Last week, the European Commission published a draft Directive on Corporate Sustainability Due Diligence introducing minimum due diligence obligations in the EU-27. It follows French and German supply chain legislation and is based on international standards and conventions obliging, companies to embed sustainability and human rights standards in their own operations and to establish due diligence throughout their value chains.

The proposal covers actual and potential adverse impacts on human rights and the environment stemming from international conventions set out in an Annex. This includes for instance the International Labour Organization conventions, the Paris Agreement, and violations of prohibitions to unlawfully evict or to cause pollution of soil or drinking water. It covers companies’ own activities, those of their subsidiaries, and most significantly, companies involved in their value chain operations with whom they have an “established business relationship”.

Which companies will be in scope?

The proposal applies to both EU and non-EU companies. For those established in the EU, the thresholds are:

• Group 1: With over 500 employees and a worldwide net turnover of over €150 million in the last financial year; or
• Group 2: With over 250 employees and a worldwide net turnover of over €40 million in the last financial year if over 50% of this turnover was generated in a specific sector (manufacturing and wholesale of textiles, leather and footwear; agriculture, forestry and fisheries, including raw materials, live animals, beverages; and mineral resources including fossil fuels, quarry products, construction materials, fuels and chemicals).

For those companies established outside the EU, the thresholds are:

• Group 1: Generated a net turnover of over €150 million in the EU in the last financial year; or
• Group 2: Generated over €40 million net turnover in the EU in the last financial year, 50% or more of which in one of the abovementioned sectors.

When will companies have to comply?

As it stands, the new rules would apply to Group 1 companies after two years once the law is in force and to Group 2 companies operating in the specific sectors after four years. These dates may still be adjusted as the draft law is amended.

What are the obligations?

The obligations are numerous, incurring significant compliance costs for most businesses. Selected key points include:

• Including due diligence into all company policies: Companies will need to integrate due diligence across the board and regularly publish and update a due diligence policy that meets the Directive’s specific criteria;
• Identifying potential and actual adverse impacts: This can be done through Environmental, Social and Governance (ESG) audits, independent reports, stakeholder consultations, and more. It is left to each Member State to provide further guidance. Financial services companies will face special obligations in that they will have to carry out an impact assessment before providing a credit, loan or other financial service.
• Preventing or mitigating potential and actual adverse impacts: This will require companies to take actions including developing prevention action plans, seeking contractual assurances from their business partners, investing into management of production processes, etc. They will also have to verify whether their business partners adhere to their contractual obligations and suspend or end the business relationship where this is not the case.
• Establishing a complaints procedure: Companies will be required to establish a complaints procedure for those who may reasonably be affected by the company’s activities, including individuals, trade unions, and civil society organisations.
• Reporting: Companies must monitor the effectiveness of their due diligence policy, publishing an annual statement in line with the Corporate Sustainability Reporting Directive.
• Civil liability: Member States are required to establish civil liability for failure to prevent or end adverse impacts which have led to damage.

The Directive also imposes a duty of care on company directors. The setup and implementation of any due diligence strategy will be the responsibility of the company director, with this individual being tasked with ensuring it remains embedded in corporate strategies. When taking decisions on behalf of the company, all directors will be required to take human rights, environmental, and climate considerations into account when assessing consequences. Any variable remuneration should also take the contribution of the business model and strategy towards achieving the Paris climate targets into account.  

Supervision and sanctions

The proposal is a Directive, which means that each EU-27 Member State will have some flexibility when adapting the text into their own law. Supervision will be in the hands of national authorities, who are also tasked with imposing sanctions. Pecuniary sanctions should be based on turnover, though no more guidance is given. For comparison, German national law currently allows for a 2% annual global turnover fine for severe non-compliance. This set up is already raising concerns over a patchwork of 27 different sets of rules and a race-to-the bottom for sanctions.

Next, the proposed text will be discussed and amended by the European institutions.

For questions on the above or the EU’s approach to ESG, please get in touch. Our experienced sustainability team will be happy to help.