European Commission proposal for the Corporate Sustainability Due Diligence Directive

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Yesterday, the European Commission finally released its long-awaited proposal for the Corporate Sustainability Due Diligence Directive (Directive), that would require companies to carry out due diligence across their value chain, as well as embed sustainability and human rights considerations into their business strategy, decisions and oversight. Companies in scope need to prepare now both across their own business operations and their value chain. While 2024 is the earliest the Directive will come into effect, the lead time will be needed to put compliant measures in place, or to face civil liabilities and significant fines based on turnover.

The proposal, anticipated in the 2019 European Green Deal, was officially announced by Commissioner for Justice Didier Reynders almost two years ago and has been subject to an active debate on the need and the practicalities of a supply chain due diligence mechanism. This has included the adoption by the European Parliament of a detailed proposal for a Directive which has clearly influenced the present proposal. While recognising that an increasing number of European companies already comply with existing international voluntary standards, such as the United Nations Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises, the Commission claimed that the lack of legal clarity and proper enforcement does not efficiently tackle adverse impacts on human rights and the environment, nor does it contribute to make European supply chains more resilient. To address these issues, the Commission has proposed new ambitious EU-wide rules that will have a significant impact on the operational and business activities of numerous companies in the coming years, both to those based in the EU and those with substantial operations in the EU.

Key takeaways for companies

What’s the purpose of the proposal?

The Commission’s proposal aims to:

  • Improve corporate governance practices through the integration of the identification, prevention and/or mitigation of human rights and environmental risks and impacts (including those arising from global supply chains) into corporate strategies, policies and procedures and contract terms.
  • Counteract the rise of fragmented legal obligations across the EU and provide for legal certainty for businesses and stakeholders on the standard that is expected from them
  • Increase corporate accountability for adverse human rights and environmental impacts.
  • Improve access to remedy for stakeholders affected by the direct and indirect operations of businesses.
  • Improve transparency through reporting obligations.
  • Increase enforceability through civil liabilities and significant penalties.

Who needs to comply?

The proposed Directive will apply to:

  1. EU very large companies (ie companies with more than 500 employees and a net turnover worldwide of more than EUR150 million) ;and

  2. two years later, to EU large companies operating in high-risk sectors (ie, companies with more than 250 employees and a net turnover of more than EUR 40 million when at least 50% of their turnover derives from the textile and footwear, agriculture, forestry, fisheries or extraction and trading of minerals sectors).

  3. The rules will also apply to non-EU companies that generate a net turnover of more than EUR150 million (or EUR40 million for the high-risk sectors listed above) in the Union. Such companies shall designate an authorised representative in one of the EU Member States.

The due diligence obligations for these companies will focus on severe adverse impacts in a way that is commensurate to their operations and the geographies they operate in. SMEs are not directly in the scope of the due diligence duty, but might be indirectly affected as a result of the actions taken by large companies to comply with the new requirements.

Which human rights and environmental obligations are covered by the Directive?

International human rights instruments and environmental conventions relevant to the due diligence exercise are listed in the Annex to the proposed Directive. These include, inter alia, the Universal Declaration of Human Rights, the International Covenant on Civil and Political Rights and the International Covenant on Economic, Social and Cultural Rights and the principles concerning the fundamental rights in the ILO’s Declaration on Fundamental Principles and Rights at Work and other core ILO conventions Special attention should be given to particular human rights impacts on individuals or groups at heightened risk of marginalisation or vulnerability, including women. Specific instruments on the right to women and indigenous group are also covered by the Directive. In relation to the  environment key environmental treaties such as the Basel and Cites conventions, the Minamata convention and others on biological diversity and the protection of the ozone layer are included.

Scope of due diligence process

The due diligence duty will apply both across companies’ own operations and their value chains. In terms of the latter, to ensure companies are able to have leverage on their contractors and subcontractors, the due diligence duty will be limited to established direct or indirect business relationships, ie those “ which are, or which are expected to be lasting, in view of their intensity and duration and which do not represent a negligible and ancillary part of the value chain” (Article 3(f)). “Leverage” means the ability to persuade the business relationship to take action to cease or prevent adverse impacts (para 33). Companies are expected to create leverage through the introduction of relevant contractual terms. The proposed text makes it clear that due diligence measures will have to be carried out through an obligation of means, eg companies won’t be required to guarantee adverse impacts from stopping in all circumstances.  However, companies will be obliged not to enter into new business relationships where adverse impacts cannot be sufficiently prevented and/or mitigated.

How to comply?

Companies in scope will need to:

  • Integrate due diligence into all their corporate policies and to establish and annually update a due diligence policy describing company’s approach to due diligence in the long term and a code of conduct for employees and subsidiaries.

  • Take appropriate measures to identify actual or potential adverse human rights and environmental impacts in their own operations, in their subsidiaries and their established direct and indirect business relationships.

  • Prevent and minimise potential adverse impacts through actions that may include the development and implementation of a prevention action plan, the conclusion of contractual assurances from business partners, make necessary compliance related investments and provide targeted support to SMEs with which the company has an established business relationship.

  • Bring to an end any actual adverse impacts through various actions, including inter alia the payment of damages to the affected persons or financial compensations to the affected communities, the development and implementation of a corrective action plan with improvement measurements and the obtention of contractual assurances ensuring that business partners abide by the code of conduct and corrective action plans if necessary. Temporary or permanent termination of the business relationship may be necessary where the adverse impact is considered as severe and cannot be brought to an end or adequately mitigated.

  • Establish complaint mechanisms to allow affected persons, trade unions, workers’ representatives and civil society to raise grievances regarding actual or potential human rights or environmental impacts. Member States will be required to ensure that companies follow up on the complaints raised.

  • Finally, to monitor the effectiveness of their measures and publish an annual statement in line with the Corporate Sustainability Reporting Directive.

Very large EU and non-EU companies operating in the Union will also need to adopt a plan to combat climate change. In particular, such plan should ensure that the business model and strategy of the company are in line with Paris Agreement (ie limiting of global warming to 1.5 °C) and includes emission reduction objectives. The variable remuneration of directors will be linked to the fulfilment of the plan.

Companies not established in the European Union will have to take steps  to establish Authorised Representatives where suitable arrangements do not already exist. The Authorised Representative will need to be in a position to ensure, with respect to the businesses activities, compliance with the requirements of the Directive as transposed into national member state law.

Who will supervise?

Compliance with the due diligence obligations established in this Directive and concrete enforcement will be performed by national supervisory authorities, that will have the power to request information and carry out investigations (initiated on their own or on the basis of substantiated concerns from natural or legal persons) on alleged breaches by a company. A European Network of Supervisory Authorities will be created to ensure coordination and alignment between Member States. Companies in scope will have to publish an annual report on their due diligence, potential and actual adverse impacts and actions taken on those.

Penalties and liability?

Member States will establish sanctions for non-compliance with the national provisions (adopted as a result of the transposition of the Directive) in the form of remedial action to be taken by the non-compliant company within an appropriate period of time and/or financial penalties based on the turnover. It is clear therefore that enforcement will be by member states as is the case for many other similar compliance requirements. In case of damages resulting from the failure of a company to carry out adequate due diligence, civil liability of the company will be triggered and governed by the rules established by Member States. This means that victims will have the possibility to file complaints in national courts against companies whose own operations or those of their subsidiaries and/or established business relationships led to damages that could have been avoided or mitigated with appropriate due diligence measures. This will be subject to limited protection for defendants against liability for the acts of indirect  business partners where reasonable contractual measures have been taken, including as regards verification of compliance.

Directors’ duties?

The proposed Directive clarifies the meaning of the duty of care that directors have towards their company, specifying that this involves including long term human rights, climate change and environmental considerations in their decisions. Furthermore, it requires directors of EU companies to adapt the corporate strategy to take into account the actual and potential adverse impacts, to establish and supervise the implementation of corporate sustainability due diligence actions, with due account to the input from stakeholders and civil society organisations, and to report to the board in this respect. .  

Next steps in the legislative process

Despite the intention of the executive to adopt the legislation swiftly, we expect a heated and difficult debate between the co-legislators in the coming months, with potential delays and changes in the final law.

First of all, the proposal significantly differs from the original ambition of the Commission and from the position of the European Parliament outlined in a resolution with recommendations to the Commission of 10 March 2021 that included very broad obligations and strict sanctions to be imposed on companies operating on the EU market. Commissioner Reynders’ text has also seen major pushback from the European Commission’s independent advisory body, the Regulatory Scrutiny Board, which twice remanded a draft version of the proposal. In spite of those setbacks, the proposed Directive is still substantially more robust than expected by many.

Secondly, emerging national due diligence rules, outlined below, can also create fragmentation and difficulties in the legislative process. Furthermore, delays in the legislative process might also occur due to the need to align this Directive with the forthcoming legislative proposal to ban products made by forced labour from entering the EU market (the so-called import ban), announced by Commission President Ursula von der Leyen in 2021 and actively supported by numerous MEPs. Such ban was initially planned to be included in the present proposal but is now set to potentially become a separate legal tool in the form of a product withdrawal from the market. The Commission still does not have a clear idea of how such instrument should work but is aware that alignment should be guaranteed between the initiatives.

Once the proposal is adopted by the European Parliament and the Council, Member States will be granted two years to transpose the new rules into national legislation. Thus we can expect the new rules to become applicable to companies in scope as of 2024 at the earliest. For mid-cap companies operating in high-risk sectors, the due diligence obligations will start to apply after a transition period of three years. The EC will also be issuing model contractual clauses and facilitating sectoral collaboration.

Interplay with national legislation

Over the past years, national legal frameworks or civil society initiatives on corporate due diligence have emerged in several EU Member States. Both France and Germany have already enacted national human rights due diligence legislation, with the French Loi de vigilance being in effect since 2017 and the German Lieferkettensorgfaltspflichtengesetz set to apply as of 1 January 2023 to companies with more than 3000 employees and as of 1 January 2024 to those with more than 1000 employees. Other Member States, most notably the Netherlands, are in the process of enacting similar national legislation. In light of this patchwork of national legislative project, ensuring legal certainty and developing a level playing field have always been key reasons for the proposed Directive.

We are confident that the proposed Directive will indeed succeed in developing a level playing field Although the proposed Directive shall not constitute grounds to reduce the level of protection of human rights or the environment provided by the law of the Member States at the time of the adoption, more far-reaching provisions in national human rights due diligence do currently not exist, and it appears unlikely that other Member States such as the Netherlands would hurry to implement national legislation before adoption of the EU Directive.

Interplay with other EU policy provisions

The Corporate Sustainability Due Diligence Directive is closely interrelated with other existing and upcoming EU initiatives, in particular the Sustainable Finance strategy, drawn by the Union to attract investments towards more sustainable activities. Two legal frameworks, the so-called Taxonomy and the Sustainable Finance Disclosure Regulations, will set specific criteria for economic activities and financial products to be ably to qualify as sustainable. These must be supported by appropriate due diligence. To this aim, the Corporate Sustainability Due Diligence Directive is set to establish rules on how companies should identify, prevent, mitigate and account for actual and potential adverse impacts that their business activities might have on people and the environment while the Corporate Sustainability Reporting Directive – adopted in April 2021 with the aim to review the existing non-financial reporting rules in the Union – will require companies to report the outcome of the conducted due diligence (ie, risks, impacts, and measures taken) following ad hoc sustainability reporting standards and communicate it to stakeholders, in particular investors. The Corporate Sustainability Due Diligence Directive will also complement existing and planned sectoral due diligence legislation, such as the Conflict Minerals Regulation, the proposed Regulation on deforestation-free supply chains and the proposed Batteries Regulation, by expanding due diligence requirements to companies and activities that are not in scope of the above-mentioned acts.

How can we help?

European and third-country companies operating in Europe should start preparing for upcoming legislative changes, including  by conducting risk analysis of their value chains and incorporating sustainability and human rights considerations into their corporate policies and contracts with suppliers. A report Commissioned by the French Ministry of Economy on the French law of vigilance noted that it took about three years for companies to map out human rights risks in their supply chain. Human rights due diligence is not solely a reporting exercise: it is a journey. It requires a shift away from traditional risk management strategies to a focus on rights and perspectives of those who may be affected by the operations of the company and others in their value chain. Companies would be well advised to anticipate the transposition of the Directive into national legal systems and make sure that a right and environment respecting culture is embedded in their operations, so that the due diligence process becomes less onerous when the standard comes into force.

The proposal also highlights the potential need to collaborate with others, including through multi-stakeholder initiatives. Businesses who do not already do so should also take stock of opportunities in this area.

The complexity of global supply chains and a mix of national and European existing and upcoming due diligence rules might pose major challenges for businesses. The DLA Piper Sustainability and ESG Business & Human Rights and Global Government Affairs teams can help you to navigate the fast-changing regulatory environment, identify risks and opportunities, support in developing human rights due diligence policies, including codes of conduct and grievance mechanisms, and updating contracts with your business partners.

To learn more about the EC proposal and the potential impact on your business, please contact any of the authors listed below.