This post is the third in our series on navigating the landscape of US commercial contracts for international businesses. Here, we examine why rigorous counterparty due diligence is not just a compliance formality, but a strategic imperative.
Companies need to know their business partners. Before contracting with a US company—and throughout the contractual relationship—companies and their counsel should consider conducting careful due diligence to help identify and potentially mitigate the unique risks arising out of international business relationships, especially when those relationships intersect with the United States.
US connections can have unintended consequences. Companies typically accept tradeoffs when benefiting from US market access. As discussed in our prior post, any intersection with the United States brings with it possible litigation risks, particularly given the uniquely broad discovery powers, class action mechanisms, and statutory causes of action in US courts. US touchpoints may also trigger regulatory obligations, including rules governing sanctions and anti-bribery. Critically, a counterparty’s sanctions exposure or compliance failures, in certain situations, may be deemed to flow through to create liability that has nothing to do with a company’s own conduct. These considerations warrant knowing exactly who you are contracting with, because your counterparty’s problems can quickly become your own.
Start with the fundamentals. Public records typically are the best place to start, allowing you to research your counterparties’ financial health, litigation history, and enforcement record. Patterns of behavior like vendor payment delays and compliance shortfalls may telegraph potential risks down the road. Even social media presence can tell you about a company’s customers and public persona, which can help avoid conflict later on.
Follow the subcontracting chain. In cross-border contracting, subcontracting is par for the course, but companies may not have a clear view of all potential contractors prior to signing. Companies may be able to mitigate this risk by considering contract language carefully, including provisions concerning subcontracting, counterparties’ own diligence standards, and potential audit rights.
Dig deeper. Evaluating the risk of some counterparties and relationships may require information only available through direct requests to counterparties. This is especially the case for privately held companies, which may have only a limited public record, as well as for contracts for long-term relationships or those involving high-risk jurisdictions or subject matter.
Take ownership structures, for example. Not all US states require companies to publicly disclose their beneficial owners, and federal rules do not make beneficial ownership registries available to private parties. As a result, public-source diligence may not uncover whether a counterparty is made up of layered holding companies that could render it judgment proof in the event of a dispute.
Depending on the risks involved, careful diligence may entail thoughtful use of open-source intelligence combined with direct requests to counterparties. Assessing what level of diligence is appropriate, and what the findings mean in practice, will depend on your contract, your risk tolerance, and the specific commercial and regulatory landscape of the relationship.
Diligence is not a one-time exercise. Risk profiles shift, and inertia can make changes harder to act on. So while diligence should begin early, companies should consider continuing diligence through the life of a relationship. Counterparties acquire new liabilities, enter new markets, or restructure in ways that may alter risk exposure under existing contractual relationships. Negotiating audit rights and conducting regular screenings of counterparties are among the tools that can be used in appropriate situations to turn diligence from a pre-signing checklist into a living process. It is that ongoing discipline that separates companies that manage risk from those that merely react to it.
For international businesses, counterparty due diligence typically is not a one-time, one-size-fits-all exercise. It is a dynamic discipline that seeks to help protect against the full spectrum of commercial, compliance, and litigation risk, particularly where US businesses are part of the picture. Counsel experienced in US commercial and regulatory law can help ensure your diligence framework is calibrated to the specific risks of your counterparty, your industry, and your transaction.
For a collection of related previous posts and webinars, please click this link. Additional posts in this series on US commercial contracts for international businesses include:
