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August 16, 2012 Articles

Complying with the California Transparency Supply Chains Act

By Matthew A. Fischer

On January 1, 2012, the California Transparency in Supply Chains Act, S.B. 657, went into effect and has been codified in Section 1714.43 of California’s Civil Code. The act applies to retail sellers and manufacturers doing business in California that have annual worldwide gross receipts exceeding $100 million. The broad scope of the act means it will impact many companies located outside of California that either have significant sales in the state or supply companies that do business in California. Affected companies must disclose their efforts, if any, to ensure that their product supply chains are free from slavery and human trafficking. While the act only requires disclosure of a company’s practices, the real teeth in the law lies in the court of public opinion, as the obvious intent is to guide consumers’ purchases based on companies’ human rights policies.

The act has far-reaching consequences because, even if it does not apply to a company, that company’s customers who do conduct business in California will require the company to certify that the materials used in its products comply with the laws regarding slavery and human trafficking of the countries in which it conducts business.

Applicability of the Act
SB 657 adds Section 1714.43 to the California Civil Code to mandate disclosure and reporting requirements for every

  • “retail seller and manufacturer”
  • having annual worldwide gross receipts in excess of $100 million and
  • “doing business in the state” of California.

Whether a company must comply with the act depends on whether it meets each of these three conditions as outlined more fully below.

Retail Seller or Manufacturer
Whether a company is a “manufacturer” or “retail seller” under the act depends on whether the company designates “manufacturing” or “retail trade” as its principal business activity code on its California tax return. Cal. Civ. Code § 1714.43(a)(2)(C & D).

Worldwide Gross Receipts in Excess of $100 Million
“Gross receipts” are defined as

the gross amounts realized (the sum of money and the fair market value of other property or services received) on the sale or exchange of property, the performance of services, or the use of property or capital (including rents, royalties, interest, and dividends) in a transaction that produces business income, in which the income, gain, or loss is recognized (or would be recognized if the transaction were in the United States) under the Internal Revenue Code [without any reduction for the cost of goods sold].

Cal. Rev. & Tax C. § 25120(e)(2).

Doing Business in California
A company is doing business in California for taxable years beginning on or after January 1, 2011, if it meets anyof the following four conditions:

  • The company is organized or commercially domiciled in California.
  • Sales in California for the applicable tax year exceed the lesser of $500,000 or 25 percent of the company’s total sales.
  • The value of the real and tangible personal property of a company in California exceeds the lesser of $50,000 or 25 percent of the company’s total real and tangible personal property.
  • The amounts paid by a company in California for compensation exceeds the lesser of $50,000 or 25 percent of the total compensation paid by the company.

Compliance with the Act
By January 1, 2012, companies governed by the act must disclose on their websites what actions, if any, they are taking to do the following:

  • Audit suppliers to verify compliance with company standards on trafficking and slavery and whether such audits are independent and unannounced.
  • Evaluate and address the risks of human trafficking and slavery in their product supply chains, including whether companies are using third parties to substantiate such risks.
  • Require their direct suppliers to certify that the materials incorporated into company products comply with laws regarding slavery and human trafficking in the countries in which they are doing business.
  • Maintain accountability standards and procedures for employees or contractors that fail to meet company standards regarding slavery and human trafficking.
  • Provide training to those employees and managers who have direct responsibility with supply-chain management on the mitigation of human trafficking and slavery risks.

Under new Revenue and Taxation Code § 19547.5, California’s Franchise Tax Board (FTB) shall provide to the state attorney general a list of retail sellers and manufacturers that must comply with the act based on tax returns filed for taxable years beginning on or after January 1, 2011. The first such list will be provided by November 30, 2012, and each November 30 thereafter. Even if a company determines that it is not required to comply with the act, it should review the FTB’s list on November 30, 2012, to ensure it is not identified. As a practical matter, if a company does not file tax returns in California, then it will probably not be included on the FTB’s list. However, the FTB’s list will likely include those companies that file payroll tax returns reflecting more than $50,000 in compensation to California employees.

Compliance with the Certification Requirement
Regardless of whether a manufacturer falls within the scope of the act, many of its customers that do conduct business in California will require the manufacturer to certify that the materials it uses in its products “comply with the laws regarding slavery and human trafficking of the country or countries in which they are doing business.” (Cal. Civ. Code § 1714.43(c)(3).)

This certification requirement could involve significant expense if a company decides to do more than simply rely on verifications from its suppliers. In such instances, certification could involve an analysis of the applicable human-trafficking laws in each country and/or state in which the suppliers do business, as well as a review of their facilities and activities within that location to independently confirm the suppliers’ compliance with the applicable law(s).

The sole remedy for a violation of the statute is an action brought by the California attorney general for injunctive relief. Cal. Civ. Code § 1714.43(d). The FTB must submit the first list of covered companies to the state’s attorney general by November 30, 2012. While no monitoring body has been established, companies can expect that advocates of the act, as well as the plaintiffs’ bar, will monitor the compliance of those companies on the FTB’s list. It is expected that interest groups will access and use a company’s disclosure on its website to put public pressure on the company to modify its practices. The act expressly provides that “[n]othing in this section shall limit remedies available for a violation of any other state or federal law.” This caveat leaves the door open for the possibility of consumers using the act as a basis for false-advertisings claims or alleged violations of California’s Unfair Competition Law and/or the Consumer Legal Remedies Act.

How to Prepare for Compliance
Companies should take the following steps to comply with the act:

  • Determine whether the act applies to your company.
  • If your company falls under the act, examine all corporate policies and supplier standards that address, or should address, human rights’ issues within the company’s supply chain. An important factor to consider when preparing the required disclosure is how the company will communicate its policies to its suppliers.
  • Review and, if necessary, implement auditing and verification mechanisms. Evaluate the capacity of existing verification procedures and modify where appropriate. Determine whether your company has systems in place to audit its suppliers and, even if it does, consider retaining independent, third-party auditors.
  • Determine whether a system is in place to ensure accountability and sufficient training for those employees responsible for managing the company’s supply chain and, if not, implement appropriate procedures. This will likely entail an analysis of supplier guidelines to confirm that suppliers have integrated human-rights policies into their guidelines and standards.
  • Start the process now for preparing your disclosures. The statute allows for a variety of possible approaches, but the overall process may be quite time-consuming, especially when a company is reliant on verifications from its suppliers.

 Federal Legislation May Not Be Far Off
Compliance with the California law may soon be irrelevant because, on the federal level, Rep. Carolyn Maloney (D-NY) introduced a similar bill on August 1, 2011. The Business Transparency on Trafficking and Slavery Act (H.R. 2759), modeled on SB 657, was referred to the Subcommittee on Capital Markets and Government Sponsored Enterprises on August 22, 2011, where it has remained.

Keywords: litigation, mass torts, California Transparency in Supply Chains Act, human trafficking, human rights, slavery, manufacturing processes

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