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HCR Law Events

15 April 2021

Why are those packages ticking? – supply chain due diligence

If you source your products, raw materials or essential services from someone else and have not investigated their origin, you’re placing your company’s reputation at risk and possibly even attracting criminal liability.

If you thought a cleverly worded contract would protect you, you’re wrong: that might only take you some of the way there. In some scenarios, especially in transacting cross-border, it is not enough to rely on an indemnity clause or a representation from your supplier because those might not be enforceable. Besides, it is not necessarily the company you deal with that is the risk factor here. Often, the risk entity lies further down the supply chain – it’s the company that supplies to the supplier that supplies your supplier that might cause you trouble. This article gives a few tips on how to deal with the problem of supply chain risk.

The supply chain is the foundation of a company’s operations. The third parties that you use for your materials’ provision, product supply or business infrastructure services are an integral part of the infrastructure and success of your business. No-one tries to do everything in-house because that would be inefficient and would require a costly investment. So, what are your risks?

  1. Exposure to corruption carried out by third parties. Anti-bribery legislation matters because it can rebound on you if you should have known about it. Turning a blind eye to it does not impress the prosecutors, and in some cases, accurately accounting for minor bribe payments, while still illegal, attracts lesser liability and legal consequences than trying to build contractual or accounting barriers between you and the bribery, because in the latter case you add intentional obfuscation to your offence.
  2. Risk of insolvency. If the supplier runs out of money or can’t pay its workforce, it won’t be able to provide you with your goods or services. It’s no use comforting yourself that you pay on delivery only – the fact is that you now have no product to sell or, in some cases, business critical services to rely on.
  3. Region risk. An example of this is this year’s Xinjiang cotton scandal. Nike, Burberry and various others have been keel-hauled by public opinion, due to their alleged sourcing of cotton produced by forced labour. It has done them no good that they investigated their first-tier supplier and received assurances of ethical sourcing.
  4. Risk of IP theft. Companies that need to share their brand or tech details tend to rely on contractual provisions to manage the risk of trade mark counterfeiting or tech theft. That’s fine if you are operating on home territory and the contract is under your home governing law and jurisdiction, but less useful if those contractual provisions are breached and can’t actually be enforced outside the UK. Due diligence helps you understand your supply partner.

Of course, not all suppliers are equally risky, and your investment in due diligence ought to be proportional to the importance of the relevant supplier to your business plans, together with gauging other factors that affect the level of risk. If you do not speak the language of your supplier, and if your supplier is geographically remote, then risk is generally higher. There are also various indices that can provide useful pointers as to country risk: e.g.

– the Reporters Without Borders press freedom ranking
– Transparency International’s bribery and corruption ranking
– The Human Development Index, which covers education.

It is worth noting that the human touch can make a huge difference in your risk profile. In some countries, efforts to engage with and make friends with third party business partners reduces risk significantly.

There are various ways of performing supply chain due diligence. The cheapest is to trawl through various databases, and this can be done almost automatically.

An enhanced version of this involves professional OSINT work (open source intelligence) which may require knowledge of the relevant language and a sophisticated search for adverse information. It may also be necessary to review litigation and insolvency records, as well as adverse media and industry-specific regulatory records.

The next stage beyond this is to use people on the ground to make inquiries into the third party.

HCR has helped UK and US clients with supply chain risk reduction for dozens of jurisdictions, from Egypt to Ecuador, from China to Czechia. One thing we have learnt, with decades of experience, is that the business carries on once we’ve done whatever investigations need doing.

And that is the real challenge, because once the lawyers disappear, a company needs to maintain and manage its relationship with those very third parties, sometimes for many years. It is the ability to effectively and proportionately engage, supervise and manage the relationship during day to day life that will ultimately minimise supply chain risk.

If you need help understanding and minimising supply chain risk, we can help. Contact Nicolas Groffman or Rajeshree Bhojnani

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About the Author
Nicolas Groffman, Partner, Head of International Team

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