A Primer
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Why are contracts important for promoting human rights in global supply chains? Along with supplier codes of conduct, contracts are the most widely used tool for managing supply chain risks, including human rights and environmental risks. Contracts take a company’s policies, which, on their own, are unenforceable, non-binding documents, and make them binding. Otherwise put, when human rights and environmental policies are incorporated in contracts, they become legally binding and enforceable. Contracts therefore make soft policies hard and make it possible for these policies to “go global” by binding parties operating in different parts and legal jurisdictions of the world.
Unfortunately, although contracts are widely used to manage supply chain risks, they are typically misused for purposes of managing human rights and environmental risks. All too often, companies use their contracts to shift human rights and environmental risks and responsibilities onto their contract counterparties and other actors in their supply chains. The responsibility for mitigating human rights and environmental risks is typically placed on the shoulders of the less powerful party (usually the producer-country supplier) by the more powerful party (usually the consumer-facing buyer / brand / retailer), with little acknowledgement that human rights and environmental risk may be caused in whole or in part by the acts (e.g., purchasing practices) and omissions (e.g., lack of assistance) of the more powerful party. To formalize this type of risk-shifting, suppliers are frequently required to make a contractual promise (by way of a representation or a warranty) that there are no human rights and environmental violations anywhere in the supply chain and that all is perfect. Such promises are unrealistic because there is no such thing as a perfectly clean supply chain, but they are also dangerous because they incentivize suppliers to hide infractions out of fear of losing the contract and to push infractions further out of the buyer’s view, where they are even less likely to be addressed. In addition to bearing the bulk of the contractual risk, suppliers are often expected to assume the costs associated with upholding human rights and environmental standards, usually without support, financial or otherwise, from their buyers. Moreover, suppliers often contend with prices that do not cover the costs of production, let alone the costs associated with responsible business conduct, and other poor purchasing practices.[1] These dynamics combine to create serious commercial pressures on suppliers, which are passed on to workers and their communities.[2] While risk-shifting may be effective for some aspects of supply chain risk management, it is ineffective, and even dangerous, for purposes of managing human rights and environmental risks. A key take-away from this Investor Guidance is that, when it comes to preventing adverse human rights and environmental impacts, risk-shifting is not the same thing as risk management. Risk-shifting contracts tend to aggravate human rights and environmental risks, not mitigate them. Investors should understand that when their investees use their supply chain contracts to shift human rights and environmental risks onto their business partners and suppliers, this is unlikely to support effective human rights and environmental risk management or better human rights and environmental outcomes. The most effective way to manage human rights and environmental risks is to proactively mitigate them to prevent their escalation into harm or actual adverse impacts. And this is what HREDD is all about— prevention. As explained below, moving toward responsible contracting is not only more effective for preventing and remedying adverse impacts, but also for achieving compliance with rapidly-evolving legal requirements, including the new HREDD laws, sustainability reporting laws, and trade sanctions laws. To serve as effective components of HREDD processes, supply chain contracts should move toward a responsible contracting model whereby both parties commit to cooperate in carrying out ongoing, risk-based HREDD, to share responsibility for upholding human rights and environmental standards, and to cooperate to provide remedy to victims in the event of an actual adverse impact. The shared-responsibility approach supports more balanced buyer-supplier relations and more effective implementation of human rights policies and risk management processes that can in turn support better human rights and environmental outcomes in global supply chains. It also enables better legal compliance. [1] Examples of poor purchasing practices include: imposing prices that are too low to cover production costs (including labor costs); making last-minute changes to orders; requiring suppliers to assume HRE-related costs without providing additional—technical or financial—assistance; making unfair retroactive modifications to payment terms (e.g., asking for steep discounts after the order has been completed or shipped); inaccurate forecasting of how much of suppliers’ production capacity should be reserved and not paying for unused reserved capacity; short turnaround on delivery of goods, accompanied by steep penalties for delays; and irresponsible exit.
[2] For example, in the face of COVID-related lockdowns, many buyers unilaterally invoked force majeure clauses in their contracts to get out of their contractual obligations to purchase from suppliers without considering the human rights impacts of their decisions. Suppliers, in turn, reduced their labor forces, passing on the economic impact to workers (and their families and communities). The order cancellations also generated a serious wage theft epidemic, whereby millions of dollars of wages – for completed work – were never paid to workers. For example, Ramatex, a Nike supplier, closed a factory during the pandemic and failed to make required severance payments to over 1,500 workers. Neither Ramatex nor Nike have compensated the workers to date, despite public reporting on the issue, and repeated investor inquiries. |
