Tim Wright, Partner and Matt Oresman, Counsel at international law firm Pillsbury,discuss some of the legal risks inherent in managing a global supply chain, including risks relating to export controls and sanctions, and provide pointers to help mitigate them.

Enterprises depend on increasingly complex and sophisticated supply chains in order to assemble and deliver goods and services to the marketplace and to the ultimate consumer. Global supply chains, large components of which are outsourced to a variety of third parties, are increasingly under threat from a wide range of risks including natural disasters, financial crisis and terrorism. Other events which can take place in the supply chain but have wider ramifications higher up include bribery and corruption, strike, theft, manufacturing problems and insolvency.

The risk to reputation cannot be understated. The tragic collapse of the Rana Plaza garment factory in Bangladesh in 2013 caused significant loss of life and nearly 20 well-known brands including Walmart, Primark, Benetton, Monsoon and Mango, will be forever associated with the disaster.

Matthew Oresman

With supply chains typically comprising a large number of actors across widespread functions including sourcing, manufacturing, logistics and distribution, there is an increased need to focus on managing and mitigating the associated risks. However, a survey published by the University of Tennessee’s Global Supply Chain Institute in June 2014[i] found that 90% of firms surveyed did not quantify risk when outsourcing production and that, whilst 66% did have legal and/or compliance risk managers, supply chain risk was virtually ignored.

How then can businesses best manage the risks of a global supply chain? Companies’ risk and legal functions will increasingly need to devote time and effort developing policies and programs to help manage and mitigate, across the supply chain, compliance with diverse laws and regulations such as anti-bribery and corruption, anti-trust, cyber security, sanctions and export controls.

From a contracting perspective, a wide range of commercial agreements, such as long-term supply, distribution, outsourcing, contract manufacture and standard form agreements, are used at various interaction points between different supply chain actors.Starting with their highest value and most strategically important contracts, businesses should evaluate their exposure in the event of the interruption of a key supply.Where a business subcontracts in order to deliver services or products to a customer higher up the chain, a failure of one of its suppliers can in turn put it in contractual breach with its customer with the risk of a damages claim for losses incurred, liquidated damages (e.g. delay payments)or service credits. Commercial contracts often contain clauses which provide relief for events outside a party’s reasonable control (e.g. force majeure)but care needs to be taken to ensure that the actual wording reflects the agreed balance of delivery risk in unforeseen and unavoidable circumstances. These clauses can be buried at the back with other standard looking terms and conditions but should not be overlooked.

One area of growing concern is the impact of export control and sanctions regulations around the world on the movement of goods and payments across the supply chain.Most countries have some type of regulation to track or control the export of military or dual-use (i.e., can be used for both a civilian or military purpose) items.However, the United States export control regime follows U.S. military and dual-use items wherever they go in the world, even if they are incorporated into larger non-U.S. products. This regulatory regime is quite complicated, often requiring U.S. exporters or non-U.S. re-exporters to register with the U.S. State Department or Commerce Department and obtain licenses before moving any item. Failure to manage this process carefully can result in significant delays and even full production stoppage.

Similarly, U.S. sanctions (and, to a lesser degree EU sanctions) on certain countries, individuals, businesses, and other entities can prohibit companies from dealing with them. Most businesses would not knowingly enter into contracting arrangements with sanctioned counterparties, but the lists of sanctioned entities are constantly updated. This has been seen recently with the imposition of sanctions on certain Russian entities and sectors, as many that had been engaged in international commerce for a considerable time found themselves cut off from international markets. Those international businesses, especially energy companies, that relied on these Russian businesses as part of their supply chain found themselves in a very challenging situation.

Tim Wright

Related to this, many Russian companies have found it hard to use the international banking system to make or receive payments. This has created cause for non-performance of contracts by counterparties and increased the risk of receiving payment for services rendered. This serves as a good reminder that managing political and counterparty risk is a key component of overall supply chain risk management.

Insurance contracts should also be regularly reviewed from a supply chain risk perspective. Companies are advised to work closely with their insurers and brokers who will willingly share best practices – practices which must be operationalised on a day-to-day basis if they are to be effective mitigants of stress points in the supply chain. Where a customer identifies that is has a dependency on a small number of key suppliers, mitigating actions can include regular monitoring of these suppliers for early signs of financial stress which might lead to insolvency, increased relationship management and governance, as well as the development of a multi-sourcing strategy.

[i] http://globalsupplychaininstitute.utk.edu/publications/documents/Risk.pdf