Hartford Fire Insurance Co. v. United States: Trumped by The Freedom Of Information Act and Sovereign Immunity
Sections 12(1) and 37(1) of the Restatement (Third) of Suretyship and Guaranty set forth a pair of well-settled principles concerning the formation of a surety’s obligation and incidents of suretyship. Section 12 provides, in pertinent part, that a bond is voidable if the surety’s assent to the bond “is induced by a fraudulent or material misrepresentation by the obligee on which the [surety or] secondary obligor is justified in relying …. ” Restatement (Third) of Suretyship and Guaranty § 12(1) (1996). Section 37(1) describes impairment of suretyship as “[a]n act that increases the [surety’s or] secondary obligor’s risk of loss by increasing its potential cost of performance or decreasing its potential ability to cause the principal obligor to bear the cost of performance ….” Id. § 37(1). An impairment may discharge the surety from its obligation in an amount equal to the loss suffered by the surety. Id. § 37 cmt. f.
Both of these principles were trumped by the doctrines of preemption and sovereign immunity last month in a case in the United States International Court of Trade, Hartford Fire Insurance Company v. United States, --- F. Supp. 2d ---, 2012 WL 3291854 (Ct. Int’l Trade Aug. 13, 2012).
The case arose out of the importation of frozen cooked crawfish from the People’s Republic of China. Between July 30 and August 31, 2003, Sunline Business Solution Corporation (Sunline) imported eight entries, or shipments, of frozen cooked crawfish from China into the United States. The entries were produced in China by Hubei Qianjiang Houho Frozen (the Hubei entries). The Hubei entries were subject to an anti-dumping duty order covering freshwater crawfish meat from China and were permitted to enter the United States following the United States Bureau of Customs and Border Protection’s (Customs) approval of eight single entry customs bonds on which Hartford Fire Insurance Company (Hartford) was surety. The bonds secured the payment of the anti-dumping duties.
Customs liquidated – or made the final computation of duties on the entries – in July 2004 and March 2005 at an anti-dumping rate of 223%. Sunline failed to pay the anti-dumping duties and on June 22, 2005, Customs made a demand on Hartford for payment on the eight single entry bonds.
Hartford did not file a timely protest, pursuant to Section 514 of the Tariff Act of 1930 as amended, 19 U.S.C. § 1514, regarding the June 22, 2005 demand for payment. The protest had to be filed within 90 days of the demand. On September 20, 2005, Hartford’s period for protesting Customs’ June 22, 2005 demand expired.
On May 6, 2005, before Customs made its demand, Hartford learned from an outside source that certain Sunline personnel had been arrested, and later prosecuted, for filing false invoices with Customs. United States v. Shen, No. 03-CR-1208 (C.D.Cal. Nov 23, 2003). Rather than file a protest, on October 7, 2005, Hartford requested a copy of the court case file for Shen. Hartford received most of the court case file on October 14,2005 and the balance of the file on November 22, 2005. As a result of receiving the Shen file, Hartford learned that on June 19, 2003, Customs had been informed by a letter from Shanghai Taoen International Trading Co. of the illegal importation of crawfish meat into the United States from China (this notification occurred more than a month before Hartford started issuing surety bonds for Sunline) and that on August 27, 2003 and December 19, 2003, Customs had released to Sunline approximately $270,000 in cash deposits Sunline had posted to secure other entries of crawfish meat.
Hartford filed suit in the United States Court of International Trade on February 26, 2007 seeking to have its Sunline bonds voidable at Hartford’s option because of the information it discovered after investigating the Shen criminal case file. Hartford Fire Insurance Company v. United States, 679 F. Supp. 2d 1362, 1365 (Ct. Int’l Trade 2009). Customs moved for dismissal on the grounds that Hartford could have asserted a timely protest and that the court lacked subject matter jurisdiction. The court agreed and dismissed Hartford’s case for lack of subject matter jurisdiction. 679 F. Supp. 2d at 1368-69.
Hartford appealed and on appeal, the United States Court of Appeals for the Federal Circuit reversed and remanded to the Court of International Trade. Hartford Fire Insurance Company v. United States, 648 F.3d 1371 (Fed. Cir. 2011).
On remand the court considered the four causes of action, or counts, that Hartford alleged in its amended complaint. Customs moved to dismiss all four counts for failure to state a claim. In counts one and two, Hartford asserted that Sunline bonds were voidable under the common law theory of material misrepresentation. In counts three and four, Hartford claimed in the alternative that its obligation on the Sunline bonds should be discharged in the amount of $270,000, the value of the cash deposits that Customs returned to Sunline without Hartford’s knowledge.
The court dismissed count one on the grounds that the Freedom of Information Act, 5 U.S.C. § 552 (2006) (“FOIA”), preempted Customs’ purported common law duty to disclose that Sunline was the subject of a law enforcement investigation. The FOIA preemption precluded a material misrepresentation claim based on a duty to disclose. The court explained its decision as follows:
FOIA is a comprehensive statute governing the rules of agency disclosure; therefore as this case centers on Customs’ obligation to disclose, FOIA cannot be avoided.
FOIA establishes a three-part disclosure requirement for all federal agencies: § 552(a)(1) requires federal agencies to proactively disclose certain information through publication in the Federal Register; § 552(a)(2) requires federal agencies to make certain information available for public inspection and copying; and § 552(a)(3) requires federal agencies to disclose all records not covered under § 552(a)(1) & (2) upon request. FOIA also sets out exemptions in § 552(b) that are applicable to all disclosures made pursuant to § 552(a). Particularly relevant to this case in the § 552(b)(7) exemption for “records and information compiled for law enforcement purposes … [that] could reasonably be expected to interfere with enforcement proceedings,” and the § 552(c)(1) limitations on when an investigation qualifies for a § 552(b)(7)(A) exemption.
Because FOIA establishes a comprehensive statutory framework for disclosure of agency records, when it conflicts with existing common law rights to disclosure, such rights are preempted.
2012 WL 3291854 *5.
The court held that as a law enforcement investigation, Customs’ investigation of Sunline was within FOIA’s purview. “Therefore, any common law right Hartford may have to Custom’s law enforcement investigation under the theory of material misrepresentation is preempted by FOIA.” Id. at *6.
Hartford also argued that Customs could have met it common law obligation to avoid material misrepresentation by rejecting the bonds and requiring cash deposits from Sunline for the Hubei entries. “Hartford’s theory rests on Customs’ discretionary ability to accept a cash deposit in lieu of a bond. 19 C.F.R. § 113.40(a) (2012). ("In lieu of … [a] bond … the port director is authorized to accept United States money, United States bonds … United States certificate of indebtedness, Treasury notes or Treasury bills in an amount equal to the amount of the bond.")”. Id. at ⃰ 7. The court ruled that Hartford had failed to adequately plead a plausible claim for abuse of discretion but granted Hartford leave to amend its complaint to plead that Customs’ decisions to accept bonds from Hartford rather than cash deposits from Sunline, was an abuse of discretion. Id.
In its second cause of action, Hartford asserted fraudulent and material misrepresentation by Sunline and relied upon the Restatement (Third) of Suretyship and Guaranty § 12(2) which provides:
If the [surety’s] assent to the secondary obligation [the bond] is induced by a fraudulent or material misrepresentation by either the principal obligor or a third person upon which the secondary obligor is justified in relying, the secondary obligation is voidable by the secondary obligor unless the obligee, in good faith and without reason to know of the misrepresentations, gives value or materially relies on the secondary obligation.
Nevertheless, the court dismissed count two on the ground that Hartford did not adequately plead fraudulent or material misrepresentation by Sunline. But again Hartford was given leave to amend. Id. at *8.
The third and fourth counts were also dismissed. The third count asserted a claim for impairment of suretyship or pro tanto discharge. Hartford argued that by returning the $270,000 in cash deposits to Sunline, Customs impaired collateral that Hartford could have applied to the debt owed on the Sunline bonds. The court dismissed count three holding that Hartford’s claim was barred by sovereign immunity. Id. at *9. The court relied upon Lumbermens Mutual Casualty Co. v. United States, 654 F.3d 1305 (Fed. Cir. 2011) which held that the government had not waived sovereign immunity for implied-in-law contract claims such as impairment of suretyship.
Finally, the court dismissed count four in which Hartford asserted that its liability on the Sunline bonds should be offset by the amount of the cash deposits Customs returned to Sunline. The court held: “Hartford’s claim must fail because it can neither setoff nor subrogate funds that are no longer in the possession of Customs … Customs no longer possesses any money owed to Sunline because the cash deposits in question were returned.” Id. at *10. The court did not leave Hartford completely empty handed stating, “[A]n affirmative claim for impairment of suretyship must be dismissed as barred by sovereign immunity but may remain open to Hartford as a defense to the enforcement on the bond.” Id. at *10.
This case introduces new financial risks for sureties who write Miller Act, customs bonds or other miscellaneous bonds in favor of the United States as obligee. A surety’s claim for material misrepresentation may be preempted by the Freedom of Information Act and a claim of pro tanto discharge may only be used defensively. Because this case is still in the pleading stage, it remains to be seen whether Hartford can prevail on a claim for abuse of discretion and a defense of pro tanto discharge.
For more information regarding this alert, please contact Robert Carlton (215.764.6275; firstname.lastname@example.org).