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