European Commission issues major proposal on due diligence obligations to protect human rights and the environment across supply chains
16 min read
On 23 February 2022, the European Commission ("Commission") issued its long-awaited Proposal for a Directive on Corporate Sustainability Due Diligence to tackle human rights and environmental impacts across global value chains ("the Proposed Directive").1 The Proposed Directive would impose a corporate due diligence duty on large EU and third-country companies, and smaller companies in certain "high-risk" sectors, to identify and take steps to remedy actual and prevent or mitigate potential adverse impacts on human rights and the environment in the companies' own operations, and their subsidiaries and value chains.
Concurrently, the Commission published a Communication on Decent Work Worldwide2 outlining plans to tackle forced labour and promote decent work worldwide – including a proposal to ban products produced with forced or child labour from the EU market. The Proposed Directive will also complement the Sustainable Finance Disclosure Regulation3 and the Taxonomy Regulation.4
The Proposed Directive has been described as "a watershed moment for human rights and the environment"5 and is controversial in light of the far-reaching and potentially costly obligations it would impose on companies, and the potential penalties (including for company directors) and civil liability it could entail. The number of companies covered by the Commission proposal is substantially reduced compared to the recommended proposal6 adopted by the European Parliament in 2021,7 which has been met with disappointment by a number of NGOs.8 The Commission estimates that 13,000 EU companies and 4,000 third-country companies would be within the scope of the Proposed Directive. These companies would have to (i) integrate due diligence into their policies, (ii) conduct due diligence to identify actual or potential adverse impacts from their operations on human rights and the environment, (iii) prevent, mitigate and end such adverse impacts, (iv) put in place a complaints procedure, (v) monitor effectiveness of their due diligence policies, and (vi) publicly communicate on their due diligence. The Proposed Directive envisages enforcement by Member State administrative authorities, with fines for non-compliance and specific directors' duties in relation to human rights and environmental law. It would also introduce a civil liability regime to allow victims to sue companies for damages for harm which could have been avoided by proper due diligence measures.
This initiative is still at the stage of a legislative proposal for adoption by the European Parliament and the Member States (acting as "the Council"), so the measures announced by the Commission are subject to change. The final Directive must then be transposed into national law by the Member States within two years of the entry into force of the Directive for the largest companies covered, with a further two-year transitional period for those smaller companies operating in high-risk sectors specified by the Proposed Directive.
One closely watched issue was whether the Proposed Directive would include a mechanism relating to a ban on imports or withdrawal from the EU market of products made with forced and child labour, following an announcement by Commission President Ursula von der Leyen in her September 2021 State of the Union address that the Commission would propose an import ban on such products.9 The Proposed Directive does not cover this, however. Instead, the Commission published a Communication on Decent Work Worldwide ("the Communication"), confirming that it is preparing an additional legislative initiative to prohibit goods made with forced labour, including forced child labour, from the EU market. The Commission does not indicate when a legislative proposal to that effect will be made. Statements by the Commissioner for Trade and the Director General of DG Trade have suggested that this will take time.
The Proposed Directive will work in tandem with the Sustainable Finance Disclosure Regulation (“SFDR”) and the Taxonomy Regulation. While the Proposed Directive creates obligations on companies to perform ESG due diligence and to adopt ESG policies aligned with global policy commitments, the SFDR and the Taxonomy Regulation have established a parallel regime applying to investors and those structuring and issuing sustainable investments. Put another way, the Proposed Directive will impose obligations on companies to provide ESG data which would then allow them to access the market demand for ESG investments which is supported by the frameworks provided by the SFDR and the Taxonomy Regulation.
Scope and thresholds
The Proposed Directive would apply to both EU-based companies and companies incorporated in third countries. Whether a company would be subject to the provisions of the directive would depend on its size, sector, and source of revenue:
- Companies based in the EU with more than 500 employees and a net worldwide turnover of more than EUR 150 million during the last financial year.
- Companies based in the EU with more than 250 employees and a net worldwide turnover of more than EUR 40 million in the last financial year, if at least half of that net turnover was generated in specific high-risk sectors: (i) the manufacture of textiles, leather and related products (including footwear) and the wholesale trade of textiles, clothing and footwear; (ii) agriculture, forestry, fisheries, the manufacture of food products and the wholesale trade of agricultural raw materials, live animals, wood, food and beverages; and (iii) the extraction of mineral resources regardless of where extracted, including crude petroleum, gas, coal, metals and metal ores, the manufacture of basic metal products, other non-metallic mineral products and fabricated metal products, and the wholesale trade of mineral resources and basic and intermediate mineral products, including metals and metal ores, construction materials, fuels and chemicals.
- Companies established outside the EU with either (i) a net turnover in the EU of more than EUR 150 million during the financial year preceding the last financial year, or (ii) a net worldwide turnover of more than EUR 40 million but a net turnover in the EU of less than EUR 150 million, if at least 50% of the net worldwide turnover was generated in the high-risk sectors listed above.
Small and medium enterprises are not directly in the scope of the Proposed Directive, but may be impacted if they operate within the value chains of companies that are in scope.
Relevant human rights and environmental standards & specific climate change obligation
The human rights and environmental standards the Proposed Directive seeks to protect are set out in its Annex, and either explicitly defined or by reference to international treaties.
Companies covered by the Proposed Directive solely because of their size (i.e., the largest companies) would have to adopt a plan to ensure that their business model and strategy are compatible with a transition to a sustainable economy, as well as with limiting global warming to 1.5 °C (in line with the Paris Agreement). The plan would have to identify the extent to which climate change is a risk for, or an impact of, a company's operations.
Where climate change would be found to be a "principal risk" or a "principal impact" of a company's operations, emission reduction objectives should be included in a company's plans. The fulfilment of these obligations would have to be taken into account in the calculation of a director's variable remuneration, where remuneration is linked to his or her contribution to the company's business strategy, and long-term interests and sustainability.
Some criticism has come from environmental NGOs due to the absence of certain specific climate-related environmental treaties listed in the Annex, which might exclude certain environment-related harms from the scope of the Proposed Directive, as well as disappointment regarding the text relating to climate change which has ultimately been included in the proposal.10
Due diligence obligations
The Proposed Directive would establish specific human rights and environmental due diligence requirements on companies within its scope.
- Policies: covered companies would have to integrate human rights and environmental due diligence into their corporate policies, and adopt a specific due diligence policy. This due diligence policy would have to include the company's approach to due diligence, a code of conduct describing rules and principles to be followed by employees and subsidiaries, and a description of processes put in place to implement due diligence. The due diligence policy would have to be updated on an annual basis.
- Assessment: covered companies would have to identify actual and potential adverse human rights and environmental impacts arising from both their own operations and those of their subsidiaries. This requirement would also extend to the operations of the business relations of the covered companies, to the extent that their operations would be part of the supply chain of the covered company.11
- Prevent and mitigate: covered companies would have to take measures to prevent and mitigate potential impacts. Companies would be required to develop and implement a prevention action plan in consultation with affected stakeholders, seek contractual assurances (along with measures to verify compliance) from business partners and companies with which they have an indirect relationship, make necessary investments, support SMEs with which they have established relationships where complying with the code of conduct or action plan would be too costly, or collaborate with other entities where appropriate. Where potential adverse impacts would not be prevented or sufficiently mitigated by such measures, covered companies would be required to refrain from entering into new business with the problematic partner and, where legally possible, temporarily suspend their commercial relationship (or terminate it altogether if the potential adverse impact is severe). Member States would be required to adapt their contract law to make this possible.
- End or minimise: Covered companies would also have to end actual adverse impacts. Where this would prove impossible, they would have to minimise adverse impacts instead. They could also be required to pay damages to affected persons and provide financial compensation to affected communities. Payments would be proportionate to the significance of the adverse impact and to the contribution of a covered company's conduct. Where the adverse impact could not be immediately brought to an end, the company would have to implement a corrective action plan. Like for potential impacts, a covered company could be required to seek contractual assurances from business partners. Such contractual assurances could in turn require business partners to seek their own assurances from their own business partners. This would be limited to activities relevant to the supply chain ("contractual cascading"). Investment could also be required from covered companies to bring actual adverse impact to an end. Companies could additionally be required to provide support to affected SMEs and collaborate with other entities. Covered companies could also be required to refrain from entering into further business with a given company, suspend their collaboration, or fully terminate their business relationship.
- Complaints procedure: covered companies would have to allow interested parties (i.e., affected persons, trade unions, and relevant civil society organisations) to submit complaints to them. Covered companies would also have to establish a procedure for dealing with complaints. Complainants would be entitled to request appropriate follow-up on a complaint and to meet with the company's representatives.
- Monitoring: covered companies would have to carry out periodic assessments of their operations and measures. This requirement would also extend to the operations and measures of their subsidiaries, as well as those of their established business relationships where related to their own value chains.
- Transparency and communication: covered companies not subject to reporting requirements under Articles 19a and 29a of Directive 2013/34/EU would have to publicly report on due diligence on their website.12
Directors' duty of care
Directors' duties were an issue subject to substantial discussion in the preparation of the Proposed Directive. The text now proposed is that Member States would have to amend their laws on breaches of directors' duties to ensure that, when fulfilling their duty to act in the best interest of the company, directors of EU-based companies would take into account the consequences of their decisions for sustainability matters. This would include, where applicable, human rights, climate change, and other environmental consequences in the short, medium and long term. With this provision, the Commission aims to increase the involvement of directors of companies in corporate sustainability due diligence obligations and strengthen the integration of sustainability in corporate strategy.13
The Commission proposes enforcement by administrative measures imposed by national supervisory authorities who would have powers of investigation, as well as potential civil liability.
A European Network of Supervisory Authorities will be established, to facilitate cooperation and alignment. EU-based companies covered by the Proposed Directive would be supervised by the competent supervisory authority of the Member State in which they have their registered office. A non-EU company would be supervised by the supervisory authority of the Member State in which it has its branch. Should the covered company not have a branch in a Member State, or have more than one in different Member States, the competent supervisory authority would be that of the Member State in which it generates the most turnover within the EU.
Supervisory authorities would be empowered to verify compliance with the Proposed Directive through information requests and investigations (at their own initiative or following substantiated concerns). Where supervisory authorities identify a violation of national provisions adopted to implement the Proposed Directive, they would be required to grant the company concerned time to take remedial action. They would also (at least) have the power to order the cessation of the infringement, abstention from any repetition of the conduct and proportionate remedial action, pecuniary sanctions, and interim measures. Administrative sanctions would be determined by each Member State and imposed by the relevant Supervisory authority, and should be effective, proportionate, and dissuasive, and take into account a company's efforts to comply.
The Proposed Directive introduces a civil liability regime which foresees actions for damages by victims linked to a company's failure to comply with the Directive and conduct adequate due diligence, and as a result, to prevent potential adverse impacts or end actual adverse impacts. The Proposed Directive contains certain limitations on liability, intended to ensure proportionality for the companies covered.
The Commission's proposal will now be discussed and, in light of its ambitious and controversial proposals, be subject to amendment in the process of adoption by the European Parliament and the Council. Pressure for early agreement and adoption of the Proposed Directive is expected to be intense, since the aim is to harmonise requirements in the EU in the wake of a number of national laws (such as the French Duty of Vigilance law, the German law on Corporate Due Diligence in Supply Chains14) and limit other national laws imposing due diligence requirements leading to a patchwork of inconsistent obligations. Once adopted, Member States must transpose the measure into their national laws. The obligations would then apply for the largest companies in scope within two years, and those companies covered in the specific "at risk" sectors within four years of the entry into force of the Directive.
1 European Commission, Proposal for a Directive of the European Parliament of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937, COM(2022) 71 final, available here.
2 European Commission, Communication from the Commission to the European Parliament, the Council and the European Economic and Social Committee on decent work worldwide for a global just transition and a sustainable recovery, COM(2022) 66 final, available here.
3 Regulation (EU) 2019/2088, available here.
4 Regulation (EU) 2020/852, available here.
5 Richard Gardiner of "Global Witness", reported by Bloomberg here.
6 See European Parliament resolution of 10 March 2021 with recommendation to the Commission on corporate due diligence and corporate accountability, 2020/2129(INL), available here.
7 See White & Case: "Pressure mounts on EU Regulator to deliver on mandatory human rights, environmental and governance due diligence".
8 See e.g. here.
9 European Commission President Ursula von der Leyen, 2021 State of the Union Address by President von der Leyen, 15 September 2021, available here.
10 E.g., by the environmental law NGO ClientEarth.
11 Companies within the scope of the Proposed Directive by virtue of their activities in specific sectors would only be required to identify actual or severe adverse impacts relevant to the sector in question.
12 Directive 2013/34/EU of the European Parliament and of the Council of 26 June 2013 on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings, OJ L 182, available here.
13 European Commission press release, "Just and sustainable economy: Commissions lays down rules for companies to respect human rights and environment in global value chains", 23 February 2022, available here. As indicated above, EU companies will also have to take into account the fulfilment of obligations regarding a corporate climate change plan when setting variable remuneration linked to the contribution of a director to the business strategy of the company.
14 Discussed here.
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