The Importance of Conducting Due Diligence on Your International Distributor
Many U.S. companies, including franchisors, conduct rigorous internal compliance programs to better ensure their adherence to the U.S. Foreign Corrupt Practices Act (FCPA). Similar laws prohibiting corrupt acts include the U.K. Bribery Act, which has the same international reach as the FCPA and additionally includes commercial bribes. FCPA makes it a crime to promise, offer, or make a bribe directly or indirectly to a foreign official to retain business or to secure an improper business advantage.
Some of those same franchisors (and others who may believe that simply selling or shipping goods internationally does not trigger such anti-corruption and anti-bribery laws) will fail to ensure that their international distributors also adhere to the laws' requirements and, importantly, fail to appreciate that they can be held responsible for violations of such laws by their international distributors.
What is also true is that FCPA enforcement by the U.S. government is alive, active, and well. There remains an appetite for large fines and increasing multiple prosecutions because of the adoption of FCPA-like laws in many countries.
To that end, every franchisor should consider the following guidelines for adopting a sound approach to compliance with the FCPA, with a special focus on dealing with international distributors.
- Clearly understand how products are delivered to end users and confirm the existence of any intermediaries, including distributors, sub-distributors, resellers, sales agents, and representatives.
- Prohibit use by distributors of sub-distributors, resellers, sales agents, representatives, or other intermediaries unless each has been investigated by the distributor based on the franchisor's standards (including the items noted below) and has been approved by the franchisor.
- Create and enforce participation in a compliance program that takes into consideration the most stringent requirements of the FCPA and the U.K. Anti-Bribery Act. The FCPA has two parts. The first prohibition concerns government officials, candidates for public office, political party representatives, and certain public organizations. Basically, any attempt to influence government officials to secure some type of action by that official in return for any kind of payment by a franchisor or a distributor could violate the FCPA. What is gained does not matter - it can be an action resulting in a new contract, lower costs, rates or duties, a material license, or permitting a higher sales price. Payment can include anything of value including cash, entertainment, and promises of future employment.
FCPA: Further caution advised
The second part of the FCPA deals with books and records and internal accounting and control requirements. Although the latter applies only to public companies, most U.S. companies adhere to the best practices standard of complying with these requirements as well.
Importantly, as all of this relates to relationships with distributors, the FCPA prohibits payments made through a third person. The FCPA also applies where payment is made while "knowing that all or some part of the payment will be made to a government official." The "willful blindness standard" can apply when a franchisor fails to conduct adequate due diligence on a distributor or sales agent. It does not matter whether the bribe was successful or originates with someone other than the person actually making the bribe, including an intermediary like a distributor or agent.
Failure to comply with the FCPA can carry severe consequences including fines up to $2 million per incident; and up to 5 years of imprisonment and fines up to $250,000 per individual.
The compliance program should be coordinated by a designated person in charge with sufficient resources and pursuant to a written code or policy of conduct that spells out the anti-corruption policies in a clear, concise, and accessible manner.
9 tips for compliance
It is a given that any company should know how its funds are being disbursed and have assurances that its interests, including the interest of avoiding crimes, be implemented. This is especially the case for companies that have employees or use intermediaries located far from corporate headquarters. So with respect to distributors used by U.S. franchisors or their U.S. and international franchisees, a robust compliance program should also include the following action items:
- Vetting the distributor by conducting a thorough due diligence investigation, including completion of a questionnaire; initial and periodic background checks into the distributor entity and principal owners' reputation; and confirmation of any civil, criminal, bankruptcy, or other activity that may be applicable to the distributor and its owners.
- Maintaining the ability to justify the retaining of the intermediary based on the vetting exercise.
- Visiting the distributor on-site to verify the legitimacy of the distributor's claims.
- Obtaining and verifying references, including checking databases for illegal or improper activities; checking with various government agencies such as the State Department, applicable U.S. embassy, and U.S. Department of Commerce; and checking with local regulators with respect to any reported improper activities.
- Educating and training the employees who have contact with international distributors, training the distributors, and requiring the distributors to train their employees about compliance with anti-corruption laws.
- Including anti-corruption and bribery language prepared by international contracts legal counsel in all international distributor agreements requiring adherence by the distributor with compliance with the laws, reporting as required by any FCPA training program, and the ability to terminate the distributor if violations are discovered.
- Ensuring the distributors' customer margins, and any other compensation paid to them, is reasonable and customary.
- Having controls in place to raise red flags; and addressing them promptly, with the help of internal audit or finance departments equipped with proper resources to regularly monitor, report on, and document compliance by distributors.
- Having a mechanism that enables confidential reporting without fear of retaliation is essential.
Taking these steps will permit the franchisor to better identify distributors or other agents that appear likely to violate anti-bribery laws, thereby isolating potential rogue distributors and agents. Lower-level players will not normally require this breadth of inquiry, but for any major players, such as a sole or exclusive distributor, the inquiry should be commensurate with the distributor's or agent's role.
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