On 23 February 2022, the EU Commission published its Proposal for a Directive on Corporate Sustainability Due Diligence (“Proposal”).

Under the Proposal, EU Member States will be obliged to implement due diligence requirements on a variety of companies, with a view to avoid and minimize potential adverse impacts on human rights and the environment.

Below, we have summarized for you the Proposal’s key elements.

Scope

The directive will apply to EU companies that fall into the following categories:

• They have 500 employees on average and had a worldwide net turnover of more than EUR 150 million in the last financial year for which annual financial statements were prepared (large EU companies).
• They have 250 employees on average and had a worldwide net turnover of more than EUR 40 million in the last financial year for which annual financial statements were prepared, provided that at least 50 percent of this net turnover was generated in one or more “high-impact sectors” (medium-sized EU companies).

In addition, the directive will apply to non-EU companies that in the penultimate financial year generated a net turnover of more than

• EUR 150 million in the EU (large non-EU companies);
• EUR 40 million and less than EUR 150 million in the EU, provided that at least 50 percent of this net turnover was generated in one or more “high-impact sectors” (medium-sized non-EU companies).

“High-impact sectors” include textiles, foodstuffs, agriculture, fisheries, forestry, the extraction of mineral resources, the manufacture of basic metal products and other non-metallic mineral products, and the wholesale trade of mineral resources as well as basic and intermediate mineral products.

Due diligence

In particular, the Proposal foresees the following:

• Including in the existing internal guidelines human rights and environmental due diligence obligations and protective measures of the company as well as their implementation (including the obligations of employees) or releasing separate internal guidelines in this regard.
• Conducting a business activities analysis in respect of human rights and environment-related risks (risk analysis).
• Having in place internal policies, governance and control processes that are adequate to prevent – or at least mitigate if prevention is not possible or not immediately possible – potentially adverse impacts on human rights and the environment.
• Taking appropriate measures to terminate actual adverse impacts or, if not possible or not immediately possible, to minimize their extent.
• Establishing and maintaining a complaints procedure open to both affected individuals and trade unions and other organizations that allows them to raise legitimate concerns regarding actual or potential adverse human rights or environmental impacts.
• Monitoring the effectiveness of preventive and reactive measures to identify, prevent, mitigate, terminate, and minimize the extent of adverse impacts on human rights and the environment.

The Proposal goes beyond imposing due diligence obligations in relation to business activities of the company itself, as it also provides for due diligence obligations in relation to business activities of subsidiaries and companies in the supply chain with which “established business relationships” exist.

Combating climate change

Unlike the German Supply Chain Act (Deutsches Lieferkettensorgfaltspflichtengesetz), the Proposal sets out obligations that support the achievement of the EU’s climate targets. Large companies (both EU and non-EU) must

• adopt a plan to ensure that the company’s business model and strategy are consistent with the EU’s target for transitioning to a sustainable economy as well as with the EU’s actions to limit global warming to 1.5 degrees Celsius, as defined in the Paris Agreement; and
• set their own emissions reduction targets, where necessary.

As an incentive to implement these obligations, which must also be considered in the context of climate litigation, the Proposal stipulates that fulfillment of these obligations should be positively reflected in the variable compensation of the management.

Sanctions

The Proposal sets out an obligation on Member States to establish supervisory authorities that can act on their own initiative and on the basis of substantiated indications to remedy violations and enforce compliance with the sustainability due diligence obligations under administrative law.

It further provides for “effective, proportionate and dissuasive sanctions”, such as the imposition of pecuniary sanctions. The amount of such sanctions is to be based on the company’s turnover – just as required by the German Supply Chain Act. The Proposal also has the reputation of companies in mind. Decisions by supervisory authorities regarding the imposition of sanctions are to be published.

Civil liability

The Proposal defines an obligation for Member States to implement civil liability provisions in addition to the implementation of “effective, proportionate and dissuasive sanctions”. The sanctions and liability provisions will likely be of particular practical relevance, as they give the Proposal teeth, especially with regard to the obligations to implement measures in connection with climate change.

Civil liability shall require that the damage could have been detected and thus prevented or at least mitigated by appropriate due diligence measures. Which due diligence measures are appropriate, which are to be taken with regard to business partners, and when a company can rely on the effectiveness of the measures introduced, will be subject of intensive discussions.

That said, stricter civil liability rules according to national law are still possible.

How does this affect companies?

For the management of companies, the Proposal establishes further obligations for sustainable corporate governance. It is part of a global trend towards a sustainable economy, which, for example, also includes the EU Taxonomy Regulation, proposals for the EU Batteries Regulation, the EU Conflict Minerals Regulation, the EU Timber Regulation, and the EU Commission proposal for the Corporate Sustainability Reporting Directive. Together, these will lead to a significant expansion of the group of companies subject to reporting requirements.

The combination of regulatory requirements as well as reporting and disclosure obligations will likely lead to companies aligning their business activities even more closely to sustainability criteria.

Thus, companies face some major challenges.

What’s next?

The Proposal must still go through the legislative process. It will first be discussed in the European Parliament and the Council.

If adopted, Member States will be required to transpose the directive into national law within two years from its entry into force. Here, German lawmakers would have to adapt the German Supply Chain Act accordingly. The regulations with regard to obligations for large companies then shall apply within two years, for medium-sized companies it will apply only within four years after the directive has entered into force.

How do the Proposal’s obligations relate to the German Supply Chain Act’s obligations?

Even if it will be some time before the Proposal is actually implemented, it is still useful to take a look now at the obligations that are likely to come. This is especially important for companies that are in the process of preparing for the German Supply Chain Act. Companies should continue such preparations, as a future directive on corporate sustainability due diligence will not change the obligations under the German Supply Chain Act. At most it will lead to a tightening of the internal rules on due diligence in the supply chain.

We will keep you informed about further developments; in the meantime we look forward to answering any questions you may have.