23 February 2022 Guillaume Croisant Corporate Governance - ESG - EU Law

EU proposal for a Corporate Sustainability Due Diligence Directive

A potential game changer for sustainable business in the EU

After several postponements, the European Commission published, on 23 February 2022, its much-awaited proposal for a Directive on Corporate Sustainability Due Diligence (the “Proposal”), aimed at imposing on companies of a certain size operating in the EU far-reaching due diligence obligations covering the adverse human rights and environmental impacts of their own operations, and those of their subsidiaries and their upstream and downstream value chain.

The Proposal was initially branded as the “EU Sustainable Corporate Governance Initiative”, and was expected to contain wide-ranging provisions on corporate governance. Its change of name is testimony to the less detailed governance provisions, but this does not mean that the Proposal is less ambitious.

Given the political sensitivity of the Proposal and divergent views among Member States and EU institutions, intense negotiations on the Proposal are likely and, if adopted, Member States will then have two (and, in relation to certain types of in-scope companies, four) years in which to transpose the Directive into national law (see “Next Steps” below).

Context

Through this Proposal, the European Commission seeks to advance respect for human rights and the green transition, create a level playing field for companies within the EU and avoid fragmentation resulting from voluntary standards and/or EU Member States acting on their own (such as France and Germany, which have already adopted due diligence legislation – see more here and here).

The Proposal, which followed a public consultation in 2020/2021 (see here), was initially expected in Q2 2021. It was delayed several times due to a double red light by the Commissions’ internal audit body (the Regulatory Scrutiny Board).

The Proposal does not provide for an import ban of products made by forced labour, including forced child labour. However, as set out in its Communication on Decent Work Worldwide (which was published alongside the Proposal), the Commission is preparing a separate proposal for this controversial topic which is expected to cover both domestic and imported products and include a robust, risk-based enforcement framework.

In-scope companies

Companies incorporated in the EU

EU companies are covered by the Proposal if they meet one of the two following thresholds:

the company had more than 500 employees on average and had a net worldwide turnover of more than EUR 150 million in the last financial year; or
the company had more than 250 employees on average and had a net worldwide turnover of more than EUR 40 million in the last financial year, provided that at least 50% of the net turnover was generated in one or more of certain high-risk sectors (i.e. the manufacture of textiles, leather and related products, and the wholesale trade of textiles, clothing and footwear, agriculture, forestry, fisheries, the manufacture of food products, and the wholesale trade of agricultural raw materials, live animals, wood, food, and beverages, as well as the extraction of mineral resources (regardless of where they are extracted), the manufacture of basic metal products, and the wholesale trade of mineral resources, basic and intermediate mineral products). The Proposal does not affect more stringent obligations provided for by other sectoral regimes targeting high-risk sectors, such as the Conflict Minerals Regulation and the Timber Regulation.

Companies incorporated outside the EU

Non-EU companies are also covered by the Proposal if they meet one of the two following thresholds:

the company generates a net turnover of more than EUR 150 million in the EU market in the financial year preceding the last financial year; or
the company generated a net turnover of more than EUR 40 million but not more than EUR 150 million in the EU internal market in the financial year preceding the last financial year, provided that at least 50% of its net worldwide turnover was generated in one or more of the above-mentioned high-risk sectors.

Climate change action plan

In-scope companies (both EU and non-EU, but excluding companies covered by the Proposal only because they operate in high-risk sectors) are required to adopt a plan to ensure that the company's business model and strategy are compatible with the transition to a sustainable economy, including limiting global warming to 1.5 °C in line with the Paris Agreement.

Based on information reasonably available to the company, this plan must, in particular, identify the extent to which climate change is a risk for, or an impact of, the company’s operations. If this is the case (or the company ought to have reached this conclusion), the company must include emission reduction objectives in its plan.

If variable remuneration is linked to the contribution of a director to the company’s business strategy and long-term interests and sustainability, companies should also take into account the fulfilment of these obligations when setting variable remuneration.

Directors’ duties

Directors of in-scope EU companies are responsible for putting in place and overseeing their companies’ due diligence actions and policies and for adapting their companies’ strategy accordingly.

In addition, and more broadly, when fulfilling their duty to act in the best interest of the company, they are required to take into account sustainability matters including the human rights, climate and environmental consequences in their decision-making.

EU Member States are required to ensure that a breach of the above-mentioned duty of care is considered a breach of director’s duties under their domestic laws. However, it should be stressed that, under the laws of many Member States, it remains difficult for third parties (as opposed to the company) to lodge claims in courts for alleged breach of a director’s duties.

Human rights and environmental mandatory due diligence

Member States are required to ensure that companies covered by the Proposal conduct human rights and environmental due diligence, which encompasses the following six steps (in line with existing international soft law standards, in particular the OECD Due Diligence Guidance for Responsible Business Conduct, the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises).

(1) Integrate due diligence into companies’ policies
In-scope companies are required to integrate due diligence into all their corporate policies and have in place a due diligence policy, which shall at least contain a description of the due diligence approach, a code of conduct for employees and subsidiaries and a description of the processes put in place to implement the due diligence policy in practice. Companies’ due diligence policies shall be updated annually.

(2) Identify actual and potential adverse human rights and environmental impacts
In-scope companies are required to take appropriate measures to identify actual and potential adverse human rights and environmental impacts arising from: (i) their own operations; (ii) their subsidiaries; and (iii) where related to their value chains, from their established upstream and downstream “business relationships” (defined as “a business relationship, whether direct or indirect, which is, or which is expected to be lasting, in view of its intensity or duration and which does not represent a negligible or merely ancillary part of the value chain”). The value chain encompasses the whole lifecycle of a product or service, from the development to the use and, in the case of a product, its disposal.

The definition of appropriate measures introduces an element of proportionality and means that while companies should look to implement measures capable of achieving the regime, they are able to take into account the circumstances of the specific case. These include the degree of severity of the harm and likelihood of an adverse impact occurring, the characteristics of the sector, the specific business relationship and the company’s level of influence. The Proposal also recognises the need to allow for prioritisation of action where there are multiple impacts which cannot all be addressed at once.

Adverse human rights and environmental impacts refer to adverse impacts on protected persons or the environment resulting from the violation of one of the rights, prohibitions or obligations covered by the Annex to the Proposal. These include forced labour, child labour, inadequate workplace health and safety, exploitation of workers, as well as greenhouse gas emissions, pollution, biodiversity loss and ecosystem degradation.

Companies covered by the Proposal because they operate in high-risk sectors are required to identify adverse severe impacts relevant to those sectors only.

Credit institutions and (re-)insurance companies granting credits, loans or other financial services are only required to identify actual or potential adverse impacts before providing that service.

(3) Prevent, cease or minimise actual and potential adverse human rights, and environmental impacts

In-scope companies are required to take appropriate measures to prevent/bring to an end or (where prevention is not possible) to minimise potential/actual adverse human rights and environmental impacts.

Measures that shall be taken by companies, where relevant, include:

developing and implementing a prevention/corrective action plan (with reasonable and clearly defined timelines for action, qualitative and quantitative KPIs and – where relevant – the involvement of stakeholders);
seeking contractual assurances from direct business partners that they will ensure compliance with the company’s code of conduct and prevention action plan (including by seeking corresponding contractual assurances from its partners; “contractual cascading”);
making necessary investments (such as into management or production processes and infrastructures); and
providing targeted and proportionate support for SMEs with which the company has an established business relationship.

When contractual assurances are obtained by the company from an SME, the terms should be “fair, reasonable and non-discriminatory”.

For the purposes of verifying compliance, the company may refer to suitable industry initiatives or independent third-party verification (whose costs should be borne by the company).

The Proposal also provides for an obligation on companies to refrain from entering into new, or extending existing relations, with business partners if appropriate measures could neither prevent/bring to an end nor mitigate the potential/actual impacts. Companies must also, where legally entitled to, suspend (while pursuing prevention and minimisation efforts reasonably expected to succeed) or terminate (where the potential impact is severe) the business activities with respect to the activities concerned.

(4) Assess the effectiveness

In-scope companies must carry out periodic assessments, at least annually, of their own operations and measures, those of their subsidiaries and, where related to the value chains of the company, those of their established business relationships, to monitor the effectiveness of the above measures.

They are also required to provide the possibility for actual or potential victims, trade unions and civil society organisations to submit complaints to them (and to meet with the company’s representatives at an appropriate level) where they have legitimate concerns regarding actual or potential adverse human rights impacts and adverse environmental impacts with respect to their own operations, the operations of their subsidiaries and their value chains.

(5) Communicate

In order to avoid duplicating reporting obligations, the Proposal does not introduce any new reporting obligations in addition to those under the proposed Corporate Sustainability Reporting Directive (“CSRD”) (see here).

In-scope companies that do not fall under the proposed CSRD should publish on their website an annual statement in respect of their activities (whose exact content should be defined by the European Commission through a subsequent implementing act). Such a statement would be required to be published by 30 April each year.

(6) Remediate

In-scope companies must draw up a corrective action plan and neutralise the adverse impacts or, if impossible, minimise their extent (including by the payment of damages to the affected persons and of financial compensation to the affected communities).

Public and private enforcement of the due diligence obligations

The Proposal contains a number of enforcement mechanisms, but it expressly provides that taking all appropriate measures to set up and carry out due diligence measures is considered an obligation of means, not of result. Therefore, the appropriate measures that companies will need to adopt will depend on the specifics of their value chain, sector, geographical area, their degree of influence on business partners, etc.

The Proposal provides for the possibility for the European Commission to issue guidelines for specific sectors or adverse impacts, where necessary, as well as guidance about voluntary model contract clauses.

Civil liability

In-scope companies may be held liable for damages if they fail to comply with their obligations to prevent and mitigate potential adverse impacts as well as to minimise or bring these impacts to an end.

However, a company will not be liable for damages caused by an adverse impact arising as a result of the activities of an indirect business partner if the former obtained contractual assurances from their direct business partner which were cascaded down to the latter – unless it was unreasonable, in the circumstances of the case, to expect that the action actually taken would be adequate to prevent, mitigate, bring to an end or minimise the adverse impact.

Civil liability of the parent company is without prejudice to holding the subsidiary or the business partner liable.

Importantly, the Proposal also explicitly provides that civil recourse will be not be denied solely on the basis that the law applicable to such claims is not the law of a Member State. This is to avoid the disputes as to jurisdiction that currently arise where claims are brought against companies for harms suffered elsewhere as a result of third parties.

Public enforcement

EU Member States are required to designate one or more authorities to supervise compliance with the obligations laid down in their transposing act. They will have the power to request information and carry out investigations, on their own motion or as a result of substantiated concerns submitted to them by any natural or legal person who has reasons to believe a company is not complying. They will also have the power to order the cessation of infringements, impose administrative fines and adopt interim measures to avoid the risk of severe and irreparable harm. Decisions of the supervisory authority shall be published and a judicial remedy against these decisions shall also be provided for under national law.

Although criminal liability is not explicitly provided for in the Proposal, this is without prejudice to the Environmental Liability Directive which does provide for some environmental offences to be subject to criminal sanctions (see our previous blog post here). Also, the Proposal does not preclude EU Member States from providing for more stringent rules.

With respect to public procurement, Member States will have to ensure that companies applying for public support certify that no sanctions have been imposed on them for breaches of these obligations.

Next steps

The adoption of the proposal for a Directive by the Commission only marks the beginning of the legislative process. The European Parliament and Council will now need to scrutinise and will likely amend the Commission’s proposal. Once they have defined their respective positions, they will try to reach a political agreement before the two institutions can formally adopt the Directive.

Under the ordinary legislative procedure, the average timeline from the Commission proposal to formal adoption is around 18 months. Therefore, the earliest the new rules are likely to be adopted is mid-2023. Given the political sensitivity of the Proposal and divergent views among Member States and EU institutions (as well as industry), intense negotiations and possible delays are expected.

If and when adopted, Member States will then have to transpose the Directive into national law within two years (or four years, for in-scope companies involved in high-risk sectors) of the Directive coming into force.

So far, two Member States (France with its Loi relative au devoir de vigilance, 2017) and Germany with its Lieferkettensorgfaltspflichtengesetz, 2021) have already introduced a general due diligence law. A number of other Member States are in the process of legislating or considering action (Austria, Belgium, Denmark, Finland, Italy, Luxembourg and the Netherlands).It remains to be seen what impact the Commission’s Proposal will have on these domestic regimes and initiatives.