The fragility of supply chains is at the forefront of business thinking: heightened by disruption caused by global events and natural disasters exacerbated by climate-change. But responsible supply chain management is driven not only by an ethical imperative that warrants a place at the top of boards' agendas. There are legal and commercial risks for companies that fail to implement adequate due diligence processes.
According to the 2020 European Commission's "Study on due diligence requirements through the supply chain," the three primary incentives for businesses to take due diligence seriously are: "reputational risks; investors requiring a high standard; and consumers requiring a high standard."
From a legal and commercial perspective, these risks and pressures are reshaping the landscape for corporate governance and M&A, including private equity transactions. Buyers and investors are increasingly seeking that target companies provide detailed supply chain management and human rights impact assessments not only across a target's own business operations, but across the operations of its entire value chain, and to report on environmental impacts and modern slavery risk (regardless of whether such reporting is mandatory under applicable regulations).
In recent years, high-profile firms have been caught up in supplychain related misconduct, across all sectors, ranging from fast fashion to household appliances, mining to supermarket chains, financial institutions and retail services. These companies have suffered reputational damage and financial loss when such scandals made the headlines; and in some cases led to major shareholders dumping stocks, auditors stepping down over reputational concerns, or boards of directors buying shares to stabilise the market price.
Consumer boycotts and grassroots action also present a significant risk. By way of example, in a victory for campaigners in March 2020, Mexico terminated construction permits held by a global beverage producer, which caused the company's stock to plummet by 11 per cent. The company had been granted access to the town of Mexicali's drinking-water supply for its planned $1.5bn brewery. This would have seen the company use up to 20mn cubic metres of water a year (20 per cent of the city's annual supply), but the scheme was defeated in a referendum. In a similar manner, consumer pressure is likely to grow against UK tea brands following the BBC Panorama documentary in February 2023 "Sex for Work: the True Cost of Our Tea."
Shareholder activists are increasing efforts to address supply chainrelated risk by:
- Filing shareholder proposals. One example is the 15 proposals filed by Investor Alliance in January 2023 at three Big Tech companies. These relate to human rights risks in the tech sector and will be voted on by shareholders at the companies' annual meetings.
- Writing open letters to boards. In March 2023, Tulipshare, the activist investment platform, condemned a sports apparel giant for failing to act upon shareholders' concerns over potential human rights abuses in its supply chain.
Critically, regulatory and enforcement risk is also accelerating. According to the same 2020 Commission study, only 37 per cent of businesses conduct environmental and human rights due diligence based on voluntary international standards, and only 16 per cent cover the entire supply chain. For more than a decade, the UN Guiding Principles and the OECD Guidelines have informed the efforts of states and businesses to adopt best practices for effectively managing human rights/environmental risks in supply chains. While some governments are opting for voluntary instruments (for example, Japan's 2022 guidance on Respecting Human Rights in Responsible Supply Chains), the direction of travel points sharply towards mandatory obligations in corporate supply chains.
While global legislative initiatives vary in their scope, operation and goals, they fall within three camps:
- Disclosure requirements (for instance, the EU's Corporate Sustainability Reporting Directive, and the UK's Modern Slavery Act 2015 (a strengthened bill was announced in the Queen's Speech 2022)).
- Due diligence obligations (for example, the German Supply Chain Due Diligence Act (LkSG) and the European Commission's proposed Corporate Sustainability Due Diligence Directive (CSDDD)).
- Import bans (for instance, the US Uyghur Forced Labor Prevention Act and the Commission's proposal for a regulation prohibiting goods made with forced labour).
Legislative measures coexist on a sector-specific basis. Notable examples at the EU-level include the Conflict Minerals Regulation, the Deforestation Regulation and the Batteries Regulation. The proposed Critical Raw Materials Act seeks to promote responsible sourcing, requiring large companies to audit their supply chains and enhance strategies to prepare for supply disruptions. The UK's Critical Minerals Strategy has similar goals.
In terms of litigation risk, as these laws are new or still working their way through the legislative process, little jurisprudence is available to clarify how they will be interpreted and applied. Judgments will be instructive in the early legal actions filed. In February 2023, two cases were brought by NGOs against a financial institution before the French courts. These claims relate to alleged violations under the French Duty of Vigilance Law for failing to carry out adequate due diligence before agreeing to finance global corporations (such as beef producers or oil and gas companies) that contribute to human rights abuses and/or environmental harms. Claims have also been brought in the UK, US, EU and Canada on a range of grounds, including misleading consumer advertising and parent company duty of care.
Boards must stay tuned on pending decisions in these "world-first" cases, to evaluate the litigation risk they could face in connection with their supply chain responsibilities, alongside the growing regulatory pressures
White & Case LLP has partnered with the Financial Times on the publication of its Moral Money Forum reports, which explore key issues from the ESG debate. This article has been reproduced with permission from the Financial Times.
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