Key Points
- New laws in major jurisdictions make it vital that companies examine their supply chains closely for legal vulnerabilities. This entails due diligence on environmental and human rights issues, and compliance with new import controls and national security-based restrictions.
- Three new EU laws, which will apply to many non-EU multinationals as well as businesses based in Europe, have the broadest reach. They will require companies to have a deep understanding of both their upstream and downstream chains for human rights and environmental and sustainability impacts.
- The U.S. import and export laws on forced labor and technology can complicate dealings with China.
- Many of these laws allow for large fines and a key EU law authorizes private individuals and organizations to sue companies for failing to perform due diligence.
The economic disruptions of the pandemic elevated supply chain issues on board agendas. A spate of new supply chain-related laws in major jurisdictions make the topic even more critical today. Expanding due diligence laws, import controls, national security-based restrictions and anti-money-laundering regimes are making it critical for boards to understand the potential legal vulnerabilities of their companies’ supply chains. This area can be expected to become a key component of the board’s overall risk oversight function, with failures to engage in such oversight subject to challenge.
The most sweeping legal change is the EU’s new Corporate Sustainability Due Diligence Directive (CS3D), which will soon apply to many multinationals, imposing unprecedented obligations on companies to understand their suppliers and customers, and the impact of those relations. Moreover, new tariffs and the other legal changes could prompt companies to alter their supply chains, potentially exposing them to new risks.
With all the new duties and restrictions, the risk of governmental investigations and litigation continues to grow.
The Backdrop
Considerations go beyond the purely financial, with geopolitical and climate risks increasingly at the forefront of thinking. Terms such as “reshoring,” “near-shoring,” and “friend-shoring” have become part of many politicians’ and directors’ lexicons.
By now, multinationals are familiar with conducting diligence to mitigate economic sanctions, export controls and corruption risks. But today there are the added components of human rights, national security and environmental regulations, which explicitly or implicitly regulate supply chains. Since a relevant portion of these new obligations will come into effect in 2027, companies must prepare now to meet their obligations and implement the relevant controls.
The EU’s Corporate Sustainability Due Diligence Directive Will Require Deep Supply Chain Diligence
The most comprehensive example of supply-chain regulation is the EU CS3D. The CS3D mandates that EU and non-EU companies with substantial business in the EU review their entire upstream and downstream chains of activities and address adverse human rights and environmental impacts, which may entail having to terminate contracts.
The CS3D comes in addition to the EU Corporate Sustainability Reporting Directive (CSRD), which will require many multinationals to prepare granular reports on the impacts of their upstream and downstream chains, and the EU’s Forced Labour Regulation, which will apply to any company supplying goods in the EU. See our Summer 2024 Informed Board article “Multinationals Face Challenges as They Prepare To Comply With the EU’s Sustainability Reporting Law.”
The CS3D and the forced labor rules will come fully into force in 2027, while EU companies will begin filing sustainability reports this year and many non-EU multinationals next year. Companies will need to monitor developments in relation to the CS3D and CSRD closely as they are currently under review by the European Commission and their scope will likely change.
Effective implementation programs to comply with these laws will likely give companies unprecedented insight into their supply chains, which could surface previously unknown risks and issues.
At the same time, legal developments in Australia, Canada, Mexico and the U.K. will also call for additional supply chain oversight, so companies operating globally will face increasing, and often differing, legal obligations regarding their supply chains.
US Laws Add Additional Regulatory Dimensions
The U.S. stance on China creates additional supply chain risks. U.S. Customs and Border Protection has long had the authority to detain merchandise that it reasonably suspects is the product of forced labor. However, since June 2022, companies importing into the U.S. must also take account of the Uyghur Forced Labor Prevention Act of 2021 (UFLPA), which established a rebuttable presumption that all goods made in whole or in part in China’s Xinjiang Uyghur Autonomous Region (XUAR) involve the use of forced labor. Inputs as diverse as cotton, polyvinyl chloride, aluminum and gold can taint merchandise if their production traces back to the XUAR.
To minimize the risk of detention or seizure, companies must proactively engage with suppliers, thoroughly map their supply chains and gather documentation for each stage of production.
The U.S. has also ramped up the use of its national security-based authority to prohibit the use of information communication technology or services (ICTS) products that are designed, developed or manufactured in China, Russia or other countries of concern. This power can be used to prohibit classes of transactions, such as the sale of vehicles with automatic driving or other communications technology that is designed or developed in those countries, or can be used to prohibit individual products utilized within U.S. IT infrastructure. These regulations, and their increased use, will raise the risks of putting any product development work in China or other countries of concern, or using ICTS products from companies that do so.
Furthermore, companies must adapt to new tariffs that the Trump administration has promised to impose, including those recently announced on imports from China, Canada and Mexico. Naturally, these may impact companies’ decisions about their supply chains. But switching to sources in novel or lesser-known markets or suppliers carries its own risks.
Enforcement and Litigation Risks Grow
Not only have new laws with supply chain implications proliferated, they increasingly have teeth, authorizing governmental enforcement and large fines.
For example, U.S. Customs and Border Protection denied entry to 1,864 out of 4,619 shipments detained under the UFLPA in 2024. More than 70% of the denied shipments by value arrived from Malaysia, Thailand, and Vietnam, demonstrating that the UFLPA extends past China to neighboring countries that may source goods from the XUAR. Indeed, since the UFLPA entered force in June 2022, the majority of shipments detained by CBP by value originate in southeast Asia. See chart below.
Under the CS3D in the EU, national authorities, who will enforce the Directive, will be able to impose maximum fines of at least 5% of the company’s net worldwide turnover.
Moreover, the law requires EU member states to ensure that companies can be held liable for certain damages resulting from intentional or negligent failure to prevent or stop adverse impacts in their supply chains — an unprecedented expansion of the scope of civil liability under EU law that significantly increases the litigation risk for companies. In addition, injured parties may be represented by trade unions or NGOs, and claimants will be allowed to seek injunctions, as well as compensation for losses. These measures will likely encourage litigation by activists and litigation funders, who will be able to bring claims (including potentially mass claims/class actions) on behalf of alleged victims.
Conclusion
Finally, the cost of not examining supply chain risks is not just fines or private damages. The ramping up of supply chain-related regulations, enforcement and scrutiny brings with it reputational risks, and can spur shareholder activism and diminish shareholder value for companies that are not prepared to meet new requirements. Already, U.K. companies accused of benefiting from modern slavery face reputationally damaging litigation and Fortune 500 tech and manufacturing companies are seeing increased scrutiny surrounding minerals they source from suppliers alleged to use forced labor in Africa.
So, while deep due diligence may be time-consuming and costly, the costs to companies of not gearing up to comply with the new expectations could be even greater.
View other articles from this issue of The Informed Board
- DEI Under Siege: A Guide to the Trump Executive Orders
- Trump 2.0 Antitrust Policy Is Likely To Be More Predictable but Not Lax
- How Best To Measure Your Board’s Effectiveness: FAQs
- Podcast: Is an Activist Targeting Your Company?
See all the editions of The Informed Board
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.