The federal government is increasingly seeking to impose liability on corporations for the acts of third parties, such as distributors, subsidiaries and franchisees.

By Gregory M. Williams and Robert A. Smith

Franchisors face an increasing risk of liability under the Foreign Corrupt Practices Act. The FCPA is a critical enforcement priority. As Leslie R. Caldwell, assistant attorney general, recently stated, “[w]e are committed to combating foreign corruption, across the globe and across all industries, through enforcement actions and prosecutions of companies and the individuals who run those companies.” 

The consequences of non-compliance can be dire, with fines and penalties totaling tens and even hundreds of millions of dollars and jail time for individuals.  

At the same time, the federal government is increasingly seeking to impose liability on corporations for the acts of third parties, such as distributors, subsidiaries and franchisees, in the FCPA and other contexts.

Against this background, a franchisor is well-advised to adopt appropriate measures to address its FCPA exposure. However, the cost of compliance, if mishandled, can be significant. This article recommends an approach that seeks to square this circle, helping franchisors to insulate themselves from possible FCPA liability based on the actions its franchisees at a moderate cost.

Third Party Risk under the FCPA

Broadly speaking, the FCPA prohibits companies from, directly or indirectly, providing money or anything else of value to a foreign (i.e., non-United States) public official in order to obtain or retain business.

The U.S. Department of Justice and the Securities and Exchange Commission, which have overlapping enforcement authority, aggressively interpret the key provisions of the FCPA.

Notably, the FCPA’s knowledge standard is broader than actual knowledge; it encompasses the concept of “willful blindness.” Thus, a company cannot avoid liability under the anti-bribery provisions by failing to implement anti-corruption compliance measures or ignoring red flags. Moreover, merely doing business in a country regarded to pose an elevated corruption risk (most of the world outside of Western Europe and Japan) has served as a basis for finding constructive knowledge of improper payments.

This broad constructive knowledge standard coupled with the prohibition on indirect payments means that a company may be held liable for the acts of its partners on the theory that the company was willfully blind to the improper payments. Indeed, a majority of the FCPA enforcement actions are based on third-party payments.

Traditionally, the primary concern has been commercial agents. Recently however, the government has expanded the bounds of such third-party liability. For example, a number of enforcement actions have been based on the conduct of a company’s distributor, despite the fact that the arm’s length nature of the distributor relationship (like that of franchisor-franchisee) has traditionally been viewed as barrier to liability. 

Further, in a $384 million enforcement action, the government held Alcoa Inc. liable for payments made by its subsidiaries, despite the fact that Alcoa neither had knowledge of, nor participated in, the payments. In doing so, the SEC concluded that the Alcoa subsidiaries were the agents of their parent and did so based on factors so nebulous as to cover almost all parent-subsidiary relationships. The result is a dramatic departure from the traditional tenets of corporate liability, which would require either that the parent and subsidiary disregard corporate formalities to the extent that they are functionally a single company or that the parent direct the specific acts of the subsidiary on which liability is based. 

There are obvious parallels in the National Labor Relations Board’s recent efforts to treat McDonald’s franchisees and their franchisor, McDonald’s USA, LLC, as joint employers. 

In short, there is a real, and increasing, possibility that a franchisor may face exposure under the FCPA as a result of the actions of its franchisees.

Also of note, under the FCPA, a payment to “obtain or retain business” is — according to the DOJ and the SEC — “broadly interpreted.” This “business purpose test” thus captures a wide range of conduct beyond the payment to win a contract award, including potentially a payment to receive or expedite regulatory approval, obtain an advantage in a pending court case, or receive preferential customs or tax treatment. 

Thus, a franchisor faces the risk of potential liability if its international franchisee makes improper payments to local government officials to obtain favorable regulatory treatment or other government approvals, a type of conduct that can be common in certain parts of the world.

FCPA Compliance for Franchisors

An appropriate compliance regime, including adoption of an FCPA manual, inclusion of FCPA provisions in contractual agreements, and other similar measures, is critical to help detect and deter FCPA violations. 

Of particular importance is third-party due diligence, which helps a company combat an assertion of willful blindness in the event that its business partner is alleged to have made improper payments. Such due diligence frequently occurs prior to the formal agreement with, or retention of, the third party. A significant focus of the due diligence is on whether the proposed relationship is a legitimate business arrangement or, by contrast, possibly could be perceived as a channel for improper payments to government officials. 

Because of the franchisor-franchisee relationship, such upfront (FCPA-specific) due diligence is not typically necessary. Generally, there should be not be a significant question that a franchisor’s relationship with its international franchisee is a legitimate business arrangement and the franchisee has been selected due to its perceived ability to operate the franchise successfully. Further, because the franchisee likely will not be soliciting business from foreign government officials on behalf of the franchisor, there should be little reason to suspect that the franchisor has entered into a relationship merely as a conduit for payments to foreign officials. As a result, in the absence of specific anti-corruption concerns, upfront FCPA due diligence on a franchisee would not appear to be a favorable use of a franchisor’s resources. The traditional business and financial due diligence conducted by a franchisor will likely be sufficient.

Nevertheless, for the reasons set forth above, international franchisees do pose a potential FCPA concern. To help assess that risk and demonstrate its commitment to compliance, a franchisor should periodically review its franchisees’ operations and interactions with government officials to ensure that they are not engaging in conduct that might expose the franchisor to possible FCPA liability. Such a review will largely consist of interviews of the franchisor’s and franchisee’s employees with potential knowledge of the manner in which the franchisee interacts with foreign government officials (for example, customs and tax officials and health inspectors) and, where appropriate, targeted document and email review.

The due diligence review should not be global and comprehensive in the first instance. Rather, a franchisor should adopt a risk-based, phased approach, which focuses in the first instance on the highest risk location(s). 

If the initial review of the highest risk locations does not raise significant corruption concerns, reviews for other locations may not be necessary. The franchisor would then have a reasoned basis for defending its compliance approach and in arguing that it should not be charged with constructive knowledge in the event of a suspicion of improper payments by a franchisee. On the other hand, if the initial review reveals concerns, the franchisor can tailor its remedial measures and further due diligence reviews accordingly.

This type of measured approach will help a franchisor balance its risk of potential liability and the cost of FCPA compliance.

Gregory M. Williams and Robert A. Smith are partners with the law firm Wiley Rein. Find them at fransocial.franchise.org.

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