Compliance within the Supply Chain
Pitfalls when introducing Supplier Codes of Conduct
The implementation of compliance management systems is often accompanied by the introduction of a code of conduct that is applied throughout the company and a supplier or business partner code of conduct to be acknowledged by suppliers and other business partners. A code of conduct generally defines the corporate values of a company including compliance and ethics. In addition thereto, a supplier code of conduct sets out the rules of conduct for business partners to be adhered to in the business relationship as well as potential enforcement instruments that may be applied in case of a violation of the corporate values defined in the supplier code of conduct. However, the introduction of a supplier code of conduct often confronts companies with numerous factual and legal challenges. These challenges often begin with the initial drafting of a supplier code of conduct and extend to the possible lack of acceptance by suppliers and other business partners.
Pitfalls when drafting a supplier code of conduct
A supplier code of conduct should transparently communicate the corporate values of a company and effectively commit (potential) business partners thereon. A code of conduct may also enable a company to execute control and enforcement instruments (e.g., termination and audit rights) in the event of a violation of a company’s corporate values by a business partner. The challenge a company may be facing when introducing a supplier code of conduct into a new or existing business relation is, on the one hand, to clearly and unambiguously express and define the corporate values and, on the other hand, to define appropriate control and enforcement instruments in the event of a violation of these corporate values by a business partner. Furthermore, a supplier code of conduct must be effectively agreed by the affected parties and conform with the legal requirements defined for the application of general terms and conditions – in particular those of Sec. 307 German Civil Code (Bürgerliches Gesetzbuch – BGB).
A supplier code of conduct may, for example, violate these legal requirements for general terms and conditions in case the respective clauses are formulated in a manner that may be deemed unreasonable, vague or far-reaching and may result in an unreasonable disadvantage to the business partner. This may especially be the case for excessive, rampant or non-event related audit rights. Furthermore, excessively structured audit rights may lead to the assumption of willful blindness if these are contractually agreed but not enforced when necessary. The assumption of willful blindness with respect to contractually agreed audit rights may result in the anticipation and deemed acceptance of the business partner violation of the obligations and behavioral rules defined in the supplier code of conduct. In addition to the introduction of audits rights into a supplier code of conduct, also termination rights need to be drafted carefully. Especially with regard to Sec. 308 No. 3 BGB, the individual termination clause has to clearly describe the reasons enabling a company to terminate an agreement entered into with the business partner violating the obligations set out in the supplier code of conduct as well as further remedies of the affected company.
The obligation of a supplier or business partner to also to commit its own suppliers, subcontractors or other business partners to a customer’s supplier code of conduct needs to be drafted cautiously. If the relevant clause is obliging the business partner to use best efforts to pass on the obligations of the supplier code of conduct further down the supply chain to its subcontractors, it is generally deemed to comply with the general requirements for general terms and conditions in accordance with German civil law. A clause obliging the supplier to effectively commit its suppliers, subcontractors or other business partners to a supplier code of conduct of a customer may be deemed to be unreasonable and may be deemed to be void accordingly.
Mutual Recognition Procedure
In addition to the general legal risks described above, introducing a supplier code of conduct into a business relation with a supplier or other business partner may often be a tightrope act that requires careful consideration of various factors. Whereas adapting a supplier code of conduct to the individual demands of a (potential) supplier may result in a possibly higher acceptance, this approach at the same time softens a company’s corporate values and places them at the negotiating employee’s disposal and at risk. Furthermore, the absence or waiver of control and enforcement instruments in a supplier code of conduct may also contribute to its acceptance by business partners but literally turn it into a paper tiger without any teeth.
Furthermore, it will often be the case that the (potential) business partner itself has already defined its corporate values and principles in a code of conduct and may question the need to commit itself to a supplier code of conduct that is potentially perceived as equal or even conflicting with its own code of conduct. The possibility of contradicting clauses in the different (supplier) codes of conduct has to be especially considered when business partners have to commit themselves to a vast number of conflicting codes of conduct issued by a large number of their business partners resulting in an opaque and legally insecure situation.
In order to solve these factual problems associated with the implementation of supplier codes of conduct, the Federal Association of German Industry (Bundesverband der Deutschen Industrie e.V., “BDI”) has developed a concept of mutual acceptance. According to this concept, the involved parties may commit themselves to their own code of conduct and waive the application of the other party’s code of conduct at the same time. The BDI’s concept of mutual recognition of codes of conduct is particularly helpful in case the codes of conduct in question are considered as equal and providing sufficient protection to the involved parties. Any additional control and enforcement rights can be agreed upon in the recognition agreement.
Conclusion
The implementation of effective compliance management systems in light of the still to be enacted German Law of Combating Corporate Crime (Verbandssanktionengesetz) will be a challenge for almost every company. Supplier codes of conduct are an effective way to commit external stakeholders to a company’s corporate values including compliance and ethics. Nevertheless, it is important to carefully draft the respective supplier codes of conduct and to ensure they are effectively included in a company’s the business relationships and not be at risk of being considered void.
Please let us know if you have any questions about the implementation of effective compliance management systems or any related topic such as compliance policies or codes of conduct.