Challenging Year Highlights Supply Chain Risks – Corporate/Commercial Law

Companies are under increasing pressure to closely
manage their supply chains, including providing more transparency
on financing strategies and improving workers’
rights.

The year 2020, with all of its tumult and tragedy, has
challenged the relationship between companies and supply chains.
Companies have faced operational challenges in sourcing goods from
suppliers impacted by the COVID-19 pandemic. Moreover, many
suppliers have found themselves in financial extremis and facing
difficulty meeting their ongoing cash-flow needs. To meet their
needs, companies and suppliers have begun to use supply chain
financing arrangements with increasing regularity. Such
arrangements have, however, raised concerns with the US Securities
and Exchange Commission (SEC) and prompted the Financial Accounting
Standards Board (FASB) to consider the proper accounting treatment.
Finally, while not a new phenomenon, the year 2020 has seen new
litigation seeking to hold companies responsible for the conduct of
their suppliers.

COVID-19 crisis puts pressure on supply chains

Supply chain management requires the careful assessment of an
array of environmental, social, and governance (ESG) issues (see Companies Should Consider ESG Supply Chain
Issues). The COVID-19 crisis has shined a light on the critical
risks that companies face regarding their supply chains. As goods
have been delayed or become unavailable by the global shutdown,
companies have faced the challenge of finding alternative sources
of goods. “Near shoring” and building redundancy and
resilience in supply chains has become a key strategic concern. The
pandemic has been a stark reminder to companies of the importance
of managing their supply chains not only for cost and efficiency,
but also for resiliency and disaster preparedness.

Supply chain financing appears in the SEC’s and FASB’s
crosshairs

The pandemic has also raised concerns about the increasing use
of supply chain financing strategies.¹ Supply chain financing acts as
bridge financing to free up cash flow for companies and their
suppliers. Banks provide short-term financing, paying suppliers
early and at a slight discount, while companies pay banks later
than the original payment due dates – thereby freeing up cash for
companies.

Supply chain financing arrangements have come under SEC scrutiny
as questions have arisen about companies’ transparency in
disclosing the terms of the arrangements. At issue is whether
companies are accurately portraying their cash flow position and
revealing the role of supply chain financing in improving
liquidity.

Companies could also find themselves in a precarious position if
banks were to call payments due. The Big Four accounting firms and Moody’s have all expressed concern over
the accounting treatment of supply chain financing arrangements and
whether such arrangements should be carried on companies’
balance sheets as debt rather than accounts payable. The FASB announced last month that it will study the
accounting treatment of supply chain financing arrangements.²

Litigation risk arises when overseas suppliers get into
trouble

The focus on supply chains has increased scrutiny on the working
conditions of those in the supply chain, particularly workers’
human rights and the communities impacted by the supply chain’s
activities. This scrutiny has led to new regulation on modern
slavery diligence, and has prompted more companies to adopt human
rights policies. Further, connections are being made between
climate change and human rights, and claims have been brought
against companies related to alleged poor health and safety
conditions in their supply chains.

A closely watched case currently pending before the US Supreme
Court involves claims against Nestlé USA and Cargill for
allegedly aiding and abetting the violation of child labor laws in
their overseas supply chains. Similar claims were presented in
other cases involving Chiquita Brands and RJR Nabisco. The issues
presented to the Supreme Court are whether an aiding and abetting
claim against a domestic corporation brought under the Alien Tort
Statute may overcome the extraterritoriality bar, and whether the
judiciary has the authority under the Alien Tort Statute to impose
liability on domestic corporations. The case will be heard on
December 2, 2020.

The road ahead

The current focus on supply chains is likely to continue. Given
the risks involved with the governance and management of
increasingly complicated supply chains, companies are focusing
greater attention on the strategic design and management of their
supply chains. This focus includes:

• Assessing the resilience and contingency planning for key
  suppliers




• Scrutinizing supply chain financing arrangements and the
  disclosures related to such arrangements




• Ensuring that vendor contracts include protections against
  identifiable risks and agree with the company’s standards for
  its vendors




• Conducting rigorous supplier diligence to prevent environmental
  and human rights abuses that could subject the company to legal and
  reputational damage Latham & Watkins will continue to monitor
  developments in this area

Latham & Watkins will continue to monitor developments in
this area.

Footnotes

1. Supply-Chain Finance Is New Risk in Crisis,
Wall Street Journal (April 4, 2020).

2. FASB to Explore Greater Disclosure of Supply-Chain
Financing, Wall Street Journal (October 22, 2020).

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