You cannot outrun a "bad ESG diet"

The proposed Corporate Sustainability Due Diligence Directive in an M&A context

The Corporate Sustainability Due Diligence Directive ("CSDDD") imposes a duty upon companies to identify, prevent, bring to an end, mitigate and account for potential and actual adverse human rights and environmental impacts arising from their business activities, as well as those of their subsidiaries and value chains. 

The final text of the CSDDD is only expected in early 2024 and Member States will have a further two years to implement the CSDDD into national law. However, as the saying goes, you cannot outrun a bad diet (or in this case, poor governance and ESG hygiene), and companies should not expect to be able to wait until the last minute to review their ESG health, hoping for "crash diet" success, particularly in the context of M&A.

Preparing for M&A with the CSDDD in mind

Looking at the measures currently proposed in an M&A context, there are several things that buyers, sellers and target boards may wish to start considering.

Buyer’s perspective

A prospective buyer may wish to ascertain, either as a preliminary scoping matter or as part of a formal due diligence exercise:

1. the likelihood that a target or its group will be in direct scope of the CSDDD, and to what extent it might be impacted indirectly if it is in the supply or value chain of an in scope company; 
2. the status of a target’s “readiness to comply” with the CSDDD, including whether it has carried out a review of its policies and procedures; any related dialogue the target board may have had with stakeholders, shareholders and employees; and any plans to implement changes as a result; 
3. existing jurisdictional CSDDD (super) equivalent measures (such as the German Supply Chain Due Diligence Act or the French Corporate Duty of Vigilance Law) to which a target’s operations may be subject, including: (i) its compliance with those measures; (ii) exposure to fines, sanctions, claims, litigation or disputes relative to such regimes (including directors' liabilities and availability of indemnities); and (iii) the extent to which a restructure of a target operational in unduly onerous or costly ESG regulatory regimes may be possible or necessary; and
4. the ESG health of the relationship between a target and its business partners in its supply or value chain, including whether existing contractual provisions need to be amended to give the target further assurance of compliance with CSDDD within its value chain, or failing that, identifying which business relationships may need to be terminated and how that might affect the target’s business or its enterprise value.

Until the CSDDD comes into force, the answers to these questions may not have an immediate impact on a target business. However, they may become very relevant and potentially very costly to remediate, by the time a buyer is operating the business or wishes to sell the target in the future.

Until the CSDDD comes into force, the answers to these questions may not have an immediate impact on a target business. However, they may become very relevant and potentially very costly to remediate, by the time a buyer is operating the business or wishes to sell the target in the future. Therefore, depending on a buyer’s findings during a due diligence process now, it may wish to factor in such future risk in their deal valuation and consider what, if any, consideration adjustments or deal protection measures (such as bespoke W&I coverage for ESG matters) may be desirable or available before progressing a potential acquisition. 

Seller and Target perspective

In anticipation of buyers factoring CSDDD considerations into their M&A due diligence processes, sellers and Target boards should work towards ensuring they are prepared to demonstrate the steps they are taking towards getting into tip top “ESG” shape.

To maximise the chance of a target being acquired or taken over successfully and efficiently, sellers or the target board may wish to consider preparing the target by undertaking a gap analysis of the target's existing policies and procedures.

The CMS CSDDD Navigator, and the list of buyer’s due diligence considerations above may be a useful starting point for this. 

Such review, any related analysis and any other company decision making in respect of the same should be documented, and if presented to a buyer, may encourage smoother deal flow and reduce the risk of price chipping or deal protection measures being proposed.