18/03/2022

European Commission publishes long awaited proposals for a Directive on Corporate Sustainability Due Diligence

On 23 February 2022, the European Commission (EC) published its proposals for a Directive 2022/0051 on Corporate Sustainability Due Diligence (the Directive). This provides a pathway for companies, in respect of their products’ lifecycle and/or their business activities, to implement the necessary due diligence procedures to enable them to better identify, prevent, mitigate and bring to an end adverse impacts of their activities on human rights and on the environment that may occur within their value chains or operation structures, such as child labour, exploitation of workers and pollution.

Background

The EC’s proposals were first envisaged as part of the 2019 European Green Deal which pledged that “sustainability should be further embedded into the corporate governance framework” and come almost a year after the European Parliament passed a resolution on 10 March 2021 with recommendations to the EC on corporate due diligence and corporate accountability in relation to corporate activities that may negatively impact the environment and human rights.

While a number of existing Member States have introduced rules on corporate sustainability due diligence at national level, the Directive aims to reduce fragmentation of these existing frameworks and assist with the transition to a sustainable economy across the single market. It will also compliment an existing suite of EU policy provisions and legislation that provide for sustainable and responsible corporate governance, including, but not limited to, the EC’s recent proposals for a Corporate Sustainability Reporting Directive, the Sustainable Finance Disclosure Regulation and the Anti-Human Trafficking Directive.

The EC’s proposals, as set out in the Directive, will now be put before the European Parliament and Council for debate and approval. Once approved, the Directive will come into force twenty days after its publication in the Official Journal of the European Union and Member States will have two years to implement it into their national laws.

Scope

The Directive will cover approximately 13,000 European Union (EU) companies and 4,000 third-country companies. It will apply to:

EU companies

  • Large limited liability EU companies with more than 500 employees and a net worldwide turnover of more than €150 million in the last financial year.
  • Mid-sized limited liability EU companies with more than 250 employees and a net worldwide turnover of more than €40 million in the last financial year, providing that 50% of which was generated within specific ‘high impact’ sectors (discussed below).

Non-EU companies

  • Non-EU companies which have generated a net turnover of more than €150 million within the EU in the financial year preceding the last financial year.
  • Non-EU companies with a net turnover of more than €40 million in the financial year preceding the last financial year, providing that 50% of which was generated within one or more of the specific high impact sectors.

High impact sectors

The following sectors are considered high impact:

  • Manufacturing and wholesale trade of textiles, leather and related products, clothing and footwear.
  • Agriculture, forestry, fisheries (including aquaculture), the manufacture of food products, the wholesale trade of agricultural raw materials, live animals, wood, food and beverages.
  • Extraction of mineral resources (regardless from where they are extracted), the manufacture of basic metal products, other non-metallic mineral products and fabricated metal products (except machinery and equipment), wholesale trade of mineral resources and basic intermediate mineral products.

The list of high impact sectors is set to be updated by the EC periodically.

Although the UK is no longer part of the EU, its corporate sector is likely to be affected by the Directive given that UK companies generate significant turnover within the EU, or supply those who do. 

Small and medium sized enterprises (SMEs)

SMEs are exempt from the due diligence obligations provided for under the Directive in acknowledgement that they generally lack the resources and expertise to implement a due diligence process and that the cost of carrying out such due diligence would impact them disproportionately.

Nevertheless, SMEs could be exposed indirectly to some of the costs through association with business partners who are within its scope, as companies are expected to pass on demands to their suppliers.

Due diligence obligations and requirements

The Directive requires large companies to have in place a plan to ensure that its business model and strategy are compatible with the transition to a sustainable economy and with limiting global warming to 1.5 degrees Celsius in line with the Paris Agreement.

It also sets out six key actions that Member States are required to introduce into new or existing corporate social due diligence frameworks in order to ensure that companies implement uniform and effective due diligence processes.

Integrating due diligence into corporate policies

Member States are required to have a due diligence policy in place, to be updated annually, containing:

  • A description of the company’s approach to due diligence, including in the long time.
  • Setting a clear and detailed code of conduct to be followed by company employees and subsidiaries.
  • A description of the processes put in place to implement due diligence, including measures taken to verify compliance with the code of conduct and to extend its application to established business relationships.

Identifying actual or potential adverse impacts

Member States shall ensure that companies should take appropriate measures to:

  • Proactively identify adverse human rights and environmental impacts associated with internal operations, the operations of subsidiaries, as well as from established business relationships.
  • Make use of appropriate resources, including: internal and external complaints procedures, independent reports, information gathered through complaints procedures as well as carrying out consultations with potentially affected groups, including workers and other stakeholders in order to gather information on actual or potential adverse impacts.

Preventing and mitigating potential adverse impacts and bringing actual adverse impacts to an end

Member States shall ensure that companies should take appropriate measures to:

  • Develop and implement a prevention action plan in consultation with affected stakeholders.
  • Seek contractual assurances from a business partner with whom it has a direct business relationship that it will ensure compliance with the company’s code of conduct and prevention action plan, including seeking contractual assurances.
  • Provide support for a SME with which the company has an established business relationship, where compliance with the code of conduct or the prevention action plan would jeopardise the viability of the SME.
  • Collaborate with other entities to bring the actual adverse impact to an end.
  • Refrain from entering into new or extending existing relationships with partners where potential adverse impacts cannot be prevented or adequately mitigated.

Establishing and maintaining a complaints procedure

Companies should establish a complaints procedure that allows persons or organisations to submit legitimate concerns regarding actual or potential adverse human rights and environmental impacts.

Complainants must be entitled to follow up on the complaint, as well as access to company representatives to discuss the subject matter of the complaint.

Monitoring the effectiveness of their due diligence policy

Companies should carry out, at least every 12 months, periodic assessments of internal operations and measures, those of subsidiaries and, where related to the value chains of the company, those of established business relationships.

Publicly communicating on due diligence

Companies that are not subject to reporting requirements under the EU Accounting Directive 2013/34/EU on annual financial statements, consolidated financial statements and related reports of certain types of undertakings will be required to report on the matters covered by the Directive by publishing an annual statement on their website, by 30 April each year.

Directors’ duties

The Directive also imposes additional obligations and duties on company directors.

When fulfilling their duty to act in the best interest of the company, directors of large EU companies will be required to consider the consequences of their decisions for sustainability matters, including those relating to human rights, climate change and the environment - in the short, medium and long term.

Directors will also be responsible for putting in place and overseeing the due diligence processes outlined in the Directive and due diligence policies, with due consideration for relevant input from stakeholders and civil society organisations. They will also be obliged to report to the board of directors in this regard.

Enforcement

The EC proclaims that effective enforcement of due diligence obligations, by way of a combination of sanctions and civil liability, is key to achieving the objective of corporate sustainable governance.  

The Directive sets out proposals for both public and private enforcement as well as an European Network of Supervisory Authorities to help with the implementation of the Directive and facilitate coordination and compliance by companies of their due diligence obligations. 

The supervisory authorities will be empowered to:

  • Investigate potential breaches of a company’s due diligence obligations.
  • Order the cessation of infringements, abstention from any repetition of conduct, remedial action proportionate to the infringement and necessary to bring it to an end.
  • Impose pecuniary sanctions and adopt interim measures to avoid the risk of severe and irreparable harm.

Member States are to establish effective sanctions for non-compliance, to be proportionate to company turnover and to be imposed by the relevant supervisory authority. 

Companies will also be at risk of civil liability claims for damages where the harm could have been identified, prevented, mitigated, brought to an end or its extent minimised with proper due diligence measures as provided for by the Directive. The risk of civil liability not only arises in relation to a company’s own operations but also those of its subsidiaries and/or direct, established business relationships.  

A company will, however, not be liable for damage caused by an adverse impact that arose from the activities of an indirect partner with whom it has an established business relationship if the company had obtained the required contractual assurances from its direct business partner. Unless it was unreasonable in the circumstances for the company to expect that the action taken, including verifying compliance, would be sufficient to prevent, mitigate, end or minimise the extent of the adverse impact.

Victims can also claim compensatory damages under the Directive in respect of claims arising from adverse environmental impacts, notwithstanding that they might overlap with human rights claims.

Any civil liability claims brought against a company are to be governed by the provisions of national law.

Looking ahead

The Directive will have far reaching implications for large EU and non-EU companies whose responsibilities and obligations in relation to human rights and environmental impacts will extend to their subsidiaries and other stakeholders in their supply chains. Once implemented, meaningful and robust human rights and environmental due diligence policies should underpin corporate day to day operations and dealings with parties within a company’s value chain.  

A unified approach to corporate sustainability throughout the European market will enable companies to better predict the behaviour of others within their value chain, thereby easing the burden of preventing and mitigating adverse environmental and human rights impacts. 

If they have not done so already, international companies across all sectors should revisit their existing human rights and environmental due diligence processes and policies as soon as possible and take steps, as necessary, to introduce effective corporate sustainability due diligence procedures in line with the EC’s draft Directive.  

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