In a new paper, “Protecting Contract’s Hidden Parties,” I argue that harm to third parties from supply chains offers a compelling reason for requiring human rights due diligence in supply chains. Many scholars have turned to fiduciary duties or negligence theories to create incentives for companies to consider non-shareholder interests.  My article shares this objective but takes a different path by examining a corporation’s duties to others in its role as a contracting party.  This analysis can help to address human rights violations in supply chains and may also have implications for third-party harms arising in other types of contracts.

Labor and human rights violations by major companies are legion. Over the past few decades, Walmart, JC Penney, The Children’s Place, Nestle, Mars, and Costco have all been sued over such alleged violations,[1]  and Apple, Microsoft, Alphabet, Dell, and Tesla have recently been accused of “knowingly benefiting from and aiding and abetting”[2] the use of young children in Democratic Republic of Congo (“DRC”) to mine cobalt, “a key component of every rechargeable lithium-ion battery used in the electronic devices these companies manufacture.”[3]

In order to address these and other human rights violations, the United Nations Guiding Principles on Business and Human Rights (UNGPs) recommends that businesses have a “human rights due diligence process to identify, prevent, mitigate and account for how they address their impacts on human rights.”[4]  However, not all businesses implement these principles.

Government actors from around the world have attempted to create incentives for  human rights due diligence through mandatory disclosure laws. Those laws require businesses to report their policies and practices concerning the identification and mitigation of human rights impacts within their supply chains, along with other related topics. For example, the California Transparency in Supply Chains Act requires covered corporations to disclose their efforts to address slavery and human trafficking, including verification, audits, certifications, internal accountability standards, and procedures, and training.[5]  The UK Modern Slavery Act and Australia’s Modern Slavery Act also impose reporting requirements concerning human rights practices in supply chains.  These transparency laws enable a variety of stakeholders to distinguish between businesses based on their human rights practices and to punish or reward them accordingly, thereby supplying incentives for businesses to improve those practices.

But the ability of these transparency laws to change behavior is limited.  For example, some mandatory disclosure laws do not include features that are important for reputational incentives to work well, such as creating central repositories for company statements to facilitate comparability,  lists of covered companies to identify non-compliant businesses, or sanctions for non-compliance.[6]  Others enable businesses to disclose only general or vague information.[7]  The result is that the information produced is inadequate to put the reputation of companies on the line and so change their behavior.  A final problem is that many supply chain transparency laws “do not require companies to take any steps to remedy risks that have been identified,”[8] and allow companies to comply “by simply stating they have taken no steps to address modern slavery in their operations and supply chains.”[9]

My working paper addresses these challenges by considering options that could create incentives for human rights due diligence in supply chains.  I begin by focusing on the contract externalities in the supply chain that contributes to many human rights violations. I argue that Type I externalities are harms that result from contract performance when contracting parties perform as expected; contract terms concerning price, volume, and delivery times can exacerbate risks to third parties, such as forced labor and human trafficking, because these risks are inherent in the contract.  In order to address these risks, multinational companies frequently incorporate codes of conduct in their supply contracts with their overseas suppliers.[10]  But suppliers often violate these codes, resulting in Type II externalities that result from contractual breach.  Unfortunately, despite these risks, third parties are unable to address either externality because they do not participate in contract design (Type I externalities) and are often unable to successfully assert rights under codes of conduct (Type II externalities).

I further argue that these externalities remain unaddressed because of a fundamental inconsistency in how we view contracts. While we may continue to view contracts as bilateral when it comes to assessing harms, they are multilateral when it comes to the benefits third parties confer on contracting ones.  Contracts do not exist in a vacuum. We rely upon institutions and organizations developed by a variety of third parties to support those contract relationships even while contract signatories impose externalities on them.  Social networks, trade associations, and community organizations reduce market transaction costs associated with exchanges by improving information flows, decreasing the risk of opportunism, lowering search costs, and increasing and re-distributing losses from non-cooperation. These are many of the ways that third parties enable exchanges – even those that might not otherwise occur but for the contract ecosystems that third parties provide.  As such, third parties are not outsiders in exchanges but very much integral to contracting.

Protecting these hidden parties require recognizing obligations that flow to those beyond contract signatories. My paper proposes an alternative view of contracts as an ecosystem with three accompanying objectives: (a) third party protections from negative externalities, (b) contract design obligations of contracting parties, and (c) legal remedies for third parties.  The paper also suggests a number of reforms that can help translate theory into practice, including a “duty to contract:” Contracting parties must take into account negative externalities to third parties when the contracting parties could reasonably foresee that performance of the contract would create a risk of physical harm to those third parties.  This duty would help address contract externalities by providing victims with remedies for past harms and providing a legal incentive for businesses to prevent future harms through contract design.

ENDNOTES

[1]  See, e.g., Doe v. Wal-Mart Stores, 572 F.3d 677 (9^th Cir. 2009).Rahaman v. JC Penney, 2016 WL 2616375 (Sup. Ct. Del. May 4, 2016); Class Action Complaint, Hodson v. Mars, No. 15-cv-04450 (N.D. Cal. Sept. 28, 2015).

[2]  Class Action Complaint, Doe v. Apple et. al., Case No. 1:19-cv-03737 (D.D.C. Dec. 15, 2019), at 1.

[3]  Id.

[4]  See U.N. Human Rights Office of the High Comm’r, Guiding Principles on Business and Human Rights (2011).

[5]  Cal. Civ. Code § 1714.43 (West 2012).

[6]  See, e.g., Joint Standing Committee on Foreign Affairs, Defence, and Trade, Parliament of the Commonwealth of Australia, Modern Slavery and Global Supply Chains: Interim Report of the Joint Standing Committee on Foreign Affairs, Defence, and Trade’s inquiry into establishing a Modern Slavery Act in Australia (Aug. 2017), ¶ 2.28.

[7]  See, e.g., Business & Human Rights Resource Centre, FTSE 100 & the UK Modern Slavery Act: From Disclosure to Action (2018); CORE Coalition et al., Transparency in Supply Chains Consultation (Sept. 16, 2019).

[8]  Business & Human Rights Resource Centre, Modern Slavery in Company Operation and Supply Chains, supra note ___ at 4.

[9]  Id.

[10] See, e.g., David V. Snyder  & Susan A. Maslow, Human Rights Protections in International Supply Chains––Protecting Workers and Managing Company Risk, 73 Bus. Law. 1093 (2018).

This paper comes to us from Professor Kish Parella at Washington and Lee University School of Law. It is based on her recent paper, “Protecting Contract’s Hidden Parties,” available here.