Protecting Third Parties in Contracts
American Business Law Journal (Jan. 2021 Forthcoming)
45 Pages Posted: 24 Sep 2020 Last revised: 26 Oct 2020
Date Written: September 22, 2020
There is a growing consensus among regulators, civil society, and even CEOs that corporations must consider the impact of their activities on a broad range of actors – not just shareholders. The need to do so is apparent from the externalities that corporations routinely impose on non-shareholders. These externalities are particularly apparent in global supply chains as illustrated by several recent, and unsuccessful, lawsuits against corporations involving forced labor, human trafficking, child labor, and environmental harms. Lack of legal accountability subsequently translates into low legal risk for corporate misconduct, which reduces the likelihood of prevention and results in three separate injuries to third parties: first, the initial corporate misconduct; second, denial of justice in the courts; and, third, the prospect of recurrence because of inadequate prevention.
This Article argues that corporate misconduct towards non-shareholders arises from a fundamental inconsistency within contract law regarding the status of third parties: On the one hand, we know that it takes a community to contract. Contracting parties often rely on multiple third parties – not signatories to the contract – to play important roles in facilitating exchange: kinship networks, trade associations, and community organizations help to reduce market transaction costs through screening potential trade partners, creating social preferences for pro-contractual behavior, improving information flows, and decreasing the risk of opportunism. On the other hand, we deny this community protection from the externalities that contracting parties impose on them under a traditional view of contract as an exchange between two parties.
This Article examines a corporation’s duties to others in its role as a contracting party. Contracts are the primary means through which corporations interact in the world; revising our views about the duties that contracting parties owe third parties has significant implications for our views of how corporations should treat non-shareholders. Normatively, this Article proposes an alternative view of contracts as an ecosystem with three attendant objectives that result from this view: (a) third party protections from negative externalities, (b) contract design obligations of contracting parties, and (c) recourse to legal remedies for third parties. On a policy level, this Article proposes the following duty to contract in order to translate theory into practice: Contracting parties are required to take into account negative externalities to third parties when the contracting parties could reasonably foresee that performance of the contract would create a risk of physical harm to these third parties. This duty helps to address corporate externalities by providing victims with remedies for past harms and providing a legal incentive for corporations to prevent future harms through contract design. By re-imagining contracts, we also re-imagine corporations and their duties to others.
Keywords: contracts, supply chains, corporations, ESG, CSR, human rights
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