On Third Party Compliance Management Practices Ⅰ

Due to the increasing focus of Chinese authorities on corruption cases, legal and compliance departments of many multi-national corporations (“MNCs”)in China are paying more attention to the timely discovery and effective prevention of commercial bribery and corruption. Llinks Law Offices’ regulatory compliance team will publish three articles as a series to analyze various difficulties and issues in formulating and implementing anti-corruption policies for MNCs in China. We hope that our readers will find these articles helpful from a practical perspective. This article is the third part in the series.
Chinese subsidiaries and branches of MNCs have to trade and interact with a variety of third parties in the course of their operations. If any of these third parties commits an act of bribery, receives bribes or acts as an intermediary for bribery, the good reputation of the MNC may be impaired. Even worse, the MNC may be punished by Chinese or foreign government anti-bribery authorities. Therefore, improving third party business compliance management plays an important part in the Anti-Bribery Compliance Program ("ABCP")of MNCs.
1、Risk Assessment
From the perspective of the ABCP of an MNC, third parties include the domestic shareholder(s)of a joint venture invested by the MNC, raw materials suppliers, logistics freight forwarders, customs agents, distributors or marketing agents, the third parties which provide intermediate services for the MNC’s business or transactions, customers, contractors or subcontractors of the MNC’s projects, or the co-bidders with the MNC. Third parties can take various organizational forms including limited liability companies, joint-stock companies, partnerships, and in very few cases, natural persons. Additionally, third parties can have different enterprise forms, including but not limited to state-owned, private-owned or multi-national.
MNCs should consider the following elements when formulating their Third Party Risk Management (“TPRM”)strategy: the competition level of the third-party trading market, the frequency of transactions (one-time or long-term regular transactions), the probability of bribery and corruption in the transaction areas, the association of the third party or its actual controller with the governing authority of the transaction, and the overall business compliance level of the third party’s operating area.
In order to use their compliance resources effectively, MNCs should formulate different TPRM models which are commensurate with the risk levels of the third parties. Specifically, for high-risk third parties, the management model can adopt onsite investigations. For medium-risk third parties, the management model can adopt document and material ‘red flag’ review. For low-risk third parties, the management model can include the third party conducting a self-assessment, and then submitting a self-assessment report and rectification plan.
2、Due Diligence in Advance
We advise MNCs to conduct due diligence in their first transaction with the third party, or in every transaction with a third party graded ‘high-risk’, for the purposes of managing their compliance risk. The scope and content of due diligence will vary according to the type of transaction and the functional role of the third party, but due diligence will usually examine the necessity, legality and reasonableness of such transaction with the third party. In the case of a third party that provides services to the MNC, due diligence will usually cover the following issues:
▼ Is the service lawful?
Taking the manufacturing and processing services of a medical equipment manufacturer as an example, relevant laws and regulations of the People’s Republic of China (“PRC”)prescribe a list of productions of high-risk implantable medical equipment, and prohibit toll manufacturing of such equipment. If the services provided by a third party are de facto original equipment manufacturing, such services are unlawful.
▼ Is the service a transaction that is prone to bribery?
Generally, services providing sales or project brokerage, joint bidding or assistance in bidding, assistance in obtaining customs, tax, visa or other licenses or permits, and travel, advertising, external training, media relations or external entertainment are regarded as highly risky areas prone to bribery.
▼ Is the third party service necessary for the MNC’s business?
In the well-known GlaxoSmithKline (GSK)case and in other commercial bribery cases, employees made up fictitious transactions with an independent travel agency to obtain cash for bribes or to bribe third parties through the travel agencies, for the purposes of eluding the supervision of their company’s ABCP. Therefore, due diligence should identify whether a transaction with a third party is necessary for the MNC.
▼ If applicable, is the third party obligated to obtain all necessary licenses or permits required by the relevant laws and regulations to provide the service?Is the third party service team competent enough to provide the service?
▼ Is the fee paid to the third party a fixed amount, or is it a certain percentage of the final transaction value?Is the payment in line with customary market practice?Has the amount of the payment deviated from the normal level of the market?
▼ Does the transaction contain any of the following ‘red flags’?
The MNC is required by the third party or its business personnel not to execute any written contract;
The overall risk of commercial bribery is high where the transaction is taking place;
The third party has a record of law-breaking or non-compliance in relation to business in the country of the transaction or other jurisdictions;
The third party is recommended by a government official or his or her close relative, state-owned enterprise or the MNC's director, senior manager or is the MNC’s customer, or is owned or controlled by the aforesaid personnel; and/or
The MNC is required by the third party or its business personnel to pay the service fee to another party rather than the third party.
3、Provisions on Compliance
After due diligence is completed, the MNC should formulate detailed compliance provisions in the transaction agreements with the third parties to effectively manage the risk of third party commercial bribery. In general, the compliance provisions should include the following clauses (for the sake of convenience, the MNC is referred to as the “entrusting party” while the third party is referred to as the “entrusted party” in the following clauses):
▼ Compliance with Laws Clause
This clause should express the entrusted party’s obligation to comply with all applicable anti-bribery laws in the transaction with the entrusting party. It is advisable that such clause should specify the Criminal Law of the PRC, the Anti-Unfair Competition Law of the PRC, the Interim Provisions on Prohibition of Commercial Bribery, the Foreign Corrupt Practices Act 1977 (United States)and the Bribery Act 2010 (United Kingdom). It is also recommended that such clause should include the general stipulation that the entrusted party shall comply with all applicable anti-bribery laws, local laws, departmental regulations, governmental policies and other applicable industry standards.
There may be some cases where, in practice, the entrusted party will resist inclusion of a clause mandating that they comply with the Foreign Corrupt Practices Act, the Bribery Act 2010 and other foreign laws because such entrusted party is unfamiliar with the foreign laws or internal approval requirements. In order to avoid protracted negotiations, we advise the entrusting party to directly incorporate the contents and requirements of foreign laws which it wishes to apply directly into the terms or appendices of the contracts.
▼ Compliance with MNC‘s ABCP Clause
In transactions with an entrusted party graded ‘high-risk’ (such as agents or dealers), in addition to the Compliance with Laws Clause, the entrusting party will usually require the entrusted party to comply with its ABCP. The ABCP clause sometimes is deemed as a standard clause in nature. Therefore, if the entrusted party is in violation of the ABCP, it will usually question the legitimacy of the ABCP in order to avoid responsibility.
We advise the entrusting party to expressly stipulate the following terms in Compliance with the MNC’s ABCP Clause: (1)that the entrusting party has provided a detailed description of the ABCP to the entrusted party; and (2)that the ABCP aims to encourage the entrusted party to comply with the relevant anti-bribery laws and business ethics rules, and does not exempt the entrusting party from liability, nor does it increase the liabilities of the entrusted party or exclude the main rights of the entrusted party, and the ABCP does not contain any content with the aforesaid effects.
▼ Payment Clause
In contracts with the entrusted party, the entrusting party should specify the basis for calculation of the purchase price, service fee, commission and other payments in the Payment Clause, to meet the reasonable requirements of the relevant anti-bribery laws and regulations. In the case of a service commission, the commission should be proportional to the amount of the service or sales provided and consistent with the normal level of the relevant market. In addition, in accordance with the relevant laws and regulations of the PRC, kickbacks or rebates paid “off the books” may be identified as commercial bribery. Therefore, the entrusting party and the entrusted party should correctly conduct proper bookkeeping when paying and receiving sales discounts, and issue invoices.
▼ Prohibition on Improper Payment and Bookkeeping Clause
This clause should state that the entrusted party shall not pay or promise to pay cash or property benefits to government officials, the governing authority personnel or the persons who have close relationships with the aforesaid people, or other institutions or individuals related to the transactions.
This clause usually states that the prior written consent of the entrusting party must be obtained before the entrusted party or its personnel can make a payment to related parties for the purpose of the transactions. At the same time, the entrusted party shall properly record the costs and payments in relation to the transaction in its financial books so that the entrusting party can conduct an audit.
▼ Audit Clause
TheAudit Clause should state that the entrusting party is entitled to audit theentrusted party’s financial books and records related to the transaction. Suchaudit may be conducted by the entrusting party's internal financial personnelor by other independent professionals. Generally, the scope of the audit shall includethe entrusted party's internal controls and implementation andtransaction-related costs, in particular the travel expenses of the entrustedparty's employees and entertainment expenses.
Inpractice, the entrusted party may agree to accept a special audit conducted byan independent professional, rather than disclose to the entrusting party thedetails of all costs and expenses related to the transaction. After the auditis completed, the independent professional will not disclose all audit details butwill merely inform the entrusting party whether there are circumstance where theentrusted party paid or promised to pay cash or property benefits to governmentofficials, governing authority personnel or persons who have closerelationships with the aforesaid people, or other institutions or individualsrelated to the transactions.
In addition, if theentrusted party and the entrusting party are competitors in the same industry,there exists a risk that the entrusting party may violate the anti-monopoly lawin circumstances where it audits and acknowledges the entrusted party’sproduction costs. In this case, we advise the entrusting party to engage an independentparty to conduct the audit.
▼ Termination Clause for Breach of Contract
This clause entitles the entrusting party to terminate the contract when the entrusted party violates the compliance provisions. This clause shall be separate and independent of other termination clauses in the contract.
Chinese courts have decided in some cases that, even if the parties have agreed to terminate the contract, the extent of default should be taken into consideration when deciding whether the non-defaulting party is entitled to exercise its termination rights or not. In this regard, we advise the entrusting party to require the entrusted party to make a representation and warranty of complying with the provisions of compliance in the transaction contract. Any act of the entrusted party that violates the representation and warranty would constitute a fundamental breach of contract, so the entrusting party is entitled to terminate the contract.
▼ Indemnity Clause
The Indemnity Clause should state that if the entrusted party violates the compliance provisions, the entrusted party shall compensate the entrusting party for all its losses suffered due to the entrusted party’s breach.
The Indemnity Clause is an Anglo-American legal concept, and may be independent of the underlying major transaction of the parties to the contract. In fact, if the transaction agreement is subjects to the laws and regulations of the PRC, it is likely that Chinese courts will not enforce the Indemnity Clause but will simply impose compensation liability upon the defaulting party where there is an actual breach of contract. Therefore, if the entrusting party wishes to adopt an Indemnity Clause in a contract, it may consider selecting an Anglo-American legal jurisdiction as the governing law. Under PRC law, a choice of foreign governing law is permitted where the contract involves “foreign elements”.
▼ Miscellaneous Clause
In addition to the aforesaid clauses, if necessary, the entrusting party should require the entrusted party to adopt an ABCP consistent with the entrusting party in the contract, and to encourage its employees to actively report any illegal activities. The Miscellaneous Clause can state that the entrusted party is obliged to accept the entrusting party’s continuous compliance training.
To be continued……