of other trade groups to file an amicus brief on these cases. Saying to the court, hey, this thing the customs is asserting is basically crazy because a surety needs to have an end to their liability, needs to have a reasonable end to their liability, and this is completely unreasonable what they are asserting.
Q: Where are these cases pending?
A: In the Court of International Trade.
[NOTE: In the case, United States v. Am. Home Assurance Co., 653 F. Supp. 3d 1277, 1295 (Ct. Int’l Trade 2023), in August 2023, the court ruled that Customs’ claims against the surety bonds were barred by limitations. An appeal has been filed.]
Q: Another aspect about dealing with Customs is that they won’t sign a release.
A: No, customs will not issue a release. Yeah, you have to really just sort of, through best evidence kind of stuff, say, all right, I think it is very likely the surety has no more liability on this issue based on what we have here, because Customs will not sign a release.
Stover: Yeah, I think the best we could do in our case was to get them to issue a letter saying that they were no longer looking at this issue, it is rather weak as far as releases go.
Q: [Audience] What is the Master File Extract and how does that help in determining any future claims you might have on a principle from Customs?
A: Okay, that is a great question. So, the Master File Extract is a listing of all of the outstanding duty and unpaid debt that a particular importer owes. It is set up by tax ID number. So, it lists what that particular tax ID number owes to Customs. So, that is sort of like the official record of all the unpaid debt to Customs for that importer. And, so if the principal is able to provide you with the Master File Extract and there is nothing on there, then you can be reasonably sure because again, I mean Customs issues can arise later down the road, but you can be reasonably sure that as of that point, there is no more, there is no outstanding duty, there is no outstanding debt for that importer to customs.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (410-659-1321/mstover@wcslaw.com) or any member of the Surety and Fidelity Practice Group, or our guest, Mr. John J. Sheppard, II, V.P., with C.A. Shea & Company, 6 Mill Ridge Lane, Chester, NJ 07930, Direct #: (908) 975-0912, johnsheppard@cashea.com.
