Does the recent Level 6 Influenza Pandemic Announcement Indicate a Force Majeure Event?

The World Health Organization (WHO) has announced a Level 6 flu pandemic, which may prompt many businesses to call a force majeure on their contracts. The Level 6 pandemic is being called by WHO because the swine flu (H1N1 virus) has developed into an out-of-control, world-wide pandemic and drastic measures must be taken.

The announcement came at 10:00 GMT in a closed-door meeting emergency meeting in Geneva, Switzerland -- representing the first time a Level 6 pandemic has been announced in 41 years. The last time such a pandemic was announced was in 1968 when the Hong Kong flu of 1968 claimed an estimated one million deaths.

The effect reaches far beyond the immediate impact on local, regional or global health. There is a lot of chatter in blogs and elsewhere about the effect on the global economy and the abilities of organizations to provide contracted goods and services. One of the ripple effects could likely be realized within many business contracts, under the force majeure clause.

A force measure usually indicates an Act of God, be it earthquake, landslide, flood, or any other act or occurance that is 'beyond human control'. Acts of Terrorism and other forms of violent conflict also would often fall under this same contractual provision.

A force majeure clause is usually placed within business contracts to allow one or more parties in a contract to stop meeting their obligations for that contract, because a situation has occurred that is beyond everyone’s control. Pandemics are typically listed as one of the reasons for calling a force majeure.

So how will this affect commerce and business contracts in place?

This could have significant (and potentially far-reaching) consequences that go far beyond the immediate impact of the moment. What would be the impact -- either regionally or locally -- from large numbers of employees at firms who have the flu?

Day-to-day performance levels of companies are already being affected - sometimes drastically - in parts of the world by high levels of employee absenteeism due to H1N1 outbreaks, either because employees are sick themselves or because they are caring for family members who are. Add to this the by still more employees who stay home to avoid getting sick.

With the world seemingly becoming smaller by the day, the far-reaching effects of this situation remain to be fully realized. There is no doubt that this will likely have a markedly negative impact on the global economy. Many experts are comparing the current outbreak of H1N1 virus to the 2003 outbreak of Severe Acute Respiratory Syndrome (SARS), which is estimated to have cost cost the region between $18bn and $60bn in lost output - or 0.5-2.0% of regional GDP (according to estimates by the Asia Development Bank).

As this story continues to unfold, it certainly seems that the time has already come for firms to review contracts that are in place to determine how this escalating situation could affect their operations and their abilities to provide goods and services. Likewise this situation should sound a gong within organizations concerning performing due diligence both on existing contracts and on future relationships and agreements. The impact on the operational security of organizations and the effect on the bottom line are too great not to assess how this situation may touch your organization.

The following article from ACFE highlights an issue that in distressed economic times is of critical importance:

ACFE Report Says AP-Related Insider Fraud Is Costing a Bundle

October 2008

Don’t look now, but there’s a good chance your own organization’s employees are creating phony invoices, tampering with checks, and padding their expense reports. It’s tough to think that a co-worker is trying to slip a fraud past AP, but it does happen.

Dishonest employees cost U.S. organizations an estimated $994 billion a year in occupational fraud losses. The average company loses 7 percent of its annual revenues to this type of fraud, according to the 2008 Report to the Nation on Occupational Fraud & Abuse, from the Association of Certified Fraud Examiners (ACFE).

Occupational fraud that affects AP is categorized as asset misappropriation, which is one of the three categories the ACFE uses to describe this type of fraud. The other two are corruption and fraudulent financial statements. Asset misappropriation is, by far, the most common, occurring in 89 percent of the 959 cases the ACFE reviewed.

Bogus Invoices Most Common

Fraudulent invoicing, what the ACFE calls "billing" fraud, involves any scheme in which a person causes his or her employer to issue a payment by submitting invoices for fictitious goods or services, inflated invoices, or invoices for personal purchases. Typically, an employee will create a shell company and then bill the employer for nonexistent services. Or an employee will purchase personal items and submit an invoice for payment.

This type of disbursement fraud is the most common, occurring in 23.9 percent of the cases ACFE studied (see the graphic on page 1). However, the median loss is higher for check tampering, which occurred in 14.7 percent of the cases with a median loss of $138,000. The median loss from phony invoices was $100,000. Expense reimbursement abuse yielded a median loss of $25,000.

Who Is Doing This?

As Exhibit 1 illustrates, most of the fraudsters were either employees (39.7 percent) or managers (37.1 percent). Owners and executives made up about a quarter of the perpetrators.

Not surprisingly, the higher the position of the employee committing a fraud, the greater the loss to the business. Those with significant authority have more access to business resources and, therefore, more ability to override controls that might otherwise disclose fraud.

The ACFE study found that fraud committed by owners and executives resulted in a median loss of $834,000. That’s over five times greater than the median loss caused by managers and nearly 12 times higher than that perpetrated by employees.

The study also compared the type of scheme committed with the department in which the perpetrator worked. The goal was to provide data that could be useful to organizations in structuring their anti-fraud controls by identifying the departments most commonly associated with certain types of occupational fraud.

Employees in accounting or executives and upper management were the ones most likely to commit the four types of fraud that most affect AP. For example, over half (54.1 percent) of all billing and invoice schemes were committed by accounting personnel or the top brass (see Exhibit 2 below).

Accounting staffers were the most likely to commit expense reimbursement fraud, followed by executives and upper management and employees in operations and sales. How does the accounting staff—who are less likely to be traveling on company business—get involved with this scheme? Most likely on the other end of the fraud by processing knowingly false expense reports for payment—reports filed by executives, sales personnel, and others.

Two-thirds (67.4 percent) of check tampering is perpetrated by someone in the accounting department (see Exhibit 2). This typically happens when an employee steals blank-check stock and then makes them out to himself or herself or an accomplice. It can also commonly occur by the employee stealing an outgoing check to a vendor, then depositing it in his or her own bank account. Executives who engage in check tampering are typically those with signatory authority who write company checks to pay personal expenses.

Detecting the Fraud

More often than not, occupational fraud goes undetected for years before it’s discovered. When it is detected, it usually comes to light by tips rather than by other means, including internal and external audits. Tips account for almost half (46.2 percent) of the initial detection of occupational fraud. One in five is detected "by accident"; internal and external audits account for 19.4 percent and 9.1 percent of the detection, respectively; and 23.3 percent of cases are discovered by internal controls.

What to do: Because the most common detection method is by a tip, anonymous fraud reporting mechanisms are a key component to effective anti-fraud prevention. For instance, organizations with anonymous fraud reporting hotlines suffer fewer losses than those without hotlines.

The majority of tips (57.7 percent) were received from employees (see Exhibit 3). However, a significant number of tips came from outside sources.

What to do: When designing a fraud reporting system, be sure to include not only employees but also third parties, such as customers and vendors.

For More Information

The full 68-page 2008 Report to the Nation on Occupational Fraud & Abuse is available at www.acfe.com.

Exhibit 2. AP-Related Fraud Perpetrators, by Department
		Expense
	Billing	Reimbursement	Check
	Schemes	Schemes	Tampering
Accounting	33.2%	26.9%	67.4%
Executive /Upper Management	20.9	25.0	15.5
Operations	12.2	10.2	3.1
Sales	10.2	10.2	1.6
Purchasing	5.6	3.7	–
Finance	4.1	4.6	5.4
Manufacturing and Production	4.1	3.7	1.6
Information Technology	2.6	2.8	–
Customer Service	2.0	2.8	0.8
Marketing/Public Relations	1.5	3.7	–
Board of Directors	1.0	0.9	1.6
Research & Development	1.0	1.9	–
Human Resources	0.5	–	0.8
Internal Audit	0.5	2.8	0.8
Legal	0.5	0.9	1.6
(Source: 2008 ACFE Report to the Nation)

Perhaps an assessment of such issues within your organization might be in order?

"Ready... Fire... Aim!"

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It seems that the faster the pace of business, and of life itself, the more we all seem to be in a rush to "get the deal done"... from the way that Congress rushed through financial bailout -- er, I mean "stimulus" legislation -- to the uber-instant way that business demands most everyone to "give me an answer - and, right now".

Unfortunately, this ultra-high speed frenetic race to an arbitrary and often imaginary finish line induces us not only to get there before the other guy (wherever 'there' is), but it also lulls us into a false sense of settling for less than - or, what I refer to as "good enough is good enough".

Obviously, cases in news, such as Bernard Maddoff, Sir Robert Allen Stanford, and that of Samuel Israel III (a markets whizz at Bayou Management, the hedge fund that collapsed in 2005 after defrauding investors out of $450M), remind us - albeit often way too late - that DUE DILIGENCE is much, much more important than most individuals and business give it credence, and that "good enough" often is actually not good enough.

We must fight the urge to haphazardly approach business issues from the perspective of "Ready, Fire, Aim!" when it comes to performing the proper types of DUE DILIGENCE investigations.

The current market climate demands all of us to really know who our customers, consultants, suppliers, directors and employees are. Risks abound in business at rates never before seen.

While certainly not an all-inclusive list, some risks that come to mind range from internal or external risks of theft of a firms intellectual property and critical information, to understanding whether a "potential business partner" has a skeleton or two (or three, or four) in the closet that would --at the very least -- raise some ethical questions from the Board of Directors if known, to deciding whether the investment plan is almost too good to be true, to protecting one's business from cyber threats from Romania or Korea or some other corner of the globe where a hacker would rather break into the system for what they can easily steal, instead of watching syndicated reruns of "The Jerry Springer Show", to knowing whether the key employee candidate that is the front-runner is actually who s/he represents themselves to be.

DUE DILIGENCE is more than checking a person's general information to verify that they live or work where they said they do... nor can all of the work required to obtain the degree, accuracy or depth of information necessary to make a cogent decision be obtained with a few Google™ searches (no offense to Google).

It often requires that you verify the secondhand or third hand information by investigating first-hand sources of information. And, when business goes global, the need for International DUE DILIGENCE increases exponentially... as do the complexities of obtaining the information necessary to garner a fact-based decision.

"So, who has the time and who has the where-with-all to do this? We've got day jobs, you know..."

Today's business climate is moving at Warp Factor 9. Costs are rising and the need to support and bolster the bottom line is a formidable opponent to the one commodity we seem to have the least of -- time.

However, costs arising from regulatory scrutiny and in some cases legal actions (as well as impact to a firm's reputation) are also on the rise... How will you answer the tough questions that will arise concerning your customer, partner, vendor, director, lawyer, investor or key employee – once the stuff hits the fan? And how will you explain why proper DUE DILIGENCE was not performed to avoid the problem in the first place?

Fortunately some of us are privileged to help firms that face situations like these within the course of our day jobs... And, while much of the work is not glamorous (no... we actually don't get a date with "the Bond Girl"), it is critically important to engage the right resources to help you perform the proper type and degree of DUE DILIGENCE to get the answers you need.

If you're feeling a bit inundated by the "Ready, Fire, Aim!" approach that the rush and clamor of the world seems to demand - take heart... some of us can help make a difference...