Energy directors must ask questions of their subsidiaries

“The child gold-diggers”. That was the title of a recent Sunday Times feature, which tracked illegally mined gold from the child miners of Ghana to the “clean” gold markets of Europe, via the Dubai gold souk.

A couple of weeks later, The Guardian reported that UK legal proceedings had been launched off the back of its investigation into the use of child and forced labour by suppliers of British American Tobacco and Imperial Brands in Malawi.

Both were equally shocking. Both highlight the increasing international focus on supply chains and the actions of multinationals.

The energy industry is particularly vulnerable to allegations of malfeasance arising out of supply chains, as well as liability for corruption, bribery and environmental offences. The distance between the holding company and its operational subsidiaries and joint ventures, often operating in developing jurisdictions, can make ensuring proper corporate governance lower down the chain difficult.

Vedanta

The pitfalls of this were exposed in the recent UK Supreme Court case of Vedanta v Lugowe. This concerned a group action by Zambian citizens alleging that toxic material from a copper mine, owned by a Zambian subsidiary of Vedanta, has been damaging their health and livelihoods for a number of years.

Vedanta is headquartered in the UK, and the Supreme Court case concerned whether the claimants could bring a case against it as the UK parent company despite the cause of action, and the entity that owned the mine, being located in Zambia.

The claimants had applied for permission to serve the Zambian subsidiary on the basis that there was a “real issue to be tried” against Vedanta in the UK.

The Supreme Court held that there was: whether Vedanta’s involvement in the management of the mine was sufficient to establish that it owed a duty of care to the claimants or (alternatively) a fault-based liability under Zambian environmental, public health and mining legislation.

The Supreme Court decided that there was a real issue, and the case could proceed against both the Zambian subsidiary and Vedanta. This decision paves the way for big multinationals being sued in their home jurisdictions over the actions of their foreign subsidiaries. It undoubtedly led to the issuing of the proceedings against BAT and Imperial referenced in the Guardian article, and we can expect more such proceedings in the UK over the next few years.

Duty of care

The judgment also has some salutary lessons for companies in the sector. Vedanta was found to have assumed responsibility for the implementation and maintenance of proper environmental standards by its subsidiaries, including the Zambian subsidiary, and so assumed a duty of care to anyone harmed by the subsidiary’s failure to adhere to them.

The Court noted there was a wide range of models for a parent company’s management of its subsidiaries, from complete vertical integration to a completely hands-off approach, and that the closer the relationship was, the more likely a parent would be to be held to have a duty of care in respect of its subsidiary’s actions.

The key areas for exposure identified in the judgment were: systematic errors in group-wide policies that cause harm when applied by subsidiaries; active implementation of group policies by the parent organising training for the subsidiary and policing their enforcement; and the parent holding claiming it supervises or controls its subsidiary when it does not in fact do so.

The takeaway for parent companies is this: if you are going to have group-wide policies in areas that expose you to liability, these need to be properly implemented and policed throughout the group. Otherwise, an errant subsidiary’s actions could prove expensive indeed.

Relationship issues

The same applies for regulatory and other offences where an imperfectly managed relationship between group companies can backfire.

An example from the banking sphere is the recent Jersey prosecution of Abu Dhabi Commercial Bank’s Jersey branch for failure to maintain appropriate policies and procedures in relation to customer due diligence and risk management. There, it was the branch’s inability to control its parent’s enforcement of Jersey regulatory obligations that led to its prosecution. It points to the need for multinational groups to tailor policies and procedures to individual jurisdictions.

As for corruption and bribery, these remain highly relevant risks for the energy sector, as shown by the Serious Fraud Office’s (SFO) list of current investigations, which includes several big names.

The SFO secured a much-needed win in October this year when the Iraqi partner of Unaoil was sentenced to a three-year prison term for bribing Iraqi officials to secure contracts for Unaoil in Iraq.

Personal risk

What can directors do to protect themselves from personal risk? The lesson emerging from recent developments is clear. It is no longer sufficient to turn a blind eye or rely on others to do the due diligence. Directors need to be asking questions – however uncomfortable – about what is going on in their subsidiaries and partnerships in other countries.

Any legacy issues relating to environmental concerns, regulatory compliance or corruption need to be dealt with in a way that is fully co-operative with the relevant authorities. The trend towards more vertical integration in multinational groups is good for corporate governance – this is not the time to ensure plausible deniability by severing ties with subsidiaries – but it needs to be more than just paper compliance.

Finally, as the Sunday Times and Guardian articles demonstrate, directors also need to be asking questions about their supply chains. Ethical compliance is a key requirement for a new generation of consumers, and an increasing business risk if suppliers are found to be transgressing.