Overview
After several delays, the European Commission (“Commission”) issued its long-awaited proposal for a Directive on Corporate Sustainability Due Diligence (“Proposed Directive”) on 23 February 2022. The purpose of the Proposed Directive is for EU companies and certain non-EU companies operating in the EU to address human rights and environmental issues in their value chains, through mandatory due diligence for human rights, environmental, and climate-change concerns.
The Commission’s internal Regulatory Scrutiny Board had twice issued a negative opinion on the draft legislation in 2021, leading to the delay in the adoption of the Proposed Directive. This resulted in the Commission significantly revising its proposal as compared to the preferred option it had put forward in its impact assessment.
As with other recent proposals, such as the Commission’s proposed Regulation on deforestation free products, the Proposed Directive fits in the wider context of the European Green Deal, the Commission’s flagship initiative to transform the EU from a high- to a low-carbon economy. It however goes beyond this, since it also aims to address human rights violations in the value chain. The Proposed Directive is therefore also part of the wider EU goal to promote “responsible and sustainable value chains”, a key pillar of the EU trade strategy announced in February 2021, as well as a number of human rights related EU policies, such as the EU Action Plan on Human Rights and Democracy 2020-2024.
The analysis below provides an overview of the key elements of the Proposed Directive in its current form, as well as the road ahead towards adoption, and the impact it may have on businesses.
Material scope
The Proposed Directive provides for obligations for companies on actual, and potential, adverse impacts on human rights and the environment, spanning their own operations, those of their subsidiaries, and the value chain operations carried out by entities with whom they have an established business relationship.
While the Proposed Directive aims to harmonise EU Member State legislation regarding due diligence for human rights and environmental concerns, it also clarifies that it will not constitute grounds for reducing the level of protection provided for by EU Member State legislation in force at the time of its adoption. This means that companies may face stricter rules in certain EU Member States.
Finally, in case there are stricter or more specific rules laid down in other EU legislation concerning human rights, the environment, or climate change, those stricter or more specific rules will apply in case they are in conflict with the Proposed Directive.
Companies falling under the scope of the Proposed Directive
Both EU, as well as non-EU companies, would be covered by the obligations laid down in the Proposed Directive, subject to certain thresholds and specific criteria, namely:
- Group 1 – large EU companies: EU companies with more than 500 employees on average and a net worldwide turnover of more than EUR 150 million in the last financial year.
- Group 2 – EU companies in “high-impact” sectors: EU companies that do not meet Group 1 thresholds, with more than 250 employees on average and a net worldwide turnover of more than EUR 40 million, provided that at least 50% of this net turnover was generated in one or “high-impact sectors”, namely:
- the manufacture of textiles, leather and related products (including footwear), and the wholesale trade of textiles, clothing and footwear;
- agriculture, forestry, fisheries (including aquaculture), the manufacture of food products, and the wholesale trade of agricultural raw materials, live animals, wood, food, and beverages; and
- the extraction of mineral resources regardless of where they are extracted (including crude petroleum, natural gas, coal, lignite, metals and metal ores, as well as all other, non-metallic minerals and quarry products), the manufacture of basic metal products, other non-metallic mineral products and fabricated metal products (except machinery and equipment), and the wholesale trade of mineral resources, basic and intermediate mineral products (including metals and metal ores, construction materials, fuels, chemicals and other intermediate products).
- Non-EU companies active in the EU that meet the turnover thresholds with respect to their turnover generated in the EU of:
- Group 1; or
- Group 2, provided that at least 50% of their net worldwide turnover was generated in one or more of the “high-impact sectors” as described above.
Such covered non-EU companies would have to designate a sufficiently mandated authorised representative that is established or domiciled in the EU, in one of the Member States where the non-EU company in question operates. This authorised representative would serve as the contact point for the competent Member State authority.
According to the Explanatory Memorandum accompanying the Proposed Directive, “small and medium sized enterprises (SMEs) that include micro companies and overall account for around 99 % of all companies in the Union, are excluded from the due diligence duty”, because for these type of companies “the financial and administrative burden of setting up and implementing a due diligence process would be relatively high”.
Nevertheless, the Commission anticipates that several SMEs will be exposed to some costs and burdens as it expects that companies covered by the Proposed Directive are likely to pass on due diligence related demands to their suppliers.
Finally, we note that the definition of “company” is broad, and is described in detail in the Proposed Directive.
Due diligence obligations
The Proposed Directive lays down extensive human rights and environmental due diligence obligations, mandating six broad categories of actions for covered companies:
1. Integrating due diligence into their policies.
As a first step, covered companies would have to have in place a due diligence policy to be updated annually, and integrate due diligence into all their corporate policies. The due diligence policy would have to include
a.) a description of the approach to due diligence, including in the long term;
b.) a code of conduct for company employees and subsidiaries; and
c.) a description of processes put in place to implement and verify compliance with due diligence, as well as to extend its application to established business relationships.
2. Identifying actual or potential adverse impacts.
As a second step, covered companies would have to take appropriate measures to identify actual and potential adverse human rights impacts and adverse environmental impacts arising from their own operations or those of their subsidiaries. This would also apply to their established business relationships where these adverse impacts are related to their value chains.
Adverse human rights impacts cover adverse impacts on protected persons resulting from the violation of a wide range of rights or prohibitions, while adverse environmental impacts cover adverse impacts on the environment resulting from the violation of a wide range of prohibitions and obligations. These rights, prohibitions, and obligations are enshrined in several international conventions, and are all listed in the Annex to the Proposed Directive.
For Group 2 companies, the obligation to identify adverse impacts only applies with respect to severe adverse impacts relevant to the respective “high-impact” sectors, while for regulated financial companies providing credit, loan, or other financial services, it only applies before the provision of such services.
3. Preventing and mitigating potential adverse impacts, and bringing actual adverse impacts to an end and minimising their extent.
As a third step, covered companies would have to take appropriate measures to prevent, or where prevention is not possible or not immediately possible, adequately mitigate potential adverse human rights impacts and adverse environmental impacts that have been, or should have been, identified pursuant to the second step. They would also have to take appropriate measures to bring such actual adverse impacts to an end.
Appropriate measures are measures capable of achieving the objectives of due diligence, appropriate to the degree of severity and the likelihood of the adverse impact, and reasonably available, considering the circumstances of the specific case, including characteristics of the economic sector and of the specific business relationship, and the need to ensure prioritisation of action.
Preventative steps include developing and implementing a prevention action plan in consultation with affected stakeholders, seeking contractual assurances from business partners to ensure compliance, and making necessary investments.
Steps to be taken to bring actual adverse impact to an end include neutralising the adverse impact or minimising its extent, including by the payment of damages or financial compensation to the affected persons or communities. It also includes the development and implementation of a corrective action plan in consultation with stakeholders where the actual adverse impact cannot be immediately ended. Also here, other steps include seeking contractual assurances from business partners to ensure compliance, and making necessary investments.
Regarding potential or actual adverse impacts that could not be prevented, covered companies would have to refrain from entering into new or extending existing relations with the partner in connection to or in the value chain of which the impact has arisen, and would have to, where possible, either temporarily suspend or terminate the relationship with respect to the activities concerned.
4. Establishing and maintaining a complaints procedure.
As a fourth step, covered companies would have to put in place a complaints procedure allowing actual or potential victims, workers’ representatives, and civil society organisations to submit complaints when there are legitimate concerns regarding actual or potential adverse impacts regarding the operations of the covered company in question, that of their subsidiaries, or their value chains.
5. Monitoring the effectiveness of their due diligence policy and measures.
As a fifth step, companies would have to carry out periodic assessments of their own operations and policies, those of their subsidiaries and, where related to their value chains, those of their established business relationships. In so doing, they would have to monitor the effectiveness of the identification, prevention, mitigation, ending, and minimisation of the extent of human rights and environmental adverse impacts.
Such activities would have to be carried out at least every 12 months, and whenever there are reasonable grounds to believe that significant new risks of the occurrence of those adverse impacts may arise.
The companies’ due diligence policies would have to be updated based on the outcome of the assessments.
6. Publicly communicating on due diligence.
As a final step, covered companies would have to report on the matters covered by the Proposed Directive by publishing an annual statement on their website.
This obligation only applies to covered companies that are not subject to the reporting requirements laid down in the Non-Financial Reporting Directive (NFRD), which is to be replaced by the proposed Corporate Sustainability Reporting Directive (CSRD) announced as part of the sustainable finance package.
The Proposed Directive clarifies that the Commission will adopt guidance on voluntary model contract clauses to facilitate companies’ compliance with the third step. In addition, the Commission may also issue specific guidelines on how companies should fulfil their due diligence obligations, including with respect to specific adverse impacts or sectors.
Climate change concerns
The Proposed Directive also provides for obligations on Group 1 companies to adopt a plan to ensure that their business model and company strategy is compatible with the transition to a sustainable economy and with the limiting of global warming to 1.5 °C in line with the Paris Agreement. In case climate change is, or should have been, identified as a principal risk for, or a principal impact of, the company’s operations, the company would have to include emission reduction objectives in its plan.
Directors’ duties
The Proposed Directive also introduces specific duties for the directors of EU covered companies when fulfilling their duty to act in the best interest of the company, including:
- putting in place, overseeing the implementation of, and adapting the companies’ due diligence policies; and
- considering human rights, climate change, and environmental consequences of their decisions.
Penalties
Companies would be subject to sanctions, to be determined by each EU Member State, for infringing the obligations contained in the draft Directive. Such sanctions would have to be effective, proportionate, and dissuasive.
A company’s efforts to comply with any required remedial action, investments made, and other compliance actions taken, would be considered in the assessment of whether to impose sanctions, and if so, of their appropriate level. Pecuniary sanctions would represent a percentage of the company’s turnover.
Companies would also be liable for damages if they failed to comply with their due diligence obligations relating to the prevention and mitigation of potential adverse impacts, and the bringing of actual adverse impacts to an end and minimising their extent (i.e. the third step in the due diligence process outlined above).
Competent authorities
The Proposed Directive would be enforced by the EU Member States, who would have to designate one or more authorities to supervise compliance with the obligations laid down in the Proposed Directive.
For EU companies, the competent authority would be the supervisory authority of the Member State in which they have their registered office.
For non-EU companies, the competent authority would be the supervisory authority of the Member State in which they have a branch. In case they do not have a branch in the EU, or have branches in several EU countries, the competent authority would be the supervisory authority of the Member State in which they generated the most of their net turnover.
The supervisory authorities would have adequate powers and resources to carry out their tasks, including the powers to request information and carry out investigations. They would also be able to carry out investigations on their own motion, or as a result of substantiated concerns communicated pursuant to the complaints mechanism.
Complaints mechanism
Individuals and entities would be able to submit substantiated concerns to a supervisory authority where they have reason to believe, on the basis of objective circumstances, that a covered company is failing to comply with its obligations pursuant to the Proposed Directive.
The relevant supervisory authority would have to inform the complainant of the result of its assessment as soon as possible. Such decisions would be subject to judicial review.
The road ahead: adoption timetable and potential amendments
The Commission has proposed a comprehensive set of due diligence obligations with extraterritorial effects. These aim not only at addressing adverse impacts on human rights and the environment, but also to prevent potential adverse impacts from happening. While the draft will be considered as a step in the right direction by some, the legal text is likely to be subject to many amendments as the Proposed Directive is reviewed by the European Parliament and the Council of the EU under the ordinary legislative procedure. Heated debates are expected, in particular on the scope of the Proposed Directive, and on directors’ duties.
The European Parliament will likely call for more stringent obligations, as the Commission’s proposal is significantly less ambitious than what the European Parliament called for in its report on “Corporate due diligence and corporate accountability”. In particular, MEPs are likely to call to widen the Proposed Directive’s scope, which currently only applies to approximately to 1% of EU companies, and to call for additional directors’ duties. While MEP Lara Wolters has already questioned the limited scope of covered companies, arguing that all companies in high impact sectors should be covered, MEP Pascal Canfin reached out to the Commission to link directors’ bonuses to companies’ environmental performances.
At the same time, expect companies to push back against expanding the Directive’s scope, with strong concerns having been raised regarding the workability of the Proposed Directive and the expectation for companies to control their entire global value chains. The debate within the Council of the EU is also likely to be lively.
Once it is adopted, the Directive would enter into force on the twentieth day following its publications in the Official Journal of the European Union. EU Member States would then have two years to transpose the adopted Directive in their national legislation. The obligations on Group 1 companies would apply as from two years from the entry into force of the Directive, which this would be four years for Group 2 companies.
Still to come: a proposal on forced labour. The Commission has also published a Communication on Decent Work Worldwide on forced labour which informs that the Commission is “preparing a new legislative initiative, which will effectively prohibit the placing on the EU market of products made by forced labour, including forced child labour.” This proposal is expected to be issued later this year. In the meantime, the Commission’s Guidance document on due diligence for EU businesses to address the risk of forced labour in their operations and supply chains may be consulted. We note that although the Guidance is not binding, it is likely to influence future EU legislation on this topic.
Impact on businesses
The EU is increasingly focusing on policies and legislation regarding corporate social responsibility, through a wide variety of legislative initiatives. These measures, once adopted, are likely to have a significant impact on EU and third country businesses, through compliance costs, enforcement risks, complaints from interested parties, as well as impacts on competitive and trade relationships.
Steptoe & Johnson’s teams in Brussels are closely following these developments and are able to assist with a range of questions and issues. Contact us for legal advice and advocacy support during the adoption process on assessing the implications of new obligations, assessing adequate legal remedies, as well as on matters of overlapping legal provisions, legal interpretation, and respect of general principles of EU law.
