Plaintiffs lawyers are gunning for your supply chain. It is part and parcel of a growing call for supply chain transparency—stakeholder demands that companies account for their business practices on such issues as human rights, environmental sustainability, fair labor practices and ethical sourcing. Companies are familiar enough with the consequences of false and misleading financial reporting to take it seriously. But the emergence of transnational supply chain litigation in the U.S. court system suggests that nonfinancial performance reporting requirements, like those mandated by California's Transparency in Supply Chains Act and the U.K.'s Modern Slavery Act, may be equal in importance to compliance with anti-bribery and anti-corruption laws—a vital corporate function. The website disclosures required by these laws, like Securities and Exchange Commission registration statements, are manna from heaven for the plaintiffs class action bar.
Transnational supply chain litigation is not a new phenomenon, but the playing field is quickly changing. So are the players. What began two decades ago with foreign workers seeking compensation in federal courts for alleged human rights abuses on theories of corporate complicity with violations of international law has now expanded to encompass not only victims suing companies in state courts for personal injury under common-law theories of negligence, but also shareholder activists and consumers seeking relief based on a desire to make investments and purchase goods that align with their personal preferences and "stand for something."
For companies within reach of the American court system, and its plaintiffs bar's unique nose for "justice" and money, these developments are a tangible threat to business as usual. Given the growing importance of corporate social responsibility to a company's reputation and bottom line, firms need to be proactive and vigilant about litigation risks linked to the business practices of their partners throughout the global supply chain. Incorporating the issue of supply chain risk management into the corporate compliance program is a good start.
Overview of the Litigation Landscape
Transnational supply chain litigation began in the mid-1990s, with plaintiffs using the long-dormant Alien Tort Statute (ATS) in an effort to hold multinational corporations accountable in the federal court system for allegedly "aiding and abetting" human rights abuses by third parties in their supply chains. The ATS gives non-U.S. citizens and nationals access to the federal court system for torts "committed in violation of the law of nations or a treaty of the United States."
While this effort continues, ATS claims are notoriously difficult to sustain for various reasons, now chiefly because of the presumption against extraterritorial application of U.S. law announced by the U.S. Supreme Court in Kiobel v. Royal Dutch Petroleum (2013). As a result of this rule, an ATS claim must "touch and concern the territory of the United States … with sufficient force to displace the presumption," or it has no legal merit. What this showing entails, however, is unclear and still being worked out in the lower courts. In December 2014, for instance, the U.S. Court of Appeals for the Ninth Circuit reinstated an ATS lawsuit alleging that defendants aided and abetted human rights violations by purchasing cocoa products from West African farmers known to use child slave labor in their operations—allowing plaintiffs an opportunity to amend their complaint in light of Kiobel. See Doe v. Nestlé USA (2014).
Workers in distant parts of the supply chain are also taking a more conventional approach, eschewing ATS claims in favor of common-law theories of negligence. But this way too they face obstacles. An example is a proposed class action brought last year in Delaware as a result of the collapse in 2013 of the Rana Plaza in Bangladesh, which injured and killed thousands of garment workers. A plaintiff sued on behalf of his wife, who died in the collapse, and others, alleging that defendants negligently failed to ensure safe working conditions for the employees of their suppliers. This action was recently dismissed because, among other reasons, plaintiffs were employees of garment factories within Rana Plaza, not defendants' employees—meaning defendants owed them no duty of care. See Rahaman v. J.C. Penney (2016).
Upping the ante, shareholder activists have quietly opened another front in transnational supply chain litigation. In 2012, a pension fund filed a books-and-records complaint against Hershey after that company denied its request under Delaware law for access to internal documents for purposes of investigating claims of supposed wrongdoing by Hershey in its dealings with West African cocoa suppliers. In denying Hershey's motion to dismiss the lawsuit, the court found a "credible basis" for inferring "possible violations of law" sufficient "to warrant further investigation." See Louisiana Municipal Police Employees' Retirement System v. Hershey (2014).
U.S. consumers got into the act late last year, filing a half-dozen or so proposed class actions in California as part of an effort to hold global brands and manufacturers liable under state anti-fraud laws for failing to disclose the possible presence of forced labor and other human rights abuses in their supply chains. The predicate for these claims is California's supply chain disclosure requirement, which mandates that every large retailer and manufacturer doing business in California with global gross receipts in excess of $100 million annually post disclosures on its website regarding the company's efforts, if any, to eradicate slavery and human trafficking "from its direct supply chain for tangible goods offered for sale."
Because this law does not create a private right of action, however, plaintiffs are filing suit under state consumer protection laws, arguing that defendants have a duty to disclose the likelihood that their products or raw materials may have been sourced from forced labor on product packaging. The theory of liability is that defendants' failure to disclose the possible presence of slavery, forced labor and other human rights abuses in their supply chains caused plaintiffs' "economic injury," because they would not have purchased the products or paid as much for them but for the alleged deception. These lawsuits are an extension of a broader U.S. litigation trend against food and beverage companies over product labeling claims generally.
So far, California courts are rejecting supply chain lawsuits led by consumers for failure to state a claim for relief as a matter of law—on the ground that there is no duty under the state's consumer protection laws to make the disclosures that plaintiffs seek. A few have also been dismissed because California's supply chain disclosure law creates a "safe harbor," precluding claims for failure to disclose supply chain information on product packaging.
To skirt these obstacles, plaintiffs are also using defendants' supplier codes of conduct and public statements about their supply chain business practices and principles in an effort to establish liability based on claimed misrepresentations in those disclosures. The thrust is that a reasonable consumer could interpret defendants' statements about their "responsible sourcing guidelines" and the like as meaning that there is no forced labor in the supply chain.
But this tack, too, is being turned back by courts so far. In one case, for example, the court held that no reasonable consumer could be misled by Nestlé's "aspirational" statements about its supply chain rules and expectations "into thinking that its suppliers abide by those rules and meet those expectations in every instance." Claims based on allegedly incorrect or false statements about working conditions in the supply chain, however, could very well have teeth, depending on the facts.
This is not the end of the matter, though, and the current state of play is hardly reason for complacency. The risk will only grow as supply chain disclosure laws proliferate and the ever-enterprising plaintiffs bar works to refine and retool its effort to establish liability for supply chain business practices.
Globalization has dramatically expanded the operating scope of multinational companies, making cost-saving arrangements such as outsourcing or offshoring commonplace. And while corruption, bribery, political instability and natural disasters are well-known business risks, a less obvious (and growing) risk is liability for the way in which one's supply sources do business. Global business is thus discovering an unexpected trade-off in the phenomenon of globalization: namely, growing stakeholder demands that they accept greater responsibility for people, communities and environments affected by their operations. Mitigating these risks requires companies to turn their thinking about organizational transparency inside out. Just as Sarbanes-Oxley forced companies to put more emphasis on the assessment of risks inside the organization, the advent of supply chain disclosure laws—coupled with the parasitic private litigation they attract—should prompt business entities to consider a similar approach to the assessment of risks outside their institutions, but embedded in their value chains.
These risks will continue to vex multinational business for the foreseeable future, in the court of public opinion as well as the judicial system. Like prospectors panning for gold, prospective claimants (foreign and domestic) will be sifting disclosure statements, as well as supplier codes and contracts, sourcing guidelines, corporate policies, annual reports, websites and the like, for words that can be characterized as false or misleading in some respect, or to argue that a defendant has assumed a duty or broken some promise regarding its supply chain practices. Robust due diligence, well-documented compliance programs and careful drafting are therefore critical, as is the harmonization of public messaging across end markets on a global basis. At a minimum, ask three questions about everything you say about your supply chain business practices: Is it true? Can it be verified? Is it likely to deceive?
Finally, the demand for supply chain transparency and accountability need not be all doom and gloom. This development can also be viewed as an opportunity for companies to unlock business value (strengthening brands and the bottom line)—by promoting good corporate citizenship, improving operations, addressing blind spots or information gaps in the supply chain and proactively identifying and managing potential risks. Such an approach also enables companies to shape, rather than simply react to, public debate over supply chain transparency.
This article was first published in Corporate Counsel, August 2016