There is a growing appreciation that companies can be held liable for the actions of third parties under the FCPA and other anti-corruption laws. In this article, we highlight four key challenges and related “cures” for dealing with one particularly perplexing group -- distributors.
- There is nothing in a name?
Many companies mistakenly continue to believe that distinctions between the terms “agent” “reseller” and “distributor” – useful legal distinctions for purposes of corporate, employment and tax laws – are also meaningful distinctions that might insulate them from FCPA liability. But recent enforcement actions, including those involving Eli Lilly, Biomet, Oracle and Smith & Nephew, have shown such distinctions to be without meaning in the FCPA context.
US regulators have held companies accountable for the acts of a wide variety of third parties without meaningful consideration of the nomenclature the company assigned to the third party. For this reason, companies cannot assume that the way they structure their relationships with third parties will allow them to avoid liability.
Nonetheless developing a real understanding of the scope of third parties and the actual roles they play can assist a company in determining which third parties present higher risks so as to make more thoughtful decisions about how to allocate scarce compliance resources. Accordingly, in evaluating distributors consider the following:
- What percentage of the principal company’s business does the distributor’s business represent?
- Does the distributor represent the principal in the market, including whether the distributor is using the company’s name, or other intellectual property?
- Is the distributor required to interact with government officials?
- What is the degree of involvement between the principal and the distributor, including training, selecting or managing personnel?
- Line of sight: responding to what you see and hear
The criminal intent of mens rea that will apply to a company’s liability based upon the acts of a third party will either be of actual knowledge or willful blindness. From a compliance perspective, dealing with actual knowledge of criminal conduct is relatively straightforward – it needs to be addressed immediately. Willful blindness – a high degree of suspicion that the third party is engaging in illegal conduct without subsequent reasonable attempt to alleviate that suspicion – is more difficult, particularly if the company employees otherwise charged with monitoring and interacting with that third party mistakenly believe that the legal relationship and nomenclature define the scope of willful blindness responsibility.
For example, imagine a company that sells its goods to a number of regional distributors in the Middle East; under the distributor agreement the distributors are solely responsible for marketing and selling the product to the end customer. Given the lack of contractual responsibility for the end-use sales, a company’s personnel responsible for the distributor relationship might reasonably conclude that the company’s FCPA risk ends once the goods are transferred with no risk of liability for how or to whom they are ultimately sold. Whether that is true will depend upon the underlying facts, and not just the contractual assignment of responsibility between the company and distributor. If, for example, the company’s senior vice president paid a courtesy call to the distributor while passing through Cairo, and while there heard rumors that the distributor was throwing lavish parties with expensive gifts as part of its marketing efforts for government customers, and then fails to ask any questions or otherwise attempt to discover whether illegal conduct is occurring and stop it, then the company will be viewed as willfully blind, even though the distributor agreement made it quite clear that the distributor was solely responsible for marketing. In short, any information raising suspicions of bribery must be addressed, even if the suspicions relate to an area the company is not responsible for under the distributor agreement.
- Margins, margins, margins…
By their very definition, distributors and re-sellers are one step, if not more, removed from the various controls that ensure proper oversight and compliance in an organization. Moreover, unlike other third parties that may be compensated on the basis of commissions, distributors often take title of goods and then sell them onto retailers and/or end users.
One of the challenges this creates is the lack of transparency regarding the transaction with the end user, which may then provide added opportunities to structure transactions in ways that violate anti-corruption laws. More specifically, where distributors are able to achieve higher discounts from the company, they may be able to free up funds for improper bribes unbeknownst to the company. Nevertheless, the surrounding circumstances may be such that the company will be considered to have had constructive knowledge (or to be willfully blind) under the FCPA.
Companies thus need to create procedures to audit and flag unusual distributor discounts. To do so, the company needs to develop an informed understanding of normal discount levels in the particular market, and implement additional procedures to review and approve any request to depart from such discounts.
The more significant the discount requested the greater the level of scrutiny and review needed by the company. All requests for discounts (accompanied by the appropriate justification for the request) and decisions related thereto should be memorialized in writing. Steps also should be taken to routinely compare the distributor’s margin against the end user price to ensure that third parties are not building in excessive margins that can then be used to pay improper bribes.
- Outgrowing agreements
Third parties that the company either inherits through processes like corporate mergers, acquisitions or joint ventures, and/or other third parties that have long-standing relationships with the company, may have outdated or antiquated contracts that lack many of the representations and warranties, and audit rights that are now widely considered best practices for anti-corruption compliance programs. Re-negotiating these agreements, particularly with distributors who may not have exclusive relationships with the company and who thus have less motivation to do so, can be problematic.
Look for opportunities to update and standardize distributor agreements as part of routine business discussions. At the same time, look for opportunities to share the ethos and company’s commitment to compliance through informal channels, including sharing company newsletters, trainings, compliance “updates” or best-practice tips, and otherwise through the course of discussions and business negotiations with end users and customers.