Directive on corporate sustainability due diligence

Introduction

On 23 February 2022, the European Commission ("EC") adopted a proposal for a Directive on corporate sustainability due diligence (the "Directive"). The EC believes that companies play a key role in building a sustainable economy and society, and the rules set out in the Directive are therefore directed to them. It observes that EU companies operate in complex surroundings and, especially large ones, rely on global value chains. Adverse human rights and environmental impact occur in companies’ own operations, subsidiaries, products, and in their value chains, in particular in connection with raw material sourcing, manufacturing, or in relation to product or waste disposal. They may encounter difficulties to identify and mitigate these risks. The EC therefore considers that identifying these adverse impacts will become easier if more companies exercise due diligence and thus more data is available on human rights and environmental adverse impacts. 

The rules of the Directive apply to the activities of EU companies outside the EU as well as to foreign companies that are active in the EU. The provisions of the Directive are therefore also relevant for companies established in, for example South Africa, that are subsidiaries of EU companies or that are part of a supply chain involving EU companies. Likewise, South African companies that are active in the EU with a turnover in the EU above a certain threshold (see below) may be required to comply with the due diligence obligations that are set out in the Directive.

Objectives

The stated objectives of the Directive are to: 

• improve corporate governance practices to better integrate risk management and mitigation processes of human rights and environmental risks and impacts, including those stemming from value chains, into corporate strategies; 
• avoid fragmentation of due diligence requirements in the single market of the EU and create legal certainty for businesses and stakeholders as regards expected behaviour and liability; 
• increase corporate accountability for adverse impacts, and ensure coherence for companies regarding obligations under existing and proposed EU initiatives on responsible business conduct; 
• improve access to remedies for those affected by adverse human rights and environmental impacts of corporate behaviour; and
• complement other measures in force or proposed, which directly address some specific sustainability challenges or apply in some specific sectors, mostly within the EU.

Application

According to the Directive, the new due diligence rules will apply to the following companies:

• EU companies:
  • Group 1: all EU companies of substantial size and economic power (with 500+ employees and EUR 150 million+ in net turnover worldwide).
  • Group 2: Other EU companies operating in defined high impact sectors, which do not meet both Group 1 thresholds, but have more than 250 employees and a net turnover of EUR 40 million worldwide and more, and provided that at least 50% of this net turnover was generated in one or more of the high impact sectors. For these companies, rules will start to apply 2 years later than for group 1.

• Non-EU companies active in the EU with turnover threshold aligned with Group 1 and 2, generated in the EU.
• The term "company" is broadly defined and includes all forms of limited liability companies. Regulated financial undertakings are also subject to the Directive whatever their legal form.

The Directive identifies the following sectors as "high-impact": 

• 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 (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). 

Due diligence policy

The Directive requires that companies establish a due diligence policy that contains a description of the company’s approach to due diligence, a code of conduct describing the rules and principles to be followed by the company’s employees and subsidiaries and a description of the processes put in place to implement due diligence, including measures to verify compliance with the code of conduct. The Directive requires that the code of conduct applies in all relevant corporate functions and operations, including procurement and purchasing decisions. The due diligence policy should be updated annually.

Due diligence obligations

A company must identify actual or potential adverse human rights and environmental impacts. If a company identifies potential adverse human rights or environmental impacts, it should take appropriate measures to prevent and adequately mitigate them. If necessary due to the complexity of prevention measures, companies should develop and implement a prevention action plan. Companies should also obtain contractual assurances from a direct partner with whom they have an established business relationship that it will ensure compliance with the code of conduct or the prevention action plan. The contractual assurances should be accompanied by appropriate measures to verify compliance. 

If a company identifies actual human rights or environmental adverse impacts, it should take appropriate measures to bring those to an end. Companies should prioritise engagement with business relationships in the value chain. Terminating the business relationship should be a last resort action, after having attempted to prevent or mitigate the adverse potential impacts. If the potential adverse impacts cannot be properly addressed, then companies may be obliged to refrain from entering into new or extending existing relations with the partner in question and, where the law governing their relations so entitles them to, to temporarily suspend commercial relationships with the partner in question whilst exploring possible solutions. If no solution can be found, the business relationship should be terminated. For this purpose, the Directive obliges EU Member States to provide for an option in contracts governed by their laws to terminate the business relationship in these circumstances. 

Additional obligations

According to the Directive, companies should make investments which aim to prevent adverse impacts and provide targeted and proportionate support for an SME with which they have an established business relationship, such as direct financing, low-interest loans, guarantees of continued sourcing, and assistance in securing financing. They can also help SMEs to implement the code of conduct or the prevention action plan, or provide technical guidance, such as training and management systems upgrading. 

Companies that are not governed by the laws of an EU Member should designate an authorised representative in the EU, who should also function as point of contact in connection with the obligations that follow from the Directive. 

Complaint procedure

The Directive obliges companies to set up a complaint procedure. Individuals and organisations, such as workers’ representatives and civil society organisations, can submit complaints directly to the companies in case of concerns regarding actual or potential human rights and environmental adverse impacts. The persons complaining are entitled to request appropriate follow-up and to meet with the company’s representatives at an appropriate level to discuss the subject of their complaint. 

Supervision and civil liability

EU Member States are obliged to designate one or more national supervisory authorities for monitoring compliance with rules that follow from the Directive. These supervisory authorities should be of a public nature, independent from the companies concerned and other market interests, and free of conflicts of interest. The authorities should be entitled to carry out investigations, on their own initiative or based on complaints or substantiated concerns raised under the Directive. The EU Member States must also provide for dissuasive, proportionate and effective sanctions for infringements of the Directive's rules. 

Moreover, EU Member States must introduce rules governing the civil liability of companies for damages arising due to its failure to comply with the due diligence process. In order to ensure that victims of human rights and environmental harm can claim compensation for damages arising due to a company’s failure to comply with the due diligence obligations, the Directive requires EU Member States to ensure that the relevant liability provisions of national law are of overriding mandatory application in cases where the law applicable to claims to that effect is not the law of an EU Member State. This will enable victims located outside the EU to bring their claims against a company in the EU even if they are not governed by the laws of an EU Member State.

Next steps

The adoption of the draft text of the Directive is the start of a legislative procedure under European law. The proposal will be presented by the EC to the European Parliament and the European Council for approval and adoption. It is difficult to predict at this stage how long this procedure will take. The objectives of the Directive are however clearly aligned with more general drive towards sustainability and good corporate governance, which could speed up the approval process. Once adopted, EU Member States will have two years to transpose the Directive into their national laws.