Increasingly, global suppliers are expected by downstream customers to comply with legal and ethical standards designed to ensure that their supply chains protect human rights, labor conditions, environmental sustainability, and other critical factors. How should suppliers respond to such demands? It is useful to consider the issue from four perspectives:

1. Legal obligations. Many of the standards simply memorialize existing legal requirements. In the US, federal, state, and even local laws may exist which mandate compliance with certain sourcing standards. Under the Foreign Corrupt Practices Act, for example, it is illegal for US companies – directly or through their agents – to engage in bribery and corrupt practices abroad. Similarly, under the Dodd-Frank Act, companies must disclose their use of conflict minerals, such as tantalum, tin, tungsten, and gold, sourced from conflict-affected regions. Several states in the US have also enacted Modern Slavery Acts that require (in part) that companies disclose efforts to eliminate forced labor and human trafficking from their supply chains. It should be obvious. But legal obligations are nonnegotiable and must be met. Moreover, your company should have systems and processes in place to ensure that these requirements are met. However, even when a supply contract is merely memorializing an existing legal obligation, it could result in additional liability for the supplier. Thus, such provisions should not be taken lightly.

2. Codes of conduct. Many customers now demand, prior to engaging you as a supplier, that you agree to certain codes of conduct which impose obligations over and above what may be otherwise legally required of you. These additional requirements reflect a growing corporate social responsibility movement, spurred in part by end-user demands that companies have due regard for human rights, environmental sustainability, and other ethical business practices. Often, codes of conduct require that you – and your upstream suppliers – comply with fair wage provisions, child and forced labor restrictions, worker health, safety, and association rights, environment protections, and product quality and safety standards. Although these are important standards for your company to adopt, the difficulty arises from the fact that the typical code of conduct imposes obligations upon you to enforce similar standards on your upstream suppliers. Furthermore, it is unlikely that your customer will negotiate the terms of the code itself, because to do so would draw too many questions from stakeholders. When agreeing to these codes of conduct, you should both act to limit your exposure (see point 4 below) and shift risk to your upstream suppliers by imposing on them reciprocal codes of conduct, with indemnification provisions. Of course, your ability to enforce these risk-shifting provisions may be compromised if your supplier is in certain foreign jurisdictions.

3. Transparency and audit provisions. Many downstream customers also seek to require their suppliers to comply with certain transparency and audit provisions. This may include: (a) the right to access the supplier’s financial statements or tax records; (b) the right to require the supplier to reveal information about the supplier’s relationship with competitors; (c) provisions requiring the supplier to disclose information related to the supplier’s environmental practices and sustainability efforts; (d) the right to information about wages paid by the supplier or hours worked by the supplier’s employees; (e) the right to learn certain information about the supplier’s subcontractors or upstream suppliers; or (f) the right to conduct physical inspections of the supplier’s premises. From your customer’s perspective, the standards of conduct are toothless without these provisions. But any supplier would justifiably be concerned that allowing a customer access to this kind of information could grant the customer unfair negotiating leverage and could allow the customer to circumvent the supplier by going directly to upstream suppliers or subcontractors. For this reason, transparency and audit provisions – if accepted – should be accompanied by stringent confidentiality and non-circumvention clauses.

4. Consequences of breach. You should carefully examine your supply contract to determine what consequences will result from your breach of any codes of conduct. First, be cautious of any provision which requires that you indemnify the customer for third-party claims resulting from your own breaches or – certainly – breaches by your upstream suppliers. If your customer insists on indemnification, limit your liability via limitation of liability clauses which expressly apply to indemnification. Second, the agreement should specify a process for addressing any alleged non-compliance. Typically, this would include: (a) a dispute resolution process, in the event that there is disagreement over whether you have met the requirements of the code of conduct; (b) a realistic timeframe to cure any alleged violations of the code of conduct; and (c) specific metrics that would help the parties identify when the alleged violations have been resolved. Third, the agreement should specify that your supplier’s sole remedy for breach of the code of conduct is termination of the contract (i.e., damages are prohibited), and only after you have failed to cure the breaches and/or there have been significant or repeated breaches.