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EU Corporate Sustainability Due Diligence Directive


Monday, July 4, 2022

Overview

The European Commission has recently adopted its long-awaited proposal for a Corporate Sustainability Due Diligence Directive (the “Draft Directive”). The Draft Directive aims to address human rights and environmental rights impacts in global value chains and foster responsible corporate behaviour.

In-scope companies will be required to identify actual and potential adverse environmental and human rights impacts of their activities, and where necessary, prevent, mitigate or bring to an end such activities. The Draft Directive brings welcome clarity, setting down a draft EU standard for human rights and environmental due diligence. As noted in the Draft Directive, some Member States have already introduced laws on human rights due diligence (including Germany and France), and many companies operate such initiatives on a voluntary basis.  While higher standards can continue to apply in individual Member States, it is intended that the Draft Directive will provide legal certainty and transparent rules for those doing business in the EU.

Which companies will be in scope?

The Draft Directive is directly applicable to larger companies only, with a lower size threshold applying for companies operating in specific “high-impact” sectors. The Draft Directive also extends to certain non-EU companies that are active in the EU.  In-scope companies are as follows:

Group 1 – Large Companies

  • EU companies with greater than 500 employees, and a worldwide net turnover of over €150 million in the last financial year for which annual financial statements have been prepared.
  • Non-EU companies that generated a net turnover of more than €150 million in the EU in the financial year preceding the last financial year.

Group 2 – High-Impact sectors

  • EU companies with greater than 250 employees and a worldwide net turnover of over €40 million in the last financial year for which annual financial statements have been prepared, provided at least 50% of this net turnover is generated in one or more of a specified list of high-impact sectors.
  • Non-EU companies that generated a net turnover of between €40 million and €150 million in the financial year preceding the last financial year, provided that at least 50% of the company’s net worldwide turnover was generated in one or more of the designated high-impact sectors.

High-impact sectors are listed in the Draft Directive and are those where a high risk of human rights violations or harm to the environment has been identified.[1] For companies in those sectors (Group 2), the rules will come into effect two years later than for Group 1.

While SMEs are excluded from the scope of the Draft Directive, the Commission has acknowledged the legislation may have indirect effects on SMEs as part of value chains. The Draft Directive includes measures to support SMEs – for example, an SME must be supported where complying with a code of conduct would jeopardise its viability.

The European Commission estimates that around 17,000 companies will be directly within the scope of the Draft Directive (including 4,000 non-EU companies).

Due diligence obligations of in-scope companies

  1. Integrating due diligence into company policies

In-scope companies will be obliged to integrate due diligence into their corporate policies, which must be updated annually. They must adopt a due diligence policy, including a code of conduct to be followed by company employees and subsidiaries.

  1. Identify actual or potential adverse impacts

Adverse environmental and human rights impacts are defined by reference to violations of international conventions listed in the Annex to the Draft Directive and include, for example, forced labour, human trafficking, exports of endangered species, etc.

In-scope companies will have to take appropriate measures to identify such actual and potential adverse environmental and human rights impacts arising from: (i) a company’s own operations or operations of their subsidiaries, and (ii) where related to their value chains, from their established business relationships.

The obligation to identify impacts from established business relationships is quite broad. A company’s “value chain” covers the life cycle of a product, including “activities related to the production of goods or the provision of services by a company, including the development of the product or the service and the use and disposal of the product as well as the related activities of upstream and downstream established business relationships of the company”.

Companies in high-impact sectors (Group 2) must only identify actual and potential severe adverse impacts, that are relevant to the high impact sector they are operating in.

Regulated financial undertakings providing credit, loans or other financial services are also required to identify adverse impacts before providing those services.

  1. Prevent, mitigate or remediate adverse impacts.

Having identified potential or actual adverse impacts, companies must then take appropriate measures to prevent, mitigate or remediate adverse impacts that have been identified by them (or should have been identified). “Appropriate measures” means a measure that is capable of achieving the objectives and being reasonably available to the company, taking into account the circumstances of the specific case – in other words, what is “appropriate” will depend on the facts at hand.

The Draft Directive sets out various steps companies shall be required to take to prevent or mitigate identified adverse impacts, where relevant. This includes developing a prevention action plan in consultation with stakeholders, having defined timelines for action and indicators to measure improvement.

Companies must attempt to bring existing adverse impacts to an end or at least minimise them. Actions companies may take include (where relevant) payment of financial compensation to the affected persons and/or communities. Other actions that may be taken by companies include:

  • Obtaining contractual assurances from direct business partners in the company’s value chain, to ensure that they will comply with the company’s code of conduct and any preventive or action plan – including by seeking corresponding contractual assurances from its partners, to the extent that they are part of the value chain (contractual cascading). The EU Commission will introduce guidance on voluntary model contract clauses in this regard;
  • When necessary, making appropriate investments into infrastructure or processes in order to prevent/remediate adverse impacts; and
  • Supporting SMEs with whom the company has an existing business relationship where compliance of the code of conduct may jeopardise the viability of the SME.

Where an adverse impact cannot be prevented, brought to an end or mitigated by these measures, a company must refrain from entering into new or extending existing relations with the partner in question. If law governing their relations permits, the company must then temporarily suspend commercial relations with that partner whilst pursuing prevention efforts; and, if there is a severe potential adverse impact, terminate the business relationship.

However, by way of derogation, where a regulated financial undertaking provides credit, a loan or other financial services, it shall not be required to terminate the credit, loan or other financial service contract when that action could be reasonably expected to cause substantial prejudice to the entity to receiving the service.

  1. Establish a complaints procedure

In-scope companies will have to provide for a complaints procedure for persons with legitimate concerns regarding actual or potential adverse environmental or human rights impacts, arising from a company’s operations, those of its subsidiaries or its value chain.

Complaints may be issued by actual or potential victims, trade unions or other workers’ representatives and relevant civil society organisations.

  1. Oversee the due diligence policy and its effectiveness

In-scope companies will be required to carry out periodic assessments on their operations under the Draft Directive, including the operations of their subsidiaries. They will be required to monitor, assess and verify that the identification of adverse impacts is up to date, and the effectiveness of the preventative or mitigation measures implemented by the company.

  1. Communicating on due diligence

There is no additional reporting requirement for in-scope companies that are already subject to reporting obligations under the Non-Financial Reporting Directive (NFRD) – which will soon be replaced by the Corporate Sustainability Reporting Directive (CSRD).  All other in-scope companies will be required to publish an annual statement on compliance, on their website by 30 April each year.

Climate change plan

In addition to the due diligence obligations above, all Group 1 companies (those with more than 500 employees), must adopt a plan to ensure that the company’s business model and strategy is compatible with the transaction to a sustainability economy and with limiting global warming to 1.5°C, in line with the Paris Agreement. The plan must identify the extent to which climate change is a risk for, or an impact of, the company’s operations. Where climate change is identified as a principal risk, the company must include emissions reduction objectives in its plan.

Directors’ duties

The Draft Directive envisages that a company’s directors will have responsibility for putting in place and overseeing the due diligence actions required. Directors have a general obligation under company law to act in the best interests of the company. The Draft Directive places an additional express duty on directors to take into account the consequences of their decisions for sustainability matters, including where applicable, human rights, climate change and environmental consequences, including in the short, medium and long term.

Supervision

Member States must designate a national supervisory authority to ensure effective supervision, investigation and enforcement of companies’ obligations. This includes the ability to initiate investigations and inspections, and order remedial actions to be taken.

Non-EU companies that are in-scope must designate an authorised representative established or domiciled in one of the Member States in which it operates. The details of such authorised representative must be notified to a supervisory authority in the relevant Member State.

Sanctions and enforcement

The Draft Directive provides for public enforcement by Member States as well as a civil liability regime. Sanctions must be effective, dissuasive and proportionate, and fines are to be based on the turnover of the relevant company.

Member States must also put in place civil liability rules.  A company may be liable for damages, if it fails to comply with its obligations to prevent, mitigate, minimise or bring to an end adverse impacts, and as a result of such failure, an adverse impact occurs and leads to damage.

Interplay with other EU legislation

As part of the EU’s sustainability package, the Draft Directive is related to the Corporate Sustainability Reporting Directive (CSRD) and EU Taxonomy. The CSRD expands existing non-financial reporting requirements and will introduce an EU-wide sustainability reporting standard.

The Draft Directive goes beyond reporting, in that it will require companies to take action in relation to identified adverse impacts – and into their supply chains. As noted, many larger companies are already undertaking such due diligence on a voluntary basis. We expect in-scope companies will rely on due diligence undertaken for the purposes of the Draft Directive to comply with the CSRD.

Conclusion

The Draft Directive is currently under review at the European Parliament, after which it will be presented to the European Council for approval. Once adopted, EU Member States will have two years to transpose the Draft Directive into national law.

The provisions will apply to Group 1 companies within two years of entry into force of the Draft Directive, and four years in the case of Group 2 companies.

[1] These are (i) manufacture of textiles and leather (including footwear), and wholesale trade of textiles and footwear,  (ii) agriculture, forestry and fisheries; food manufacturing and wholesale trade of agricultural materials, live animals, wood, food and beverages; and (iii) extraction of mineral resources (including oil, gas coal, metals), manufacture of basic metal and mineral products, and wholesale trade of mineral resources and mineral products (Article 2 (1)(b) of the Draft Directive).

 

For more information in relation to this article, please contact partner Anna Hickey.

This article was written with the assistance of Manuel Florendo.


Author

Anna Hickey

PARTNER


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