Extending Compliance Programs to Suppliers II

I’ve been discussing the need for companies to extend their compliance program obligations to their suppliers. 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.

Company policies regarding social and environmental responsibility are often derived from industry-wide efforts to develop, and build a consensus for, standards for socially responsible business practices that would apply to all participants in a supply chain regardless of their size or where they are located.  An example of such an approach is the Electronic Industry Code of Conduct released in October 2004 following collaboration by some of the major manufacturers in the electronics industry.  This Code of Conduct becomes the basis for company-specific policies that include standards for labor, health and safety, environmental matters, and business ethics.  In addition, companies electing to comply with the Code of Conduct would be expected to establish and maintain an acceptable system of internal controls and procedures to ensure that they carry out their business activities in a manner that meets or exceeds the specific standards in each area.

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.

The content in this post has been adapted from material that will appear in Business Transactions Solutions (Fall 2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

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