Court Interprets Trade Agreements Clause Applicable to Federal Procurements Above $180,000

The US Court of Federal Claims recently interpreted the Trade Agreements Clause applicable to federal government procurements of more than $180,000 as permitting the purchase of domestic end products, even if they are deemed to be products of India or China under the Trade Agreements Act. The decision invalidates interpretations by the US Department of Veterans Affairs and Department of Defense with respect to the purchase of pharmaceuticals. While the decision interprets the interplay between the Buy American Act and the Trade Agreements Act in all contracts subject to the latter, it leaves several important issues unresolved.

The US Court of Federal Claims (CFC) recently issued a decision in Acetris Health, LLC v. United States, No. 1:18-cv-00433 (July 10, 2018),[1] invalidating US Department of Veterans Affairs (VA) and Department of Defense (DOD) interpretations of the Trade Agreements Clause (TA Clause), 48 C.F.R. § 52.225-5, which had resulted in the agencies previously prohibiting US government purchases of pharmaceuticals classified as domestic end products under the Buy American Act (BAA)[2] if they were determined to be products of India or China (or other nonfavored countries) under the Trade Agreements Act (TAA),[3] which generally prohibits US purchases of such foreign products.

In so doing, the court found that domestic end products under the BAA are subsumed in the categories of products that can be purchased under the TA Clause, and that products “manufactured in the United States” can be purchased under the clause without regard to the source of the underlying components and ingredients, even if not substantially transformed in the United States or a favored foreign country. Under the TAA, “substantial transformation” is the test for determining country of origin of a product and its eligibility for a waiver of the BAA preference for domestic products. As a consequence, the decision removes the anomaly of preferring domestic products over ineligible foreign products when other trade agreement clauses are used and prohibiting acquisition of the same products in contracts over the TA Clause threshold.

The decision is important to all suppliers of product to the government because it interprets the interplay of the BAA and TAA in all contracts subject to the TAA—currently those greater than $180,000—and confirms that the TAA “substantial transformation” test only controls if the product is not “manufactured in the United States,” which is a separate and sufficient disjunctive test under the clause.

The decision is also especially important to generic pharmaceutical manufacturers and others who source active pharmaceutical ingredients (API) from India and China but manufacture FDA-approved prescription drugs from these ingredients in the United States. Because US Customs and Border Protection (CBP) regularly has determined that drugs manufactured from Indian or Chinese API are not “substantially transformed” in the manufacturing process and therefore remain “products of India” or “products of China,” the VA and DOD have been prohibiting purchases of these products under their interpretation of the clause. Companies have been subject to US Department of Justice investigations focused on the alleged falsity of company certifications pertaining to products that are manufactured in the United States regardless of whether CBP has, or might someday, determine that they are products of India or China under the TAA.

Background on the Trade Agreements Clause and Related Certification

Under longstanding procurement regulations, US government acquisitions of products other than domestic end products are subject to discriminatory preferences or prohibitions, depending on the dollar value of the purchase and the interplay of two separate statutes: the BAA and the TAA. Under the BAA, as implemented by the Federal Acquisition Regulation (FAR), a “domestic end product” is defined as “[a]n end product manufactured in the United States, if–(i) [t]he cost of its components mined, produced, or manufactured in the United States exceeds 50 percent of the cost of all its components . . . or (ii) [t]he end product is a [commercially available off-the-shelf (COTS)] item.” FAR 25.003. The TAA authorizes the Office of the US Trade Representative to waive the BAA’s preference for domestic end products for products of trade agreement countries so that eligible foreign products may be treated as equal to domestic end products. In order to incentivize countries to sign trade agreements with the United States, the TAA also prohibits US government purchases of products of a foreign country for which the TAA does not waive the BAA preferences, unless a qualifying product is not available. These two statutes, which impose requirements on US procuring agencies, are implemented in Part 25 of the FAR, and, as the FAR provisions relate to contractors, a series of contract clauses set forth in Part 52 of the FAR.

For contracts above the World Trade Organization Government Procurement Agreement (WTO GPA) threshold (currently $180,000), the preference for domestic end products is waived for products of trade agreement countries collectively referred to as “designated country end products.” These contracts include the TA Clause and related certifications. Under the current version of the TA Clause, a product may be purchased by the US government, without a nonavailability determination, if it is (a) a “[US]-made end product,” or (b) a “designated country end product.” When the TA Clause applies, contracts for commercial items contain FAR clause 52.212-3, Offeror Representations and Certifications – Commercial Items, which requires certification that the offered products fall into either one or the other category.

“US-made end product” is a term unique to the FAR and is defined as a product (a) manufactured in the United States or (b) “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. By contrast, a designated country end product must be either “wholly” manufactured (including all components) or substantially transformed in a designated country. Thus, only the alternative criteria (substantially transformed) in each definition is common to both terms, and a product is a US-made product if it is manufactured in the United States, regardless of components, whether or not it is also deemed a product of the United States under the TAA substantial transformation test. Acetris Health LLC v. United States, No. 18-433C, Opinion and Order (Fed. Cl. July 10, 2018).[4] In addition, an ineligible foreign product may be purchased, even if it does not meet either test, if the government makes a nonavailability determination because an eligible product is wholly unavailable or not available in sufficient quantities to meet the government’s need.

For 20 years after the enactment of the TAA in 1979, the TA Clause expressly used the BAA term “domestic end product” to describe products “manufactured in the [United States]” that are eligible for award in addition to designated country end products.[5] Domestic end products, which may be manufactured from foreign sourced materials or components as long as their cost is under 50% of the total, except for COTS items for which the foreign content limit is waived, are a subset of US-made end products. The “manufactured in the United States” criterion in the current TA Clause is derived from the BAA and is defined in the contract clause requiring certification as the place where an end product is assembled out of components or otherwise made or processed from raw materials into the finished product that is to be provided to the government.[6] See FAR 52.212-3. The substantial transformation test is derived from the TAA. 19 U.S.C. § 2518; 19 C.F.R. § 177.22.[7] This longstanding view by industry is based on laws and regulations that govern the commercial sale of drugs and API. Pharmaceutical chemicals are not interchangeable with the drug products formulated from them; they cannot be sold for consumption as drugs and their commercial markets are limited to producers of drug products, compounding pharmacies, and researchers.

The Litigation

The Acetris CFC litigation took the form of a bid protest challenging the VA’s pre-proposal, pre-award decision that the company’s product, which was manufactured in the United States from Indian API and inactive ingredients sourced from both within and without the United States, was not TA Clause compliant so that no offer from Acetris would be considered unless the product were otherwise unavailable. The bid protest also challenged the terms of the solicitation, which included provisions, not required by the FAR, stating that no offer would receive further consideration unless certified as offering a product that was TAA compliant, meaning that it had to be substantially transformed in the United States or a designated country, as opposed to being TA Clause compliant, meaning that it could be either manufactured in the United States or substantially transformed in the United States or a designated country. Finally, the protest also alleged that, under the court’s prior decision in Veterans Contracting Group,[8] the VA acted arbitrarily and capriciously in relying on CBP’s determination regarding the substantial transformation of Acetris’s product without analyzing whether CBP also applied the domestic end product standard incorporated in the definition of US-made end product in the TA Clause.

At the heart of all three arguments was the fundamental question of whether the TA Clause required consideration of domestic end products. In this regard, the plaintiff established that, beginning with the earliest iterations of the FAR in 1983, the FAR Council expressly intended the TA Clause to implement both the BAA and the TAA, not simply the TAA, and to require equal consideration of domestic end products and designated country end products. The plaintiff noted that, in 1990, the former General Services Board of Contract Appeals (GSBCA) issued a decision in International Business Machines, GSBCA No. 10532-P, 90-2 BCA ¶ 22,824, holding that the TAA prohibited the United States from entirely excluding a third category of products beyond the domestic end products and designated (foreign) country products permitted by the then-current TA Clause—those that were not domestic end products but nonetheless were substantially transformed in the United States. In response, in 1999, the FAR Council promulgated a rewrite of the TA Clause that removed the term “domestic end product” and replaced it with a new term—“US-made end product”—not used in either the BAA or the TAA, intended to expand the categories of products that could be purchased under the clause specifically to include, in the aggregate, products manufactured in the United States and products substantially transformed in the United States and designated country end products.[9] See 63 Fed. Reg. 51,642 (then-current TA Clause prohibited contractors from supplying products substantially transformed in the United States that did not meet the domestic end product test, e.g., because they failed to meet component test). The plaintiff further explained that the government’s interpretation of the TA Clause would prevent the government from procuring the domestic end products that it has always had the ability to purchase when the TAA applies. See FAR 25.402(a)(1) (requiring that the federal government give offers of eligible products of designated countries equal consideration with domestic offers). As noted by the court in Acetris, the fact that a procurement is subject to a trade agreement does not prohibit the government from purchasing domestically sourced products.

Finally, the plaintiff argued that under the applicable rules of regulatory interpretation, the term “manufactured in the United States” could not be interpreted to mean the same thing as the terms “wholly the manufacture of” and “substantially transformed,” as all three were deliberately used by the FAR Council in the same clause and thus had to be accorded different meanings.

The Court’s Decision

Finding in favor of Acetris, the court agreed that domestic end products were included in the TA Clause definition of “US-made end product” based on both the plain language of the clause and the applicable regulatory history. Having determined that Acetris was prejudiced by the VA’s actions, the court proceeded to issue both declaratory and injunctive relief. Specifically, the court declared that “domestic end products,” as that term is defined in the FAR, are included in the term “US-made end product,” as used in the TA Clause, and that the VA’s interpretation of the TA Clause as excluding domestic end products was arbitrary, capricious, and contrary to law. Further, the court declared that the VA acted arbitrarily and capriciously in issuing a solicitation requiring manufacturers to certify that products offered products were TAA compliant as opposed to TA Clause compliant, and that the VA’s failure to analyze whether the company’s product qualified as a US-made end product under the TA Clause separate from CBP’s determination of country of origin under the TAA was arbitrary, capricious, and contrary to law. Finally, the court enjoined the VA prospectively both from interpreting the term “US-made end product” as excluding domestic end products, and from relying on CBP country-of-origin decisions rather than performing an independent analysis of whether an offered product was manufactured in the United States, i.e., a domestic end product.

Unresolved Issues

There are at least two important issues left unresolved by the Acetris CFC litigation. The first has global significance and the second has particular relevance to pharmaceutical manufacturers.

Definition of “Manufactured in the United States.” Early decisions addressing the BAA frequently commented on the absence of a settled definition of “manufactured in the United States” in relation to that statute, which was enacted more than 80 years ago. Since the court in Acetris held that domestic end products are subsumed in the definition of “US-made end products” manufactured in the United States or substantially transformed in the United States, and the predecessors to the current TA Clause specified that under the clause, the government could purchase domestic end products, it is clear that, as argued by the plaintiff in the Acetris case, the “manufactured in the United States” criterion in the “US-made” definition is derived from the BAA, squarely implicating the BAA’s definition of “manufactured in the United States.”

In 2007, Congress amended the specific section of the BAA requiring purchase of products manufactured in the United States to include the requirement that agencies report to Congress on the amount of supplies purchased from entities that manufacture articles, materials, or supplies outside the United States. To implement this requirement, the FAR Council promulgated a new FAR clause (FAR 52.225-18, Place of Manufacture) and modified FAR 52.212-3, Offeror Representations and Certifications – Commercial Items) to expressly define “place of manufacture” to mean “the place where an end product is assembled out of components, or otherwise made or processed from raw materials into the finished product that is to be provided to the Government.”

The plaintiff in Acetris urged the court specifically to declare that the term “manufactured in the United States” as used in the domestic end product definition and the TA Clause definition of US-made end product had the same meaning assigned by the FAR Council in the “place of manufacture” clause implementing the BAA (FAR 52.225-18) and definition in the commercial item representations and certifications clause (FAR 52.212-3). The court’s decision does not address this request, leaving this an open issue. Nevertheless, it seems certain that, at least with respect to pharmaceuticals, where all of the manufacturing processes necessary to transform the individual raw ingredients into an FDA-approved prescription drug that can be marketed for the treatment of a human disease or condition occur in the United States, such prescription drugs must be deemed manufactured in the United States.

Substantial Transformation of Prescription Drugs. Specifically not addressed by the plaintiff in the Acetris CFC litigation was the question of whether Acetris products, which were manufactured in the United States, also were substantially transformed in the United States. CBP consistently has determined that oral solid dosage prescription drugs manufactured using a single API are substantially transformed where the API is manufactured under the theory that the raw chemical API itself is not substantially transformed when it is processed with inactive ingredients to manufacture an FDA-approved prescription drug. This means, for example, that a prescription drug manufactured in France (a designated country) from Indian API will be deemed a product of India that cannot be purchased by the government without a determination that an eligible product is unavailable. In such determinations, CBP has repeatedly indicated that the extensive manufacturing processes necessary to produce a prescription drug do not affect the medicinal use of the API. Acetris has appealed CBP’s rulings that its products were not substantially transformed in the United States to the CIT and these cases argue to the contrary that, as set forth in CIT’s prior decisions, the substantial transformation test should include consideration of the fact that API is a “producer product” not purchased by consumers because processes are required to make a chemical unsuitable for consumption into a safe and effective medication, and the resulting prescription drug is a “consumer product” with a very different market. Further, Acetris urged that, in cases where a regulatory body prohibits substitution of a component of, or precursor to, the finished product for the finished product itself, the finished product clearly is substantially transformed. Manufacturers have long held that this is intuitively obvious, particularly where the manufacturing process is complex and expensive, and that consumers, in assessing the prescription drugs they will purchase, are primarily interested in knowing the country in which their drugs are made, and the place considered the drug establishment by the FDA, not the countries from which the underlying raw chemical ingredients are sourced. In any event, because these issues were not before the CFC and have never previously been raised at CIT, they are unresolved pending completion of the Acetris litigation at the CIT.