Distributors invest significant amounts of time, effort, and capital to build stellar reputations. Each task of that investment – whether directed to customer service, value add, warehouse efficiency, technology capability, or otherwise, is in play. Because of these investment undertakings, opportunities surface regularly to build on your market channel status and to grow your distributorship – whether through new relationships involving manufacturers, suppliers, vendors, or other business partners – all of which require serious scrutiny. That is, not only can a distributor’s reputation be damaged by associating with the wrong supply chain or other parties (e.g., guilt-by-association), but it also can be injured by the wrong affiliations (e.g., ones that under the microscope are not legitimate – for many reasons).
So, no matter how attractive or lucrative a potential business relationship may appear at first glance, it is essential that distributors vet any putative business partner and conduct necessary due diligence. For example, the political, economic and/or associate status of such a party can be a force of destruction if not handled properly.
How a Sketchy Supply Chain or Other Partner Can Leave You Holding the Bag
Let’s say a low-cost overseas manufacturer reaches out to you seeking a domestic distributor. Perceiving it as a good opportunity, including expanding your current or future customer base (especially with product(s) synergistic with your current line card), you partner with the entity, and undertake to build momentum, moving their product for a year or more without incident. But suddenly, a press inquiry or report breaks about how the products are produced under exploitative labor conditions (or were garnered improperly, referencing political influence or tying their production to illegal graft). Then, another report comes out about how those products contain toxic or carcinogenic substances that run afoul of health, safety, and/or environmental laws and regulations, and may have made several users or consumers ill.
Soon thereafter, your company is on the receiving end of one or more consumer class-action product liability demands and/or lawsuits, the subject of governmental inquiries (e.g., the FDA, FTC, state attorney or secretary of state ingestions, etc.), and the target of deep concerns from other supply chain partners who want to avoid these “associated” troubles. Meanwhile, your connection to the manufacturer (or other supply chain partner) and its agents dry up, and/or are lost, unreachable, untouchable, and/or unaccountable, leaving you with little recourse to recoup any losses, no matter how robust are the indemnification or warranty provisions of any written relationship agreement.
Without question, an unfortunate business that becomes ensnarled with government investigations and/or likely forthcoming lawsuits from that investigation will need to engage costly counsel, involve their insurers, expose their senior executives, and thwart off indemnification claims. This is true regardless of how “clean” your distributorship’s own hands are. Such happens regularly.
Product Liability Lawsuits and Governmental Meddling
In the above scenarios, the product liability implications for distributors arising from their moving a dangerous or defective product to market are well-established. Under established legal principles recognized in most states, a distributor who places a defective product into the stream of commerce can be held liable to injured users/consumers, even if the distributor played no role in manufacturing the defect.
It is easy, in this situation, for the distributor to become the deep pocket – at the same time your insurance rates climb, your legal fees and other costs mount (e.g., public relations counsel), and your name is subject to serious false light and reputational damage, arguably for problems with a product that you as a distributor not only did not design or manufacture, but provided no material value added services.
This kind of exposure can pale in comparison to the host of federal and state regulators, which, under applicable regulations can create additional legal, financial, and reputational headaches if not nightmares for distributors arising from the acts or omissions of a dubious manufacturer or supplier, or other supply chain partner, as to which regulators will target the most accessible, public and solvent target. Distributors are middlemen and in the final analysis, can easily get snared in such troubles.
Vetting Best Practices Are Neither Complex Nor Expensive
The good news for distributors is that a rigorous vetting and due diligence program doesn’t require an army of investigators, accountants, or lawyers. Instead, it is a matter of thoughtful inquiry, consistent processes, and a healthy, preventive dose of skepticism. Before executing any agreement with a supply chain vendor or other party, even if publicly traded, check them out and get up-front answers to key, but simple questions to avert the kinds of concerns detailed above. For example:
- Make it clear that, as part of your standard operating procedures, you need detailed information about a potential partner before you an consider any serious legal commitments, and ensure you get such information.
- Utilize publicly available information, as such information is not only readily available, but also contains key details of your potential partner company in public filings.
- Ensure that prospective business partners complete a written disclosure form that makes inquiry about such items as business structure and ownership, years in operation, key customer references, certifications and regulatory compliance history, insurance coverage, and any pending or prior litigation. Requiring disclosure in writing creates a legal record, and misrepresentations on that record can form the basis for rescission of a contract or fraud claims down the road.
- Verify financial information – while an ordinary ask in this process are financial statements of a potential supply chain partner, verify anything provided to you, even under confidentiality (without violating any provisions of an NDA or similar agreement), including commercial credit reports, litigation history, and other information that can ensure your partners can fulfill the commitments they are making to you, and then lock those up in writing.
- Don’t rely on the party’s representations alone for your vetting. Search court records for civil judgments, bankruptcies, and criminal proceedings involving the business and its principals. Check the federal System for Award Management (SAM) debarment list. Review state licensing databases. For international suppliers, consider engaging a due diligence firm within the country of origin to obtain current, relevant information.
- Finally, should a potential significant partner come to the table to negotiate an agreement, ensure your contracts require partners to notify you of material changes to their business, including changes in ownership, regulatory actions, and significant litigation. Include audit rights that allow you to inspect compliance at reasonable intervals. Consider requiring annual recertification of key representations. And maintain a watch-list process so that news about your active vendors surfaces to someone who can act on it.
Independent Expert Consultation
The use of independent investigators or other sources should not be overlooked, and, in fact, is often a recommended step when counseling clients on new partners or potential relationships. Not only can independent investigators corroborate what you believe a business partner is all about but also uncover valuable information that could fully adjust how you proceed with a potential partner. What trained, competent investigators can unveil will in most cases give you information that even you did not expect to review and/or discover and can lead to at a minimum a meaningful basis to further investigate and/or vet a potential business partner. These partners work confidentially for you, and can easily access, compile and decipher what otherwise might be publicly available information – from BBB complaints to criminal records, to litigation and public filings, and the list goes on, frankly endlessly.
Ongoing Monitoring
Vetting isn’t a set-it-and-forget-it proposition; it is simply a snapshot in time. Business circumstances change. Ownership structures shift, and financial and market conditions deteriorate. A supplier who passes scrutiny today may be in bankruptcy or some other insolvency proceeding months later. Continuing follow up is, as a practical matter, key to minimizing risk and ensuring long standing, valuable relationships, without having to risk your own businesses reputation and/or its entanglement in any number of state, federal or international investigations, reporting or other risks that could lay waste to the goodwill you have worked years to garner.
Proper vetting of suppliers and other partners is as essential to your business’ reputation and success as any of the other efforts you make each day to build trust with business partners, customers, and others up and down the supply chain. If you have questions or would like assistance developing a robust vetting program, please contact me at 312-840-7004 or fmendelsohn@burkelaw.com.
