Where Is It From? Domestic Preference Law in Flux After Acetris Federal Circuit Decision

The Federal Circuit struck down an element of the government's longstanding definition of what qualifies as U.S.-made for purposes of procurement law. In Acetris Health LLC v. United States, No. 18-2399 (Fed. Cir. 2020),¹ a three judge panel found the Department of Veterans Affairs' (VA) definition of U.S.-made to be "untenable" and instead found that pharmaceuticals with an active ingredient from India that are manufactured into final form in the U.S. qualify as U.S.-made for purposes of procurement law. The decision, if not successfully challenged, will have broad-ranging impacts not only in the pharmaceutical industry but for many government contractors with international supply chains. It also raises important questions about how federal agencies will implement the court's guidance.

Background

As government contractors are well aware, two different statutes incentivize federal government procurement of U.S. origin products: the Buy American Act (BAA) and the Trade Agreements Act (TAA). In short, the BAA creates a price evaluation preference in the evaluation process for "domestic end products," defined as:

an article manufactured in the U.S., for which (assuming the article is not a commercial off the shelf or COTS item) the cost of the U.S. domestic components exceeds 50% of the cost of all the components.² For commercial off the shelf or COTS items, the U.S. manufactured article does not have to meet a domestic component content requirement.

The TAA implements the U.S. obligations under the World Trade Organization (WTO) Government Procurement Agreement (GPA)³; it operates by waiving the BAA price evaluation preference in procurements above a particular price threshold⁴ for items from "designated countries," thus requiring federal government procuring agencies to treat items from designated countries the same as items from the United States. Importantly, the TAA also prohibits the procurement of products "which are products of a foreign country," meaning products of non-designated countries. Countries are "designated" if they are parties to the GPA or another Free Trade Agreement with the United States, or are otherwise designated by the President. In practical terms, most European countries, as well as a number of the United States' other significant trading partners, are "designated countries;" notable non-designated countries include China, Russia, Thailand, Malaysia, Brazil, the Philippines, and India.

The TAA uses a different definition than the BAA to determine the origin of non-U.S. products:

1. It is "wholly the growth, product, or manufacture of that country," or
2. It "has been substantially transformed [in that country] into a new and different article of commerce with a name, character, or use distinct from that of the article or articles from which it was so transformed."⁵

Notably, while a COTS article may just be "manufactured in the U.S." to qualify as a "domestic end product" under the BAA, under the TAA, that same article must be "wholly the growth, product, or manufacture" of a designated country to qualify as a "product of a [designated] country" under the TAA (or else be substantially transformed in a designated country).

The Federal Acquisition Regulation (FAR) implements the requirements of the BAA and TAA for purposes of U.S. government procurements. Importantly, the FAR's TAA clause states that contractors shall deliver "only U.S.-made or designated country end products,"⁶ defining U.S. product origin as follows:

1. an article that is mined, produced, or manufactured in the United States; or
2. that is substantially transformed in the United States into a new and different article of commerce with a name, character, or use distinct from that of the article or articles from which it was transformed.⁷

The FAR goes on to define designated country end product origin differently:

1. an article that is wholly the growth, product, or manufacture of the designated country; or
2. in the case of an article that consists in whole or in part of materials from another country, has been substantially transformed in the designated country into a new and different article of commerce with a name, character, or use distinct from that of the article or articles from which it was transformed.⁸

The contracting officer is the official decision-maker on the country of origin for a particular procurement. But these contracting officer determinations are unreported, and companies bidding on a particular procurement have no practical way to access the determinations made in previous procurements. Filling that gap, U.S. Customs and Border Protection (CBP) has generally been the source of "precedent" and guiding opinions on country of origin determinations, which are published in the Federal Register.⁹ Relevant here, CBP has generally held that, if a drug's active pharmaceutical ingredient (API) originates from a non-designated country (e.g., India or China), a company generally cannot "substantially transform" the API by combining it with other non-active pharmaceutical ingredients and packaging it into another form in another country.¹⁰ According to the CBP, to which the VA and other agencies have long deferred, except in rare cases, a drug that is processed from bulk API into finished dosage form in the U.S. with non-designated country API is merely "assembled" in the U.S., and does not qualify as "substantially transformed" in the U.S., so as to qualify as U.S.-made. Moreover, CPB interprets the phrase "manufactured in the United States" for purposes of FAR's definition of "U.S.-made end product" to "correlate[]" to the TAA language requiring the products be "wholly manufactured" in a country.¹¹ For the first time, the Federal Circuit considered this position in Acetris.

Acetris

Acetris is a generic pharmaceutical distributor that obtains many of its products from a facility located in New Jersey that uses API made in India. In connection with 13 contracts that Acetris held with the VA, the VA directed Acetris to obtain a CBP country of origin determination. CBP, in accordance with the line of cases mentioned above, held that because the API was from India, the country of origin of Acetris' products was India, because no substantial transformation occurred in the U.S.¹² CPB rejected Acetris' argument that it was unnecessary to rely on the "substantial transformation" prong because the products were "manufactured in the United States," finding that this language in the FAR "correlates" to the TAA language requiring the products be "wholly manufactured" in a country. (Opinion at 10.) CPB concluded: "Since the production of [Acetris' product] partially occurs in India, we do not find that they are manufactured in the United States." (Id.)  The VA indicated it would rely on this CBP determination to find Acetris' products not TAA compliant in future procurements.

Acetris filed a pre-award protest in the Court of Federal Claims (COFC) challenging the VA's exclusion of its products. Acetris repeated its assertion that its products are "U.S.-made end products" because they are manufactured into pills in the U.S. (using the foreign-made API), invoking the FAR's definition of "domestic end product" which does not require the item to be "wholly" manufactured in the U.S. COFC agreed with Acetris' interpretation, finding "there was no requirement that the end product be 'wholly' manufactured in the United States" in order to be TAA compliant, and that as Acetris' products were "manufactured" in New Jersey, they satisfied the solicitation's requirements.¹³

The Federal Circuit

The government appealed the COFC decision. In a three judge panel opinion authored by Judge Dyk, the Federal Circuit affirmed COFC's decision but remanded the case to clarify the remedy.

First, the Federal Circuit panel declared the "product" being procured was not the API, or the "ingredients of the pill," but rather was "the pill itself."¹⁴

Second, the panel reasoned that the TAA does not exclude Acetris' products as the product of India, a non-designated country, under either prong of its country of origin test: (1) the products are not "wholly" manufactured in India, and (2) they are not substantially transformed in India "because the tablets' components are not 'substantially transformed' into tablets in India."¹⁵ Accordingly, the TAA does not exclude Acetris' products as being the product of a non-designated country.

Third, the panel found that the FAR does not exclude Acetris' products either. The manufacturing prong of the FAR's country of origin test for U.S. operations lacks the "wholly" qualifier included for "designated countries" in the TAA clause. Thus, the panel reasoned that Acetris' products are manufactured into pills in the U.S., even if they are not "wholly" so manufactured. They accordingly qualify as a U.S. end product under the FAR. The panel concluded: "If the government is dissatisfied with how the FAR defines "U.S.-made end product," it must change the definition, not argue for an untenable construction of the existing definition."¹⁶

Because the panel found COFC's order "imprecise and confusing," the panel remanded the case to COFC, which it instructed to declare that:

1. under the TAA, a pharmaceutical product using API made in India does not, because of that fact, thereby become the "product of" India; and
2. under the FAR, the term "U.S.-made end product" may include products manufactured in the United States using API made in another country.¹⁷

Implications

Acetris represents a potential sea change in the government's application of the BAA/TAA provisions. Previously, the VA and other federal agencies deferred to CBP's country of origin determinations, which essentially meant where CBP had determined that drugs containing API from a non-designated country had a foreign country of origin, those drugs were then ineligible for federal procurements requiring a FAR TAA certification.¹⁸ A Federal Circuit decision has now confirmed that such drugs satisfy domestic preference compliance requirements so long as they are not deemed to be products of a non-designated country and are manufactured in the United States. This holding could have substantial ramifications for companies with supply chains in non-designated countries such as India and China.

This decision leaves open several related questions:

First, the decision's reasoning only directly applies when the final products are manufactured in the United States. The panel's holding rests on the FAR's definition of "U.S.-made end product," which expressly qualifies acceptability on the product being "manufactured in the U.S." What about products that are manufactured in designated countries using API from non-designated countries? Products manufactured in designated countries from non-designated country API would not seem to qualify under the decision's reasoning, since they do not meet the requirement spelled out in both the TAA and the FAR that they be "wholly manufactured" in the designated country. However, such a result would fundamentally contradict the purpose of the GPA, which is to afford equal treatment to domestic and designated country products.

Second, the circuit declined to reach the second prong of the FAR test addressing "substantial transformation," as it found that the products in question met the first prong of being "manufactured" (although not wholly so) in the United States. "Mere assembly" has not typically been considered to qualify as "substantial transformation" under the standards applied by CPB, yet some may argue that is what happened to the products in question here. (However, the panel stated in passing that the pills "may very well be substantially transformed in the United States"). If substantial transformation of a pharmaceutical product does not rest on the origin of the API, on what does it rest? What treatment will be afforded to products manufactured in non-designated countries from designated-country API? How will courts and agencies respond to arguments that non-pharmaceutical products containing foreign components are "substantially transformed" in the U.S., given this ruling?

Third, the decision shifts back to procuring agencies to determine country of origin for their procurements. While CBP still has jurisdiction to issue advisory opinions relating to the TAA, and of course still determines country of origin for Customs and import purposes, the decision rejected the notion that CBP has authority relating to the FAR definitions as applied in procurements. The Acetris decision instead made it clear that contracting officers have first authority to make country of origin decisions in pending procurements. Will agencies continue to defer to CBP (with more substantial justifications for doing so), or will the CBP lose its expert status in this arena? Under this new regime, how valid or persuasive will previous CBP rulings be?

Fourth, it is worth underlining that the saga of Acetris is not over yet. While the Federal Circuit decision was fairly clear regarding what it expects in COFC's remand decision, it's not over until it's over. The government may request a rehearing en banc or Supreme Court review, and Congress or the Administration may weigh in. How will Congressional concerns regarding Chinese supply chain issues impact this issue? What impact will this decision have on the Trump administration's announcement that the U.S. may move to withdraw from the WTO GPA?¹⁹ Companies would be wise to watch this space carefully.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.