Bank Represented by Otterbourg Held Not Liable for Customs Duties for In-Transit Inventory

October 16, 2015

When a secured lender is making loans relying on in-transit inventory, there are a number of special issues and risks.  One of those risks is that while the goods may have reached the U.S., they may still be held in a bonded warehouse pending payment of custom duties.  Of course, the government requires a bond to cover these custom duties.  But what happens when the issuer of the bond pays the duties so that the goods may be released, but then the secured lender who made loans based on those goods, forecloses on them and uses the proceeds to repay its loans?

In Lexon Insurance Co. v. Wells Fargo Bank, N.A., 2014 U.S. Dist. LEXIS 132384 (S.D.N.Y. Aug. 20, 2014), aff’d, 619 Fed. Appx. 27 (2d Cir. Oct. 16, 2015), Lexon issued a customs bond for the account of Accessory Network Group.  Accessory was in the business of importing goods from Asia and selling them in the United States.  Wells Fargo was the secured lender to Accessory, with a perfected security interest in all of its assets, including the inventory that was being imported. 

Accessory was not doing too well and ultimately, entered into a peaceful possession agreement with Wells Fargo, pursuant to which Wells Fargo as the secured creditor took “possession” of all of Accessory’s inventory, including inventory in the United States, inventory in transit to the United States and inventory abroad.  Wells Fargo conducted a UCC sale of the inventory and applied the proceeds to repay the borrower’s obligations.

Meanwhile, the U.S. government had drawn on the customs bond issued by Lexon and Lexon had paid the customs duties for imported goods which were then released from customs and were part of the inventory sold by Wells Fargo in the foreclosure sale.  Because a portion of the debt owing by Accessory to Wells Fargo was paid with proceeds from the sale of goods released through customs based on Lexon’s bond, and Lexon in fact paid the customs duties when its bond was called, Lexon sought restitution from Wells Fargo on various legal theories, including equitable subrogation and unjust enrichment. 

For equitable subrogation, Lexon made two arguments.

First, Lexon argued that by honoring its bond, Lexon was entitled to be subrogated to the government’s customs lien because a surety that pays a claim under a bond is subrogated to the claims of the entity it pays on a bond.  Since that lien could have prevented Wells Fargo from taking peaceful possession and conducting the secured party sale, Lexon claimed that its subrogated lien had priority over Wells Fargo’s prior perfected security interest in the goods.  The Court dismissed this claim because under 19 C.F.R. § 141.1(d), the government’s customs lien may only be enforced while the goods were in the government’s custody.  Once the goods were released from customs, there was no lien.

Second, Lexon argued that Wells Fargo was the “de facto” importer of the goods, and since 19 C.F.R. § 141.1(b)(1) provides that the importer is liable for customs duties, Lexon was entitled to enforce the government’s remedies against Wells Fargo.  The secured party bill of sale showed that Wells Fargo sold the borrower’s right, title and interest in the goods.  The Court rejected this theory as well, holding that the contracts established that Wells Fargo did nothing other than provide the borrower with financing secured by the borrower’s goods, and that at all times the borrower, not the lender, owned the goods, Wells Fargo was not the de facto importer of the goods.  Since Wells Fargo was not the importer, the government had no claim against it, so Lexon’s alternative subrogation theory also failed.

Lexon also sued Wells Fargo for unjust enrichment.  Lexon claimed that it was not fair that Wells Fargo got to retain the proceeds, when there would not have been any proceeds had the goods been held in customs.  The Court rejected this argument on several grounds.  First, there was nothing inequitable or unfair about what happened.  The parties got the benefits of their respective bargains with the borrower, and there was no allegation of Wells Fargo engaging in an inequitable scheme with the borrower.  Second, in order to establish an unjust enrichment claim, there had to be a close relationship between the parties to the dispute.  While Lexon pleaded that Wells Fargo knew or should have known that its bond would be used to release the goods, the Court held that an unjust enrichment claim cannot be predicated on mere knowledge, and that the connection between Wells Fargo and Lexon was too attenuated to support an unjust enrichment claim.

The District Court granted Wells Fargo’s motion for judgment on the pleadings, and denied Lexon’s motion for leave to file an amended complaint on the ground that the amendment was futile.  The Second Circuit unanimously affirmed, finding no error.

The District Court observed in its opinion (and the judges of the Second Circuit observed at the argument) that Lexon’s remedy was against its customer, and that had Lexon wanted additional security or protections in the event the borrower did not pay the duties, it should have arranged for such protection at the time it issued the bond.  Here, there was no collateral or agreement to protect Lexon.  Sureties can try to protect themselves by getting a letter of credit from the secured lender (where the exposure can be factored into the borrowing base and a fee charged) or through other means such as a guarantee. 

In good news for secured lenders relying on in-transit inventory, based on this decision, a prior perfected security interest of a secured lender in imported goods should prevail over the claims of the issuer of a customs bond when the goods are sold and the proceeds used to pay off the secured lender’s debt.

Links to the decisions are here: _______