EU Corporate Sustainability Due Diligence Directive calls for more stringent measures

The planned directive on corporate due diligence is much more far-reaching than the German Supply Chain Due Diligence Act (Supply Chain Act).

On 23 February 2022, the European Commission published its proposal for a directive on corporate sustainability due diligence. The European Parliament had already called on them to do so on 10 March 2021. The Commission itself had announced the legislative proposal a while back, but postponed it several times.

Both non-governmental organisations and many companies had recently been putting increasing pressure on the Commission to present the draft. This was contrasted by the negative stance of numerous business associations. There had been similar delays and requests in the legislative process for the Supply Chain Act.

If the directive comes into force with the proposed content, the German legislator will have to make the Supply Chain Act much more stringent.

Due diligence obligations must be fulfilled in the areas of human rights and the environment

The core elements of the Supply Chain Act and the proposed directive are the same:

The companies concerned will be obliged to fulfil human rights due diligence obligations and environmental due diligence obligations regarding their own activities and in their supply chains on an ongoing basis. This includes, among other things, risk assessments and prevention and remedial measures to identify, prevent and end negative impacts of business activities on human rights and the environment.

In addition, a complaints procedure must be established and a report must be published once a year on the company's website.

Proposed directive on corporate sustainability due diligence expands the circle of affected companies

There are clear differences between the proposed directive and the Supply Chain Act in the personal scope of application. The circle of affected companies is much wider under the directive than under the Supply Chain Act. For one thing, the directive also covers smaller companies: While the Supply Chain Act is only binding for companies with at least 3,000 employees (from 2024: 1,000) employees, the directive applies to:

• companies with more than 500 employees and worldwide annual turnover of more than EUR 150 million
• companies with more than 250 employees and worldwide annual turnover of more than EUR 40 million, provided that at least 50% of the turnover was generated in certain sectors with increased risks for human rights and the environment. These include, for example, the textile sector, agriculture, the food industry and mineral resources, basic and intermediate mineral products.

For another, unlike the Supply Chain Act, the directive has extraterritorial effect. It also applies to companies from third countries with:

• an annual turnover in the Union of more than EUR 150 million
• an annual turnover in the Union of more than EUR 40 million, provided that at least 50 % of the worldwide turnover comes from the risk sectors mentioned above

Whether these non-EU companies have a branch in the EU is irrelevant. In contrast, the Supply Chain Act only applies to foreign companies if they have a branch in Germany.

However, the scope of application of the directive falls short of the Supply Chain Act in so far as basically only corporations are affected - in Germany namely stock corporations (AG) including European public limited-liability companies (SE), partnerships limited by shares (KGaA) and limited liability companies (GmbH). General partnerships (OHG) and limited partnerships (KG) also fall within the scope of application, but only if they are held exclusively by corporations. However, this is rarely the case. Regulated financial undertakings must comply with the directive regardless of their legal form. By contrast, for the applicability of the Supply Chain Act, the legal form is completely irrelevant.

In scope companies also have to check subsidiaries and clients

The directive also differs from the Supply Chain Act in terms of what has to be examined: According to the Commission's intention, an in scope company is obliged to exercise due diligence with regard to

• its own operations,
• the operations of its subsidiaries and
• the value chain operations carried out by such companies with which it has an established business relationship.

The proposed directive defines the latter very broadly as a long-term direct and indirect business relationship, which in terms of intensity and duration, does not represent a negligible or merely ancillary part of the value chain. Upstream and downstream relationships in the value chain are to be examined, in particular suppliers and customers.

In contrast, the Supply Chain Act refers solely to the company's own business area and the supply chain. The own business area only includes subsidiaries in the case of the parent company; and the supply chain essentially concerns the upstream relationships. For example, a freight forwarder who transports the product to the customer may be part of the company's supply chain. But according to the express intention of the German legislator, the customer should only be examined in the case of financial services of special importance.

No parent company, no attribution of employees

Unlike the Supply Chain Act, the proposed directive does not recognise the concept of a parent company or the attribution of employees. This means that many questions that are currently causing legal uncertainty with the Supply Chain Act do not arise here.

Only limited rules for sanctions in the event of a breach of due diligence obligations

The Commission wants to essentially leave it up to the Member States to regulate the official sanctions for a breach of the due diligence obligations. The proposed directive only provides a few parameters: For example, pecuniary sanctions must be based on the company's turnover. The Supply Chain Act only partially fulfils this requirement, as some financial penalties are not turnover-based. Furthermore, the planned directive stipulates that all decisions by supervisory authorities on sanctions must be published (naming and shaming).

EU Supply Chain Directive provides for civil liability for breach of due diligence obligations

The severity of the proposed directive is most evident through the civil liability for breach of due diligence obligations: While the Supply Chain Act explicitly excludes such liability, it is required under the directive. With this, the Commission is paving the way for direct claims by affected persons against the in scope companies for damages due to human rights violations or environmental damage in the value chain.

The directive provides for relief from liability if the damage was caused by activities of an indirect business partner with whom the company has an established business relationship.

The liability is mandatory internationally. Accordingly, a court in a Member State must recognise this liability even if the claims are not governed by the laws of a Member State. The directive thus prevents injured parties from not being able to obtain compensation if supply chain liability does not exist under the law of a third country. This is significant because Member State courts often have to apply the law of a third country in the relevant cases. This is because, in principle, the law of the state where the damage occurred is decisive.

The important issue of the burden of proof is not regulated in the directive and is thus left to the national legislator.

Extension of duties of directors

The proposed directive addresses the responsibility of directors for human rights and environmental concerns in a much more concrete way than the Supply Chain Act: Directors must take into account the short, medium and long-term consequences of their decisions for sustainability matters, including human rights, climate change and environmental consequences. Provisions in national law on breaches of directors' duties shall apply to this duty. Furthermore, in certain circumstances, the company must take climate change into account when setting variable remuneration for its directors.

Legislative procedure has only just begun

The draft directive still has to go through the EU legislative procedure. Both the European Parliament and the Council, in which the Member States are represented by ministers, must approve the draft. Each of the two bodies may propose amendments.

If the directive is adopted, Member States have two years to transpose it into national law. During this time, the German legislator would have to significantly tighten up the Supply Chain Act, if the directive comes into force as the Commission has now proposed.

According to the proposed directive, the due diligence obligations for larger companies (turnover of more than EUR 150 million) will come into force at the end of the transposition period, for smaller companies in risk sectors, two years later.

More corporate responsibility for human rights and the environment

Judging by the European Parliament's draft and by information that was occasionally leaked, the Commission's proposal hardly contains any surprises. Whether and with what content the bill will be passed is still open. After all, the extent to which companies should protect human rights and the environment in their value chains remains a controversial issue. The trend is clearly towards more corporate responsibility, at least in Western Europe: Corresponding laws are already in force in France and Switzerland. Norway and Germany will soon follow. Legislative procedures are underway in the Netherlands and Belgium.

In addition, the current proposal for the directive is not the only initiative at EU level: On 17 November 2021, the Commission had already proposed a regulation on due diligence requirements for products that contribute to deforestation. And at the same time as the present draft directive, the Commission announced a separate legal instrument banning products made by forced labour.