Business Ethics Clauses in Supplier Contracts : Turning Responsible Conduct into Enforceable Obligations

Introduction : The firm is never independent of those people and other entities who help by supplying raw material and components, logistics, technologies, and any other services to make the firm work. Hence, the behaviour of the supplier can pose a threat to the business of the buying firm. Unreported payment of kickback for securing a government contract, unsafe working conditions, illegal exploitation of children labor, fake invoices, or retaliation to the complainant can interfere with business activities and affect the image of the buyer firm, although such corrupt practices take place in the facilities of the supplier. Ethical clauses in commercial agreements can handle this situation through specifying general behavioural norms and rules within the terms of a business agreement. Such ethical clauses may cover legal compliance, anti-bribery and conflicts of interests, labor and safety requirements, accounting, confidentiality, reporting, auditing, and other correction measures. But it does not mean that an effective ethical clause is defined solely through its wording. It should be understandable for the supplier, relevant to the risk, measurable and have legal remedies. This blog post is going to discuss ethical clauses under Indian law.

Legal Provisions

Indian Contract Act, 1872

The Indian Contract Act, 1872 is the basic law that deals with the issues of contractual liability and remedy. Section 10 describes the essential requirements of an agreement to be considered a contract and the requirements are that there should be two or more parties who are competent, there must be free consent, lawful consideration and object and Section - 23 deals with agreements which have consideration and objects which are unlawful. Sections - 73 and 74 cover the issues of compensation for losses arising due to the breach and compensation if there is a named amount in the contract or if a penalty is stated. This law plays an important part in case of any action for breach by a buyer against warranties given by the supplier or in case of compensation under a termination clause. The ethics clause must define the conduct which is prohibited and the consequences of breaching it.

Anti-bribery and corruption

Prevention of Corruption Act 1988 applies when the supplier is engaging in the bribery of public servants. Sections - 8 and 9 deal with offences that involve bribery of public servants and section 10 covers persons who have control of the commercial organisation in situations described in the Act. A supplier clause could cover bribes, kickbacks, and other improper advantages offered directly or indirectly through agents and intermediaries. The clause could also provide for proper record keeping, disclosure of demands for improper payments and cooperation with investigations. A contractual undertaking cannot substitute an effective compliance programme. The buyer has to assess risks arising from intermediaries, communicate standards to its employees and suppliers, maintain necessary documents and act upon credible allegations. International contracts could be governed by other laws. As an illustration, section - 7 of the UK Bribery Act 2010 deals with the failure of a commercial organisation to prevent bribery committed by persons associated with the business subject to certain defences on the grounds of appropriate procedures.

Labour rights, child labour and workplace safety

Ethical supply clauses normally deal with wage payments, working hours, non-discrimination, forced labor, harassment, child labor and safety in the workplace. The Child and Adolescent Labor (Prohibition and Regulation) Act, 1986 bans the use of children in industries and processes covered by the act and restricts the employment of adolescents in hazardous industries and processes. The Occupational Safety, Health and Working Conditions Code, 2020 is a consolidation of all laws pertaining to workplace safety and conditions of work. The relevant law, commencement clauses and rules for the particular establishment and obligation must be ascertained under Occupational Safety, Health and Working Conditions Code 2020. International labor standards can assist in formulating expectations from suppliers. The Declaration on Fundamental Principles and Rights at Work adopted by the International Labor Organisation recognises the right to association and collective bargaining, ban on forced and child labor, non-discrimination and safe working conditions as fundamental principles. These standards could be used for formulating a supplier code, but care must be taken to separate international guidelines from obligations under Indian law in the contract.

Responsible business conduct and due diligence

Guidelines for Responsible Business Conduct by the Organisation for Economic Cooperation and Development (OECD) cover human rights, labor, environment, bribery, disclosure, and supply-chain due diligence. OECD Due Diligence Guidance provides a risk-based framework that includes embedding responsible business conduct in policies, identifying and assessing the adverse impacts, preventing or mitigating such impacts, reporting on how the impacts have been managed and providing for remediation as needed. These are merely guidelines and not a substitute for the Indian legislation that applies in this regard. The strength of these resources is that they provide a framework for overseeing the suppliers.

Legal Analysis

Draft clear and measurable obligations

A clause stating that the supplier must “maintain the highest ethical standards” appears broad, but in fact provides little direction when conflict is encountered. A better clause sets out the conduct that is expected, references the relevant law, includes an explicitly identified supplier code and outlines how changes to the code are to be implemented. The core requirements may include a prohibition on corruption, keeping accurate records, reporting material conflicts of interest, avoiding retaliation  and compliance with relevant labor and safety laws. The standards should also address the specific relationship. A supplier that deals with public officials and/or provides labor intensive products and services will need more controls than one that provides low-risk office supplies. Risk-based requirements provide a realistic standard for compliance and allow the purchaser to apply their limited resources accordingly.

Separate signing warranties from ongoing duties

The representations can include, for instance, statements by the supplier that it has provided full disclosure about any known material investigations or policies dealing with bribery. Additional covenants can obligate compliance during the term of the agreement, as well as immediate reporting of any credible allegation of wrongdoing and cooperation with reasonable investigations. It would not be necessary to require the supplier to provide an impossible assurance that there was never an infraction, regardless of how far away from the business it occurred in the supply chain.

Make audit rights useful but proportionate

The audit right allows the buyer to check on the fulfilment of contractual agreements. An audit right clause can include provisions for an audit that is carried out on reasonable notice, access to records that are needed for the audit, and access to those individuals who will provide relevant information. The audit right clause should include details regarding the scope of the audit, the manner in which any problems identified during the audit will be resolved, who will bear the costs of the audit, and protection of confidential information if any. A more limited audit on shorter notice can be allowed if there is credible evidence of some wrongdoing. Unlimited access to records and premises at any time could create operational difficulties and might reveal information that is irrelevant.

Use proportionate remediation and remedies

An insignificant breach in the record keeping process does not always warrant the same penalty as bribery, intentional misrepresentation, or other serious violations of labor laws. The contract could include provisions for cure periods for remediable breaches and suspension or termination for serious breaches as agreed upon. The remediation process could outline what needs to be done, who is responsible for carrying out the process, deadlines, and how the process has been completed. Remediation should take into account the people affected by the misconduct, not merely the interests of the buyer. Terminating the supply contract may sometimes make conditions worse for workers or move the malpractice elsewhere in the supply chain. The decision must be recorded and proportionate to the gravity and persistence of the breach. Sections 73 and 74 of the Contract Act become relevant when seeking compensation. The amount stipulated cannot be recovered just because it is there in the contract. While drafting the contract, the parties must look into the legitimate commercial use of the remedy, probable loss, and reasonableness of compensation under law.

Flow down standards to subcontractors

Subcontractors may include labour contractors, agents, and secondary suppliers. Flow-down clauses will require the supplier to disclose the standards and ensure the inclusion of the same obligations within relevant subcontracts. Such clauses will have to define the scope of subcontractors included as well as notification regarding any substantial changes to the supply chain process. The supplier has to continue being responsible for its contractual obligations, while the purchaser has to stop trying to have complete control over remote parties when it is not possible. The risk-based approach may include the identification of major subcontractors, due diligence proportionate to risk, and action on serious risks found. This approach corresponds to the OECD's focus on the identification and management of adverse impacts resulting from the relationship.

Case law and enforceability

In Central Inland Water Transport Corporation Ltd. v. Brojo Nath Ganguly, the Supreme Court dealt with an unconscionable contract provision where there was inequality of bargaining power. This case law does not suggest that all stringent supplier ethics clauses are unlawful. It certainly indicates, however, that the issues of clarity and reasonableness, especially in cases where an unequal buyer places many obligations on a small supplier, may merit consideration. In Fateh Chand v. Balkishan Das, the Supreme Court dealt with Section 74 of the Contract Act, and explained that a stipulated sum does not automatically become payable simply because the contract refers to it. This is important when a supplier agreement contains a clause on fixed compensation in case of non-compliance. Such a clause has to be assessed against the statutory norm and the circumstances of breach, without a presumption that any penalty in it will necessarily be paid. These are cases dealing with general principles of contract law, not supplier ethics provisions specifically. However, they may be relevant as an analogy, as the clauses have to be clear and legally enforceable. One should obtain professional advice with respect to a specific agreement and circumstances before relying on a provision.

Practical Implications

Supplier ethics provisions should be included in the purchasing process for organisations and not just left to gather dust as boilerplate provisions. Prior to signing any contract, the purchasing organisation should analyse the geographic location of the supplier, its products or services, its use of labor contractors, its dealing with government officials, and its dependence on subcontractors. A supplier with minimal risk might just require a short survey and a written pledge from it. There should be an allocation of roles with regard to training, reporting, documentation, investigations, and remediation. There should also be a means of how issues can be raised without the possibility of any form of reprisal. The procurement, legal, compliance, and operations team need to discuss who will review the allegations and who can authorise the suspension or termination. The supplier should also know what is expected from them. By allowing the supplier to see the code, telling them how the audit will be done, and giving them a realistic way to solve remediable issues, compliance will be achieved. It will take some time for small suppliers to put their system in place, but cost or convenience cannot serve as an excuse for any unlawful behaviour.

Conclusion

Though business ethics clauses can institutionalise good behaviour through contractual obligations, their effectiveness goes beyond just having good language. The Indian contract law is the overarching body of law providing the framework for enforceability, and the anti-corruption, labor and workplace safety laws provide guidance on what the suppliers could be asked to comply with. The resources of the OECD and ILO are very helpful in identifying risks and developing responsible supply chain behaviour. The clause should have specific duties, risk-oriented audit rights, realistic flow-down requirements, effective remediation mechanisms and legally defensible sanctions. And yet the supplier’s situation must be considered without sacrificing any fundamental principles of law. Once this framework is embedded into the procurement process and actively monitored, it will help organisations minimise legal risks and be more responsible in their business relations.

Author: Mohith Nandi in case of any queries please contact/write back to us via email to content@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney

Endnotes

1. Indian Contract Act, 1872,  Section 10, 23, 73–74 (India). India Code.

2. Prevention of Corruption Act, 1988, Section 8–10 (India). India Code.

3. Bribery Act 2010, c. 23, Section 7 (UK). legislation.gov.uk.

4. UK Ministry of Justice, Bribery Act 2010 Guidance.

5. Child and Adolescent Labour (Prohibition and Regulation) Act, 1986 (India). India Code.

6. Occupational Safety, Health and Working Conditions Code, 2020 (India). India Code.

7. OECD, OECD Guidelines for Multinational Enterprises on Responsible Business Conduct (2023).

8. OECD, Due Diligence Guidance for Responsible Business Conduct.

9. International Labour Organization, ILO Declaration on Fundamental Principles and Rights at Work (1998, amended 2022).

10. International Labour Organization, A Safe and Healthy Working Environment as a Fundamental Principle and Right at Work.

11. Central Inland Water Transport Corp. Ltd. v. Brojo Nath Ganguly, (1986) 3 SCC 156 (India).

12. Fateh Chand v. Balkishan Das, AIR 1963 SC 1405 (India).

13. International Labour Organization, Conventions, Protocols and Recommendations.