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Corporate Counsel Connect collection

April 2013 Edition

Compliance programs for supply chain partners

By Alan S. Gutterman of Gutterman Law & Business

Alan S. GuttermanAn issue that is coming up more frequently for companies in the context of their vendor relationships is whether or not they, as the purchaser, should insist that their vendors and other parties involved in the supply chain process be subject to specified elements of the purchaser's own compliance rules and procedures. It is clear that with increased use of rapid communications technologies and sophisticated logistics tools, companies are becoming more dependent on the skills and actions of outside firms and persons who are not their employees. As such, it is understandable that companies may be concerned about whether their domestic and foreign partners are adhering to ethical principles and obeying applicable laws. However, before extending the scope of their compliance programs to their suppliers companies must carefully evaluate the legal consequences associated with that decision, including the possibility that they will be held responsible for liabilities arising from supplier legal problems.

Tipping the scale against extending compliance programs outward is the vulnerability of companies to expansion of common law principles of "respondeat superior" that could lead to liability for actions of suppliers who are deemed to have become "agents" of their customers by virtue of the duties that they undertake and the benefits derived by their customers. On the other hand, however, the US Sentencing Guidelines for Organizations have attempted to create real incentives for corporations to establish and maintain an "effective compliance and ethics program" as a way to identify and respond appropriately to misconduct and mitigate sanctions for such misconduct that might be imposed by governmental agencies. Among other things, the Sentencing Guidelines call on larger companies to encourage their smaller business partners to implement their own effective compliance and ethics programs. In addition, the voluntary Guidelines for Multinational Enterprises promulgated by the Organization for Economic Cooperation and Development includes a strong recommendation that companies actively encourage their business partners, including suppliers and contractors, to establish and adhere to principles of corporate conduct that are consistent with those Guidelines.

In addition to legal considerations, companies are becoming increasingly sensitive to how the business practices of their partners, particularly foreign vendors, may reflect on how they are perceived by regulators, customers and investors and have begun adopting and enforcing human rights policies as a matter of "good corporate citizenship." These policies typically take into account, and explicitly reference, international standards such as those included in the Universal Declaration of Human Rights and in the core labor standards set out by the International Labour Organisation. Among other things, companies generally include an affirmative statement regarding their commitment to providing a fair salary and good conditions of employment; providing a healthy, safe and secure work place for all employees and contractors; and promoting the personal development and dignity of every individual employee. In addition, companies have expressed their opposition to discrimination at work and all forms of slavery and exploitative child labor and their commitment to promoting diversity and respecting the rights of employees to join an independent trade union and freedom of association.

Human rights policies have been extended well into the supply chain of global companies, as they have publicly committed to limit their procurement activities to relationships with third-party suppliers who have demonstrated a commitment to high ethical standards and operating in a responsible and ethical manner towards their employees and their own suppliers. US companies have come under strong criticism when it is disclosed that they have used overseas suppliers that have used child and/or forced labor in their manufacturing activities on behalf of their US customers. In fact, states such as California have adopted laws that mandate more "transparency" in supply chains by requiring that companies conducting a certain minimum volume of business in their state disclose their policies and procedures with regard to auditing the personnel practices of their suppliers. In response, companies have implemented a variety of measures including product supply chain human trafficking risk assessments, which track supplier activities against a list of locations at high risk for human trafficking maintained by the US Department of State; audits of foreign suppliers to evaluate their compliance with standards established by US companies in procurement relationships with the suppliers; supplier certification requirements; sanctions against employees who violation company standards with respect to business conduct and ethics, including failure of employees to act in a manner consistent with the company's commitment to human rights; and investment in training programs for executives and all employees involved in managing and/or implementing foreign supplier relationships.

In light of how the business conduct and practices of third parties can expose companies to legal liability and/or have an adverse impact on their image and reputation it comes as no surprise that they are considering and implementing various strategies for making sure that the rules and principles in their corporate compliance programs are applicable to their business partners (i.e., suppliers and contractors performing various activities such as customer service and maintenance). One basic step that should always be taken is to include standard language in every contract with an outside party that creates a contractual duty on that party to comply with all applicable laws and regulations and spells out specific areas of concern (e.g., the Foreign Corrupt Practices Act in the case of foreign parties dealing with local government officials). Beyond that, however, companies are beginning to create their own standards for supplier activity and integrating those into how they create and manage their supplier relationships. For example, a company may promulgate a social and environmental responsibility policy for its suppliers. This policy becomes a public statement of the values and business practices that the company seeks in its supplier group and a de facto checklist for the due diligence that company personnel are expected to do before entering into a relationship with a new supplier. The requirements and expectations in such a policy can then be made a part of the formal contractual arrangement between the parties through the use of a supplier social and environmental responsibility agreement.

Companies should also include provisions in their standard forms of agreements for cross-border purchases that detail the obligations of the foreign suppliers with respect to ethical business activities and respect for the human rights of their employees, agents and sub-suppliers. In situations where a company expects to engage in a continuous flow of procurement transactions involving a specific foreign supplier it should develop a comprehensive form of standard terms and conditions for international purchases that would be integrated into each purchase order. Variations to such a form would be appropriate when the company, as the purchaser, will be providing materials and proprietary specifications to the foreign supplier to facilitate customized manufacturing of the goods.

While imposing compliance standards on partners in the supply chain seems to make a lot of sense, and may have actually become a mandate to fulfill specific legal obligations, a word of caution is in order for those companies adopting such an approach. One obvious potential problem, especially with suppliers in remote foreign countries, is making sure that adequate resources are invested in actual monitor of supplier activities and enforcement of the standards set forth in policies and supplier agreements. One of the reasons for including third parties within a compliance umbrella is the ability to represent to regulators, customers and investors that the company is indeed a good "corporate citizen" and deals only in goods and services that have been produced in accordance with the highest legal and ethical standards. If it turns out that their vendors fail to follow those standards the company runs the risk that its own reputation will be tarnished, particularly if it can argued that the company did not adequately monitor a vendor's activities. It is important therefore for companies to use their contractual audit rights and take other reasonable steps to monitor their suppliers including regular visits to supplier facilities to observe the effectiveness of the supplier's efforts to adhere to labor and environmental standards. In fact, failure to do so might even be perceived as a breach of an unexpected duty to a third party such as a customer injured by products provided by the supplier or even employees of the supplier. Potential problems of this type should be managed by including language in policies or supplier agreements that expressly deny that anything therein is intended to create duties to and rights in favor of third parties.

About the Author

Alan S. Gutterman is the founder and principal of Gutterman Law & Business, a leading provider of timely and practical legal and business information for attorneys, other professionals and executives in the form of books, online content, newsletters, programs, training and consulting services. Mr. Gutterman has three decades of experience as a partner and senior counsel with internationally recognized law firms counseling small and large business enterprises in the areas of general corporate and securities matters, venture capital, mergers and acquisitions, international law and transactions, strategic business alliances, technology transfers and intellectual property, and has also held senior management positions with several technology-based businesses including service as the chief legal officer of a leading international distributor of IT products headquartered in Silicon Valley and as the chief operating officer of an emerging broadband media company. His publications are available on the Thomson Reuters Legal Solutions website or at Westlaw at Business Counselor. Mr. Gutterman can be reached at