Archive for August, 2013

For a perspective on the legal issues related to private regulation in the case of the Bangladesh factory collapse,  please find this guest post by Caroline Kaeb:

America’s Corporate Shield and Europe’s Enterprise Responsibility

Following the Rana Plaza Disaster

By Caroline Kaeb

The author is Visiting Assistant Professor at Northwestern University School of Law.

On April 24, 2013, the Rana Plaza factory building came crashing down in Dhaka, Bangladesh. More than 1000 garment workers, who stitched garments to supply the stocks of major international brands, were crushed to death. Aside from the usual condolences, how did European and American retailers react? The answer: very differently.

The Rana Plaza factory collapse was a human catastrophe that unleashed a long overdue discussion about the progenies of economic globalization and the responsibilities of multinational corporations. It is often underestimated how deep the differences really are on these fundamental questions between the United States and Europe, both of which are home to thousands of global companies. The regulatory industry responses to this Corporate Social Responsibility challenge on either side of the Atlantic vividly illustrate the division of attitudes.

In the aftermath of the Rana Plaza disaster, Europe’s “Accord on Fire and Building Safety in Bangladesh” (the European Accord) established a legally binding agreement among major retail brands to ensure that safety standards would be implemented in their supplier factories overseas. More than 70 companies, largely from Europe, have joined the agreement.

In contrast, the “Alliance of Bangladesh Worker Safety” (the North American Alliance), which brings together 18 North American apparel retailers and brands, constitutes a voluntary commitment in classical terms. Some have argued that the plaintiff-friendly litigious system in the United States is the reason for U.S. retailers to join forces collectively in a voluntary initiative. Allegedly, a non-binding structure would prevent resources being sunk into litigation costs rather than being used to advance the primary purpose of the initiative, namely, to improve safety conditions in factories. Others defended the North American approach by claiming that the responsibility of major retailers is solely to be drivers of economic growth (through employment opportunities) in emerging markets, not (primary legal and financial) guardians for safety conditions in supplier factories. While these considerations offer important perspectives, they fall short of addressing the more fundamental underlying premises and drivers for the different regulatory choices on each side of the Atlantic Ocean.

Granted, the European Accord and the North American Alliance share many common elements of responsibility for the manufacture of major retail brands, such as inspection of factories, training, information sharing, and advocacy with local governments. However, the different underlying premises of the European Accord and the North American Alliance become painfully obvious with regard to the ultimate remedy for non-compliance with standards by local factories. Whereas North American retailers would terminate their contracts with non-compliant factories, European firms assume a form of legal and financial responsibility by seeking ways to improve safety standards. The European attitude is to lean forward (apologies to MSNBC), whereas the American attitude leans backwards and hides behind a corporate shield to avoid any meaningful responsibility. The Bangladeshi factory safety situation is emblematic of a much deeper division between European and American corporate thinking about the role, function, and responsibility of corporations as key players in a globalized world.

Many commentators have been mainly concerned with the fact that competing standards in response to the Bangladeshi crisis have generated confusion for factory owners and international brands alike and have made factories move in and out of compliance.  Although a multitude of different safety standards can slow down progress in creating a uniform standard, they also signal in this case a more fundamental challenge.

The core question underpinning corporate regulation is how and to whom responsibility ought to be attributed in legal, financial, and moral terms. Traditional corporate theory and law provides for an impregnable corporate shield of protection that allows major global firms to outsource, by contract, production to supplier firms in low-cost emerging markets without bearing the risk of legal responsibility for the acts or omissions of its business partners. This model has facilitated the modern-day supply chain management model that minimizes risk.

So it has been a bold move on the part of more than 80 major retail brands under the European Accord to assume legal responsibility not merely for their own acts but also for their business relationships in the supply chain. This is going well beyond what is required under the current state of the law, where the corporate veil protects parent corporations even from liability for their (partially- or wholly-owned) subsidiaries, which span the globe as a complex and neatly constructed network. With regard to contractual supplier relationships, the legal barrier erected acts as a corporate “shield” that offers strong protections from liability beyond the traditional parent-subsidiary “veil” of protection. In North America, companies have mainly held firm to the classical school of thought that, however tragic the situation of Rana Plaza in Bangladesh, the legal and financial responsibility for ensuring safety standards lies solely with the direct owners of local supplier factories.

Thus, while the European Accord defies traditional ownership structures in favor of the recognition of an enterprise-wide concept of responsibility (casting a long corporate “shadow”), the North American Alliance confirms the status quo attitude of parent company liability for its own conduct and no more. North American firms are wise not to ignore this discernible gap between European and American expectations regarding Corporate Social Responsibility, since Europe remains a key market for American multinational corporations. Their European branches and subsidiaries are bound by the laws of the European Union (and its member states) even if the European affiliate entities operate outside of the territory of the EU. (The prominent extraterritorial tendencies of EU law are examined in a forthcoming article, which I have co-authored, in the American Journal of International Law.)

The different standard-setting approaches taken by European and North American companies are indicative of more than just an occasional and random difference in methodological approach. Rather, the dissonance in corporate thinking is of systemic nature and engrained in the DNA of the respective legal systems, societal norms, and history.

Unlike the United States, many European countries have a long tradition of stakeholder-sensitive corporate models and governance structures. The latest example is the United Kingdom, where the Commercial Act in 2006 UK was amended to extend director’s fiduciary duties to include stakeholder interests.  Further, the rise of “enterprise entity” theory in European circles has reinforced corporations’ responsibilities for their stakeholders. Under that doctrine, multinational corporations are seen for what they really are: economically integrated enterprises that comprise a complex world-wide network of subsidiaries, affiliate entities, and business relationships.  They are all stitched together by a European understanding of responsibility stretching far beyond the corporate shield so cherished in American law.

The European Court of Justice, as the highest court in Europe, has applied (at a jurisdictional level) an enterprise entity test in the context of EU antitrust law with the result that a non-European parent company can be held accountable for their anti-competitive behavior conducted through a European subsidiary. The European Accord shows that European corporate thinking has embraced the notion that a multinational corporation, as
a corporate group, is its own entity with distinct legal and moral responsibilities based on the reality of an economic unity between the parent company and its affiliate units. This indicates an increasing awareness that the traditional model of single unit limited liability companies may no longer be an accurate reflection of the new realities of complex corporate group structures, particularly when it comes to questions of Corporate Social Responsibility.

Considering that legal risks under the enterprise entity doctrine are still more the exception than the rule, there is a clear reputational risk for multinational retail brands that contract with supplier factories violating safety standards and endangering workers’ lives and health. European retail companies have understood the signs of our time where social expectations for global corporations have raised the bar beyond archaic legalistic compartmentalization of corporate groups with siloed or disjointed affiliate entities and without an overarching umbrella (such as an enterprise) responsibility for acts occurring within the group structure. European corporate thinking is following in the footsteps of the latest UN guidelines on business & human rights, according to which corporate responsibility exists not only for a company’s own business activities but also for its business relationships, primarily within its supply chain.

However, the United States has not been entirely immune to the imminent shift in social expectations and possible implications for legal responsibilities of global brands. Thus, in its decision in Baumann v. Daimler, the U.S. Court of Appeals (9th Circuit) has challenged the holy grail of “corporate separateness” by arguing that a subsidiary is an agent of the parent company if the subsidiary’s activities are “important to [the parent] [in a manner] that they would almost certainly be performed by other means if [the subsidiary] did not exist.” At least for subsidiaries in key markets, this requirement seems almost always to be met. Bauman v. Daimler has been accepted for review before the U.S. Supreme Court, which will be entrusted with the difficult task of deciding how impervious the corporate veil really is within the parent-subsidiary relationship. While under an American understanding legal responsibility normally extends, at most, to a company’s subsidiaries, the Europeans have extended legal responsibility well into a company’s contractual business relationships.  Corporate responses to the Bangladeshi disaster show that European sentiment seems to have transcended beyond the corporate shield of outsourcing practices by promoting legal responsibility for the failures and misconduct of contracted suppliers.

The regulatory actions to the Bangladeshi garment factory safety crisis have demonstrated that there is a broad gulf between Europe and the United States with regard to the expectations of global business acting as global citizens. This is not merely a disagreement about form in terms of legally binding versus voluntary commitments. Rather, it is a divergence on fundamental questions concerning the role of corporations in society generally and, more specifically, the responsibility of multinational corporations to perform with a social mandate in their network of global business relationships.

The European experience provides an important lesson for North American firms. In times of almost instant information flow through the internet, news outlets, and social media, it is more important than ever for companies to employ a comprehensive risk calculus. This should include financial as well as so-called “soft risks,” such as environmental and social factors, for their enterprise-wide operations. Soft risks can quickly translate into significant reputational damage that has the potential of causing serious harm to the company value for its shareholders. This is the very interest that ought to be protected by the limited liability structures created through the doctrine of “corporate separateness” and outsourcing practices. The public sentiment and government position in the United States about the responsibility of corporations also has started to change slowly but surely. The California Supply Chain Act is a prime example.

It is certainly fair game for companies to stick to a narrow compliance understanding until statutory law lays out legal obligations for them to take responsibility. This would mean, however, passing over the opportunity to distinguish themselves from competitors, build a strong consumer brand, and generate resilience capacities. Rare is the day that any company receives an award or praise for merely complying with the law, which is expected of every citizen of society as a baseline form of compliance. Companies should seize this opportunity to write their own stories as proactive members of not merely the global economy, but also of global society.


Read Full Post »

Private Regulation on the Rise

Public opinion, activism compel companies to demand changes in overseas plants; critics question legitimacy of deals

August 18, 2013

This Op – Ed originally appeared in the Chicago Tribune on August 18, 2013.  This is, in part, a response to an op-ed in the FT:  http://www.ft.com/intl/cms/s/0/3571cd26-ed75-11e2-8d7c-00144feabdc0.html#axzz2cRgaKl1O

By Daniel Diermeier

It often takes a human tragedy to put an issue on the agenda. The Rana Plaza factory collapse that killed more than 1,100 in Bangladesh was the deadliest disaster in the garment industry’s history.

European companies that outsource clothing manufacturing to Bangladeshi factories agreed to a new safety and working conditions code. U.S. companies stayed out, citing liability fears, and came up with an alternative plan.

This is not an isolated case. This year Apple and its main manufacturing contractor, Foxconn, agreed to improve labor conditions at Chinese factories. This decision followed months of controversy over alleged illegal overtime and poor worker housing, as well as a string of reported suicides. Wal-Mart also has embraced sustainable supply chains after it faced controversy over environmental issues.

These cases illustrate an important phenomenon: the rise of private regulation of world commerce.

This regulation is fueled by activists, social media and public outrage. Many multinational companies now require their suppliers comply with global standards ranging from safety to labor conditions to minimum wage levels. Such requirements are not required by local law. Indeed, they usually dramatically exceed local practice. These rules and regulations have the same practical impact as traditional governmental regulation. A manufacturer that does not comply with Wal-Mart’s environmental standards may be shut out from the U.S. market.

Governments play little to no role in such agreements. They are negotiated and enforced by private parties: companies and activist groups. This new form of regulation has sparked controversy. Recently, economists Jagdish Bhagwati and Amrita Narlikar have accused activists of bamboozling retail companies into taking responsibility for safety at garment factories, a burden that should rest on the factory owners. Exit doors existed, the scholars wrote, but managers closed them.

It is true that activists choose their targets for maximum impact, often focusing on famous consumer brands rather than the worst offender or the local manufacturer that has operating responsibility. My colleague Brayden King’s research finds that when a company is boycotted, the targeted company sees an average decline in its stock price of 0.7 percent for each day it receives national media coverage. A company’s decision to give in may mainly be the result of comparing the costs of compliance with the risk to its reputation if it keeps fighting.

Battles between companies and advocacy groups are “private politics,” contests fought between interested parties in the arena of public opinion. As with all forms of politics, they involve campaigns, deal-making, and the art of the possible. Some critics question the legitimacy of such arrangements. They may have the same consequences as public regulations but do not involve elections and due process.

Nevertheless, private politics increasingly plays an important role where traditional regulatory approaches are absent or ineffective. Plagued by corruption, or simply the lack of state capacity, governments may be unable or unwilling to regulate. Safety and labor standards in diamond mines will not be enforced unless there is pressure from their customers — multinational companies that care about their reputation.

Bhagwati and Narlikar raise the prospect of companies pulling out of Bangladesh, now that they are on the hook for safety. Workers would lose their jobs, and in fact, Disney announced in May it would stop using Bangladeshi suppliers. That is why it is better for private regulation to extend across an entire industry, and not just apply to one country. Standards should apply to all suppliers, not just those in Bangladesh, which would lessen the incentives for companies to exit.

As with any form of regulation, private regulation can burden companies, their suppliers and customers. Yet such costs can be more than offset by social benefits such as a cleaner environment or the protection of human rights. In a world of expanded media coverage, globalization and rising public scrutiny of companies, private regulation will only grow. Companies need to be ready for this challenge. Simply ignoring this phenomenon will not make it go away.

Daniel Diermeier is IBM professor of regulation and competitive practice and director of the Ford Motor Company Center for Global Citizenship at Northwestern University’s Kellogg School of Management.

Read Full Post »