Supply Chain Liability: a Primer

A post by guest blogger Penelope Bergkamp

Supply chain liability is the liability of a company for a harm caused by its business partners. Until recently, this was merely an academic theory. It no longer is: we are beginning to see court cases on supply chain liability, and more such claims will likely be filed.

Court Cases

Supply chain liability is broad and varied. Some examples of these cases illustrate what may be involved.

  • In 2000, approximately 3000 South Africans sued London-based Cape PLC, a mining company, for negligent control and supervision of its South African subsidiaries. As a result of this failure, mine workers were exposed to asbestos, which caused various diseases (asbestosis, lung cancer, etc.) in the period before 1979.
  • In The Netherlands, a case was brought against a manufacturer of rock wool, which sold its product to a company that used it in potting soil. This company sold soil to a grower of Yucca plants. As a result of a change in the composition of the rock wool, of which the potting soil distributor was made aware, a large number of Yuccas died. In this case, the court ruled that the manufacturer of the rockwool, not the potting soil, should have conducted research to ensure that the products it sold were safe in applications for which they were intended. Giving notice of the change in composition to the direct customer was deemed insufficient; at the very least, the producer should have verified that the end users had been properly informed.
  • In another recent case in the Netherlands, a court found that Royal Dutch Shell may be liable for environmental damage and related economic harm caused by its Nigerian subsidiary, even if sabotage caused oil spills. This case centers on the parent’s duties to monitor the activities of its subsidiaries, to intervene, as necessary, and to monitor its pipelines and prevent sabotage.
  • In 2015, a class action lawsuit for $2 billion in damages was filed against a major retailer in Canada in relation to the 2013 Rana Plaza Bangladesh garment factory collapse, in which over 1,000 people lost their lives and over 2,500 were gravely injured. Unknown to the retailer, the Bangladesh factory sold the vast majority of its production to the retailer.

The New Theory

The question raised by all of these cases is whether, and under which conditions, corporations can be held liable for damage-causing events in its supply chain. The legal theory of corporate supply chain liability implies that a company can be held liable for damage-causing events in its supply chain if it fails to prevent the damage in violation of some duty to do so.

By and large non-existent no more than a decade ago, this new legal theory is bound to become a major avenue for law suits against corporations, but also a major headache for directors and officers of multinational corporations. As such, it will soon be a buzzword in corporate board rooms.

In this article, we first discuss the trend towards expanding corporate liability. We then turn to the foundations of supply chain liability: the theories of corporate social responsibility and  supply chain responsibility. To explain the focus on human rights violations and environmental degradation, this article discusses the impact of globalization. Thereafter, we show how hard and soft law instruments already impose supply chain responsibility, and how the law moves from supply chain responsibility to supply chain liability.

Expanding corporate liability

Corporate liability has been expanding for some time. Large corporations are sometimes viewed as ‘deep pockets’ that should compensate damage simply because they can. The theory of ‘enterprise liability’ gained prominence based on the hunch that large companies can buy insurance for the benefit of their customers. In addition, through doctrines such as piercing the corporate veil, a company can, in some cases, also be held liable for damage caused by affiliates.

An extension of enterprise liability, the latest development in corporate liability is supply chain liability. This kind of liability involves a corporation’s obligation to answer for torts committed by its business partners. These business partners can be wholly or partly owned subsidiaries, but also third parties that have entered into contract with the corporation, such as suppliers or customers. As such, supply chain liability does not require that the corporate veil be pierced. Rather, it is direct liability based on the fact that the liable company in breach of its social duties failed to prevent damage caused by other entities.

Corporate social responsibility

Supply chain liability builds on the theories of supply chain responsibility and corporate social responsibility. Over the last several decades, the thinking about the corporation’s role in society has changed. This is true in particular in relation to the large multinational enterprise. There is a growing realization that government cannot solve society’s biggest problems, such as pollution and poverty. Corporations, on the other hand, have been very successful in addressing societal needs. Through technological innovation, their efficiency and productivity gains have been impressive. Hence, the idea emerged that the corporate problem-solving capability should be harnessed to solve social problems.

Under the modern theory of corporate social responsibility, corporations may not pursue solely their shareholders’ interests, but they have a social responsibility to society “within its sphere of influence”. The concept of corporate social responsibility is not novel. To the contrary, it has been a recurring theme in legal and economic theory throughout the nineteenth century, but it never rose to the forefront. The idea made a strong come-back in this century, however. Industrialization and globalization have caused both positive and negative impacts around the world. It seems, however, that in the Western world tolerance for the adverse impacts has decreased, and resistance against globalization has gradually grown.

Supply chain responsibility

Corporate social responsibility (CSR) provided fertile soil for supply chain responsibility, which is no more than a specific version of social responsibility. There is no official definition of ‘supply chain responsibility;’ in the CSR doctrine, the terms ‘responsible supply chain management’ and ‘responsible sourcing’ are often used as synonyms. Clearly, the concept includes an element of ‘Be Thy Brother’s Keeper.’ The International Chamber of Commerce has defined supply chain responsibility broadly as a voluntary commitment by companies to manage their relationships with suppliers in a responsible way (ICC, 2007). Although this definition appears to limit the concept to the supply side, it might also be applied to the demand side, customers.

Under the theory of supply chain responsibility, companies should accept responsibility for their products after they have left their sites, and for their supplies before they arrive at their gates. It attempts to address the problem that not all companies have the same level of information, expertise, and resources when it comes to managing environmental and social issues. Thus, if the stronger companies in the supply chain take the lead and assist, they can help all entities in the chain improve.

Supply chain responsibility, thus, is a company’s responsibility across its entire supply chain, for the social, ecological and economic consequences of the company’s activities. To enable others to monitor and verify how a company meets its duties, supply chain responsibility requires also reporting on the consequences and the efforts to mitigate problems. To ensure ‘democratic’ and informed corporate decision-making, a company should also constructively engage with stakeholders, including business partners and non-governmental organizations.

Globalization

Globalization of supply chains have made the issues in supply chains more acute. In the international context, the issues get worse because there often is extensive government failure, such as failure to regulate, failure to enforce, corruption, etc. Despite capacity-building efforts, international organizations have been unable to resolve these deficiencies.

Globalization has drawn the media’s and public’s attention to human rights violations and environmental pollution committed in the supply chains of multinational corporations. Child labor, unsafe working conditions, and long work hours for low wages make regular headlines. In part due to uncontrolled manufacturing for the West, air pollution, water pollution, soil contamination, unsafe food, and a lack of resources threaten the health and subsistence of large numbers of people in the developing world.

In common iterations of supply chain responsibility, transparency, traceability, and participation are regarded as key elements. Transparency makes information available that others can act on. Governments, for instance, can see what is going on in supply chains, verify, and step in as necessary. Likewise, based on the information made available by companies, non-governmental organizations can monitor, check, and generate political pressure. So can the media and general public. As corollary, traceability establishes a trail of evidence and documents that enable verification. Participation ensures that the voices of stakeholders and activist groups are heard.

Soft and hard law

A number of hard and soft law instruments impose supply chain responsibility. Soft law instruments include the OECD Guidelines for Multinational Enterprises, the UN Guiding Principles on Business and Human Rights (‘Protect, Respect and Remedy’), and an international standard (ISO 26000) on corporate social responsibility. Legal instruments include the EU Directives on non-financial reporting, and the supply chain management regimes imposed by the forthcoming EU conflicts minerals regulation and environmental and health safety legislation, such as the REACH Regulation for chemical substances.

Further legislative initiatives are to be expected. A Dutch Planning Agency recently advised to introduce general ‘supply chain liability’ for environmental and health damage caused by ‘novel risks.’ This regime would be modelled along the lines of the REACH Regulation. A recent French proposal for amendment of the Code of Commerce would impose supply chain liability for environmental and sanitary damage («Dans le cadre de ses activités, de celles de ses filiales ou de celles de ses sous-traitants, toute entreprise a l’obligation de prévenir les dommages ou les risques avérés de dommages sanitaires ou environnementaux. Cette obligation s’applique aussi aux dommages résultant d’une atteinte aux droits fondamentaux.») It is currently stalled, but might be revived.

From responsibility to liability

It is a small step from supply chain responsibility to supply chain liability. Civil liability regimes work with open-ended concepts such as fault, negligence, or breach of a duty of care. These open concepts are to be construed by courts on case-by-case basis. The duty of care in any given situation is influenced by legal, ethical and societal principles and norms about harm prevention and compensation. While the legal principle of sustainable development requires economic development consistent with environmental and social needs, the precautionary principle requires action in the face of uncertain risk. The rise of the ‘risk society’ has made the identification and distribution of risks a central theme in politics, and intensified calls for adequate loss prevention and compensation.

As noted above, supply chain responsibility has already been introduced into legislation and ‘soft law’ (self-regulatory codes). There is much literature promoting expanded application of the concept. If the right case presents itself, courts have the substance they need to find that a corporation owed a duty of care to victims or the state to prevent harm caused by its suppliers, customers, or other business partners in the supply chain (e.g. distributors). Courts do not need to look long to find specific duties in duty of care articulated in the legal literature and scholarly opinions.

Failure to meet the demands of supply chain responsibility can thus result in a finding of fault. Under the doctrine of supply chain liability, the bottom line is that a corporation can be held liable for damage caused by its business partners on the ground that it failed to prevent damage caused by others where it had a duty to do so. The key question then becomes in what situations corporations have a duty to prevent damage in their supply chains. Courts are in charge of drawing the lines.

Further questions

Needless to say, these developments raise many novel questions at conceptual and practical levels. Critically important questions include:

  • What does supply chain liability mean for the model and role of the corporation, and the concept of limited liability?
  • How does it affect corporate liability and victims’ ability to recover losses?
  • What are the new liability standards, and where will courts draw the line?
  • What does it mean for the international operations of corporations? How will they protect themselves against this new form of liability?
  • How will supply chain liability affect corporate structuring and corporate finance?

The case pending against Shell before the Dutch courts nicely illustrates some of the issues highlighted in this article, and raises some related problems. Other cases in other countries will likely follow. As a result, supply chain liability will continue to be in flux for the foreseeable future.

Penelope Bergkamp
Bachelor of Laws (expected 2017), KU Leuven

 

Author: Joeri Vananroye

Professor of economic analysis of law (KU Leuven), attorney (Quinz)

2 thoughts on “Supply Chain Liability: a Primer”

  1. One development the author might be interested in is the Superior Court of Delaware’s Memorandum of Opinion (dated 4 May 2016) dismissing a class action lawsuit brought by representatives of Rana Plaza victims against select US brands/retailers. In her Opinion, the Judge found that the retailers did not owe a duty of care to their supplier’s employees as they were not their direct employer, did not have a “special relationship”, there was no “peculiar risk”, no sanctioned illegal conduct nor any grounds for diverging from the general rule that general contractors are protected from liability. See: http://courts.delaware.gov/Opinions/Download.aspx?id=240380 I am curious to hear whether the reasoning in this Opinion will have ramifications for the Canadian class action that is still pending.

    As unfortunate as the decision is for the Rana Plaza victims, there was one ray of sunshine in Johnston J’s 68th footnote: “This doctrine preventing contractor liability seems be contrary to public policy. A general contractor can hire independent contractors, and as long as the general contractor ignores workplace safety, the general contractor is shielded from liability to the employees of independent contractors. The Court suggests that the better rule would be to encourage general contractors to take all reasonable measures to ensure the safety of all workers on the job site. Such efforts should be encouraged – not affirmatively stifled as a means to escape liability…”

    Like

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