On Monday, the U.S. Court of Appeals for the Federal Circuit issued an opinion in Acetris Health, LLC v. United States, No. 2018-2399 (Fed. Cir. Feb. 10, 2020) (“Acetris”), that would permit pharmaceutical manufacturers to source a drug’s active pharmaceutical ingredient (“API”) from India, China and other non “designated countries” and yet still offer the end product for sale to the U.S. Government.  Under the Trade Agreements Act (“TAA”), if a drug’s API was sourced from outside of the United States or a designated country, at least some Government agencies previously had taken the position that the U.S. Government could not purchase it.  In Acetris, the Federal Circuit explained that the TAA inquiry should turn not on where the API (or some other component) is sourced, but instead on where the pill (or other end product) is manufactured.  Consistent with this approach, the court held that a pill manufactured in the United States was compliant with the TAA and implementing regulations even though the pill’s API was sourced from India.

Although the full implications of the Acetris decision are not yet clear, there is no doubt that the ruling alters the TAA compliance landscape and offers broader lessons outside of the pharmaceutical manufacturing context.  Consequently, the decision warrants close attention by contractors seeking to maximize supply chain efficiency.

Case Background & Ruling

The Federal Circuit’s ruling is the latest development in a long-running dispute between Acetris and the U.S. Department of Veterans Affairs (“VA”) over the scope and effect of the TAA’s domestic preference requirements.  The facts are not in dispute: Acetris sources API from India and then manufactures that ingredient and other excipients into final pill form at a plant in New Jersey.  The U.S. Customs and Border Protection (“CBP”) previously determined that the India-based API made Acetris’ pill a product of India, and the VA relied on this determination to conclude that Acetris’ product was not TAA-compliant and therefore not eligible for award under a VA solicitation.  Acetris challenged the VA’s position in a bid protest, and the Court of Federal Claims ruled that Acetris’ product did comply with the FAR’s Trade Agreements Clause (“TA Clause”) despite utilizing Indian API, a decision that the VA promptly appealed to the Federal Circuit.[1]

On appeal, the key question before the Federal Circuit was whether Acetris’ pill should be considered a product of India under the TAA.[2]  The Federal Circuit considered this question under both the statutory text of the TAA itself and the implementing TA Clause, FAR 52.225-5.  Ultimately, the Federal Circuit agreed with the Court of Federal Claims that Acetris’ products were eligible for purchase by federal agencies and that “the VA’s interpretation of the TAA and the FAR was erroneous.”

With respect to the TAA statutory analysis, the Federal Circuit first noted that there was no binding Supreme Court or Circuit authority to support CBP’s conclusion that the country-of-origin for a pharmaceutical product must be determined by the source of the product’s API.  The court also emphasized that the appropriate unit of analysis for the TAA inquiry was “the final product that is procured—here, the pill itself—rather than the ingredients of the pill.”  With this framing, the court concluded that Acetris’ end product was not a product of India under the TAA because it was neither “‘wholly the . . . manufacture’ of India” nor “‘substantially transformed’ into tablets in India.”

The court likewise held that the FAR’s TA Clause did not preclude federal agencies from purchasing Acetris’ product because the product qualified as a “U.S.-made end product,” defined to mean a product “manufactured” or “substantially transformed” in the United States.  Focusing on the first prong of this definition, the court stated that the source of ingredients was “irrelevant” to determining where a product was manufactured and that manufacturing occurs when “a new article is produced.”  The court then noted that Acetris’ products, which are measured, weighed, mixed, and compounded in New Jersey, “clearly satisfied” this definition and therefore qualified as U.S.-made end products eligible for purchase by federal agencies.  Because the Acetris’ products met the “manufacturing” prong of the TA Clause, the Federal Circuit declined to opine on whether Acetris’ products were “substantially transformed” in the United States.

The court concluded by explicitly stating that “a pharmaceutical product using API made in India does not, because of that fact, thereby become the product of India” and “‘U.S.-made end product’ may include products manufactured in the United States using API made in another country.”

Implications of Acetris Ruling

The Federal Circuit’s ruling is significant in that it clarifies how key principles under both the TAA and the TA Clause should be interpreted and applied.  However, the ruling also leaves open a number of important questions, including the following:

  • CBP’s role in country-of-origin determinations: CBP is vested with authority to issue country-of-origin determinations under the TAA, and agencies and industry alike historically have looked to CBP to opine on complex country-of-origin questions.  However, the Acetris case casts doubt on the practical value of CBP opinions.  The Federal Circuit pointedly noted that “CBP ha[s] no colorable authority to opine on the FAR,” which applies a different test from the TAA statute and “is a matter solely of procurement law.”  Instead, the court determined that the procuring agency, not the CBP, is ultimately responsible for determining whether an offered product is eligible for purchase under the FAR’s TA Clause, a pronouncement that raises questions about the value and effect of CBP opinions in at least some circumstances.
  • Meaning of “manufacturing”: The Acetris court had no trouble concluding that Acetris’ product was manufactured in the United States given the extent of the processing at Acetris’ New Jersey facility. However, questions about whether a product has been “manufactured” in the United States often are far less clear.  Here, the court relied on a 1908 Supreme Court case holding that “manufacturing” refers to “when ‘a new article is produced of which the imported material constitutes an ingredient or part.’”  Whether a lesser degree of activity, such as assembly, might be sufficient to constitute “manufacturing” remains an issue to be addressed on a case-by-case basis.
  • Potential conflict with TAA’s nondiscriminatory purpose: As the Acetris court itself pointed out, the TAA was designed to ensure that U.S. and designated country end products are considered for government procurement on equal footing. However, by strictly applying the FAR’s TA Clause, the opinion has the potential to create a different standard for U.S.-made end products and designated country end products.  This is because the TA Clause requires only that a product be “manufactured” in the United States, whereas a product must be “wholly manufactured” in a designated country to comply with the TA Clause.  See FAR 52.225-5.  While this distinction is supported by the text of the FAR, it arguably is at odds with the TAA’s foundational purpose of ensuring that end products of the United States and designated countries compete on an even playing field, a policy concern that the Acetris court did not address.
  • Substantial Transformation: Although the Federal Circuit did not expressly opine on whether Acetris’ product was substantially transformed in the United States, it did determine that the product was not substantially transformed in India, causing confusion about the meaning of substantial transformation. This is notable for two reasons.  First, if Acetris’ product is not substantially transformed in India, then it only stands to reason that it is substantially transformed in the United States, despite the court’s stated decision not to address that question.  Second, the court explained that Acetris’ product was not substantially transformed in India because the TAA analysis should focus on “the final product that is procured—here, the pill itself—rather than the ingredients,” and “the tablets’ components are not ‘substantially transformed’ into tablets in India.”  (Emphasis added.)  This statement could be read to suggest that the court’s substantial transformation analysis turns more on the classification of end products and components and less on an assessment of whether a functional change in character has occurred.  The distinction between end products and components can be decidedly subjective in many cases, and we would expect to see increased attention on this distinction going forward.
  • The Future of the CIT Case: The companion Acetris litigation currently pending in the CIT but stayed pending the Federal Circuit’s decision focuses exclusively on whether Acetris’ products are “substantially transformed” in the United States, a question not directly addressed by the Federal Circuit. The “substantial transformation” standard has long bedeviled the government and industry alike, and the CIT ruling was widely viewed as a welcome opportunity for clarification of this test.  In light of the Federal Circuit’s ruling, however, Acetris arguably has received the relief it seeks in the CIT from the Federal Circuit, raising the possibility that the CIT might determine Acetris’ claim before it is now moot.  Should the CIT decline to hear the pending case on its merits, uncertainty and confusion around the substantial transformation standard is likely to persist, perhaps leaving some companies unsure of the origin of their products sold to the Government.

Although this is the latest chapter of the Acetris litigation, it is not necessarily the last.  As noted, the companion Acetris litigation before the Court of International Trade was stayed pending the Federal Circuit’s opinion, and the CIT now has the prerogative to further clarify—or perhaps complicate—the interpretation and application of the TAA’s “substantial transformation” standard.  We anticipate ongoing developments in this area and will continue to monitor these events closely.  We suggest that those in the contracting community do the same.

 

[1] Separately, Acetris also filed a companion litigation in the Court of International Trade challenging CBP’s underlying country-of-origin determination and seeking a ruling that the API was substantially transformed by U.S.-based manufacturing activity.  That suit was stayed pending the Federal Circuit’s ruling.

[2] The opinion also addressed threshold questions of justiciability, including whether the case was moot because Acetris did not have the lowest bid in the underlying VA procurement.  The court determined that while the case was moot as to the specific underlying procurement, Acetris nonetheless had standing to proceed because “future procurements are virtually certain to occur, and . . . Acetris is ‘very likely’ to bid on those procurements.”  Finding that it was appropriate to proceed, the court addressed the country of origin issue.