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The German Supply Chain Law and its effects on German business in Asia-Pacific

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last updated on 5 May 2022  | reading time approx. 4 minutes


The Asia-Pacific region is by far the most important economic region for German companies in the world. According to the German Federal Ministry for Economic Affairs and Energy, over 15 per cent of German exports went to Asia and over 21 per cent of imports came from Asia in 2020. Germany's most important trading partner remains China. India and the member states of the Southeast Asian association ASEAN also play a relevant role in German foreign trade. The new German Supply Chain Act (“Gesetz über die unternehmerischen Sorgfaltspflichten in Lieferketten”, short: LkSG) will have an immense impact on German business in Asia. The law, which is based on international standards in the area of human rights and environmental standards, will apply to a politically, socially and economically complex region. Obtaining an overview as a German company and ensuring compliance under the LkSG might perhaps become one of the major challenges for German legal and compliance departments in the coming years. Below are some considerations for the practical implementation of the new requirements.




Assessing Risks

The countries in the Asia-Pacific region differ greatly in their history, legal systems, political systems, and socio-economic realities. The international agreements on which the LkSG and its compliance requirements are based on have not been fully ratified and implemented in the Asia Pacific countries. Caution is also advised with signed and implemented agreements, because the effective regulatory enforcement varies greatly in the various Asian countries. In addition to the general implementation of the LkSG in German companies (e.g. responsibilities, internal procedures, etc.), the first step should be to understand your own supply chain and analyse the country- and industry-specific risks.


Ratification status of concerned international agreements in Asia-Pacific



Considering the procurement structures

The LkSG does define three different levels within a supply chain (own business, direct supplier, and indirect supplier) and as such, companies should critically review their purchasing structures in Asia. Under the LkSG “own business” is specified as every activity of the company as legal entity which supports the company’s goals. Every activity, regardless of whether it is carried out domestically or abroad shall be covered under that definition. This means that for example a procurement department in an Asian subsidiary is covered under own business. The direct supplier is contractually or organizationally linked to an entity’s own business and is also subject to the obligations under the LkSG. Thus, a German company will need to deal with the compliance under the LkSG rather comprehensively with its direct suppliers located in the Asia-Pacific region. The local regulatory framework and culture differences might make the task complicated. The direct supplier differs from the indirect supplier, who is contractually connected with the direct supplier but not with the own business of the German company. Due to the limited scope for influence concerning the indirect supplier, the LkSG only takes effect if there is “substantiated knowledge” about a possible violation of protected rights under the LkSG. Hence, the distinction between a direct and indirect supplier is of high importance to the German company.

The LkSG expressly addresses that in the event of an improper structuring of the direct supplier relationships or transactions that serve to circumvent the obligations towards the direct supplier, the indirect supplier will be treated as direct supplier. The involvement of external procurement companies to shift compliance risks must therefore be carefully considered within the framework of the LkSG. External procurement companies that do not pursue any significant business activities of their own or that do not have a permanent presence in the form of business premises, personnel or equipment should therefore not be regarded as direct suppliers under the LkSG.


Addressing contractual risks

The comprehensive requirements regarding the due diligence of the direct supplier, who is contractually linked to the German company’s own business, requires a specific attention to the contractual framework between the company and the direct supplier. LkSG compliance should already be taken into account during the supplier selection and onboarding process. If the contractual relationship is stipulated with a supplier framework agreement, the LkSG compliance should address within a specific compliance clause. Existing agreements should be amended and supplemented accordingly. The formation of contract and the LkSG compliance is likely to be more difficult in the case of small-scale or often changing supplier relationships. On the one hand, the willingness of the supplier to comply with the LkSG is likely to be low. On the other hand, such LkSG compliance clauses would also have to be effectively included in the supplier contractual relationship. Pitfalls could arise, in particular due to the regional importance of the Common Law business hubs like Hong Kong and Singapore. Unlike in Germany, Common Law applies the “last shot” theory to conflicting terms and conditions, according to which the last referred terms and conditions within a contract negotiation apply as a whole. In typical procurement scenarios, this means that the German buyer first refers to its terms and conditions when placing the purchase order, but the Asian business partner then finally refers to his terms and conditions in the order confirmation (most likely without the LkSG compliance clause). In order to include such a clause and, perhaps, other matters, such as warranty periods, etc., into the contract, the buyer would have to contradict the supplier's terms and conditions again and refer to his own terms and conditions or at least make a partially contradicting agreement. Legal difficulties such as formal requirements, approvals and documentation are unfortunately inevitable. Thus, German companies should pay more attention to contract drafting, contract management and proper supplier selection to ensure LkSG compliance in their procurement activities.


Conclusion

German companies should address LkSG compliance in their business activities in Asia-Pacific extensively and strive for a comprehensive implementation before the LkSG comes into force in 2023 and 2024. Procurement activities should be accompanied by legal and compliance teams to avoid compliance risks. A focus on long-term supplier connections, as far as it is commercially possible, seems to be a sensible option for avoiding such risks.

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