The EU Sustainable Corporate Due Diligence proposal - what it means for business

The proposal is for a directive setting out rules:

1. on obligations of due diligence by companies regarding actual and potential human rights and environmental adverse impacts, with respect to their own operations, the operations of their subsidiaries, and the value chain operations carried out by partners with whom the company has an established business relationship; and
2. on liability for violations of the due diligence obligations.
    

What are ‘actual and potential human rights and environmental adverse impacts’?

The proposal defines an adverse human rights impact as:

‘…an adverse impact on protected persons resulting from the violation of one of the rights or prohibitions listed in the Annex [to the proposed directive], as enshrined in the international conventions listed in the Annex’.

The international conventions listed include those contained in the International Bill of Human Rights, and the ILO core conventions, among others.

Adverse environmental impacts are defined as:

‘…adverse impact on the environment resulting from the violation of one of the prohibitions and obligations pursuant to the international environmental conventions listed in the Annex’.

You can download a copy of the Annex here.

How is value chain defined?

The proposal defines the value chain as:

‘…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…’.

Certain limitations are placed on the definition of value chain for financial undertakings.

The proposal applies to companies who meet the following thresholds:

Table 1: Companies within the scope of the proposal

Article 4 of the proposal outlines the actions companies would be required to take to conduct human rights and environmental due diligence within the meaning of the proposed directive. These are:

• Integrating due diligence into their policies.
• Identifying actual or potential adverse impacts.
• Preventing and mitigating potential adverse impacts, and bringing actual adverse impacts to an end and minimising their extent.
• Establishing and maintaining a complaints procedure.
• Monitoring the effectiveness of their due diligence policy and measures.
• Publicly communicating on due diligence.
   

Monitoring (Article 10)

Companies would be required to carry out periodic assessments of their own operations and measures, those of their subsidiaries and, where related to the value chains of the company, those of their established business relationships.

These assessments should monitor the effectiveness of the identification, prevention, mitigation, bringing to an end and minimisation of the extent of human rights and environmental adverse impacts.

Such assessments shall be based, where appropriate, on qualitative and quantitative indicators and be carried out at least every 12 months and whenever there are reasonable grounds to believe that significant new risks of the occurrence of those adverse impacts may arise.

The company’s due diligence policy shall be updated in accordance with the outcome of those assessments.
 

Communicating (Article 11) 

Companies that do not already report under the Non-Financial Reporting Directive would be required to report on the matters covered by this directive by publishing on their website, by 30 April each year, an annual statement in a language customary in the sphere of international business.

The content and criteria for such reporting would be outlined by the European Commission in separate delegated legislation.

The proposal would require ‘Group 1 companies’ (see Table 1, above) to adopt a plan to ensure that the business model and strategy of the company are compatible with the transition to a sustainable economy and with the limiting of global warming to 1.5ºC in line with the Paris Agreement (Art. 15).

Such a plan should identify, on the basis of reasonably available information, the extent to which climate change is a risk for, or an impact of, the company’s operations.

Where climate change is a principal risk for, or principal impact of, the company’s operations, the company should include emission reduction objectives in its plan.

The fulfilment of these obligations should be taken into account when setting variable remuneration for directors, if such remuneration is linked to the contribution of a director to the company’s business strategy, long-term interests and sustainability.

A range of other supporting measures are envisioned, including websites, platforms or portals to provide information and support to companies and the partners in their efforts to fulfil the obligations outlined above, financial support for SMEs in the value chains of companies covered by the proposal, and measures at EU-level to support due diligence, including joint stakeholder initiatives (Art. 14).

The proposal provides that companies may rely on industry schemes and multi-stakeholder initiatives to support the implementation of their obligations, where these are ‘appropriate to support the fulfilment of those obligations’. Guidance may be made available by the European Commission in this respect (Art. 14).

Companies established outside the European Union would be required to designate an authorised representative within the European Union for the purposes of the Directive (Art. 16).

The proposal provides that each Member State shall designate one or more supervisory authorities to supervise compliance with the obligations laid down in national provisions adopted pursuant to the directive (Art. 17).

A supervisory authority may initiate an investigation on its own motion, or as a result of substantiated concerns communicated to it, where it considers that it has sufficient information indicating a possible breach by a company of the obligations provided for. Supervisory authorities may conduct inspections, and shall assist each other in cross-border inspections (Art. 18).

Where a supervisory authority identifies a failure to comply with the obligations, the company concerned would be granted an appropriate period of time to take remedial action, if such action is possible. However, taking remedial action does not preclude the imposition of administrative sanctions or the triggering of civil liability in case of damages (Art. 18).

Sanctions that are effective, proportionate and dissuasive should be provided for in national legislation. Due account shall be taken of the company’s efforts to comply with any remedial action required by a supervisory authority, any investments made and targeted support provided, pursuant to Articles 7 and 8, as well as collaboration with other entities to address adverse impacts in its value chains. If sanctions are monetary, they should be based on the company’s turnover. Any decision to impose sanctions should be published by the supervisory authority. (Art. 20). Companies applying for public support must certify no sanctions have been imposed on them under the directive (Art. 24).

The proposal provides that companies shall be liable for damages if:

• They failed to comply with the obligations laid down in Article 7 and 8, and
• As a result of this failure an adverse impact that should have been identified, prevented, mitigated, brought to an end or its extent minimised through the appropriate measures laid down in Articles 7 and 8 occurred and led to damage.

Seeking contractual assurances in accordance with Articles 7 and 8 will ensure that a company is not be liable for damages caused by an adverse impact arising as a result of the activities of an indirect partner with whom it has an established business relationship, unless it was unreasonable, in the circumstances of the case, to expect that the action actually taken, including as regards verifying compliance, would be adequate to prevent, mitigate, bring to an end or minimise the extent of the adverse impact.

Due account shall be taken of the company’s efforts, insofar as they relate directly to the damage in question, to comply with any remedial action required of them by a supervisory authority, any investments made and any targeted support provided pursuant to Articles 7 and 8, as well as any collaboration with other entities to address adverse impacts in its value chains.

The civil liability of a company for damages shall be without prejudice to the civil liability of its subsidiaries or of any direct and indirect business partners in the value chain, and are also without prejudice to stricter EU or national rules.

The proposal would require an amendment to Member State company law to ensure that, when fulfilling their duty to act in the best interest of the company, directors of EU-established in-scope companies 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. Failure to do so should constitute a breach of directors’ duties under national law (Art. 25).

In addition, directors should be responsible for putting in place and overseeing the due diligence actions referred to in Article 4 and in particular the due diligence policy referred to in Article 5, with due consideration for relevant input from stakeholders and civil society organisations. The directors shall report to the board of directors in that respect. Directors should take steps to adapt the corporate strategy to take into account the actual and potential adverse impacts identified pursuant to Article 6 and any measures taken pursuant to Articles 7 to 9 (Art. 26).

For the purposes of the proposal, a director is any member of the administrative, management or supervisory bodies of a company, the chief executive officer and, if such function exists in a company, the deputy chief executive officer and other persons who perform functions similar to those roles.

The proposal will follow the European Union’s ordinary legislative procedure (previously called ‘codecision’). Under the procedure, the next steps are as follows:

1. The European Parliament and the Council of the European Union (‘Council’) review the European Commission’s proposal in turn and may propose amendments.
   • If the two institutions agree on the text, the proposed legislation can be adopted.
2. If they cannot agree, a second reading takes place and either institution can propose amendments.
   • At this stage, the European Parliament has the power to reject the proposed legislation outright if it cannot agree with the Council.
   • If these two institutions agree on amendments, the proposed legislation can be adopted.
3. If they cannot agree, a conciliation committee works to find a solution, and the joint text is examined by both the European Parliament and the Council.
   • Either institution can block a legislative proposal at its final reading.
4. If they agree, the proposal becomes law. It will enter into force twenty days after its publication in the European Union’s Official Journal.
5. Member States would then have 2 years to transpose the directive into their national law. Certain latitude is afforded to Member States in the directive, meaning there may be slight variation across countries.
6. The national legislation would apply to companies with more than 500 employees and a turnover of more than EUR 150 million (as well as non-EU companies with net turnover of more than EUR 150 million in the EU) two years after the directive enters into force.
7. The national legislation would apply to companies in the high-impact sectors four years after the directive enters into force.

A more detailed overview of the ordinary legislative procedure process is available on the European Parliament’s website.

The Commission will review the implementation of the directive seven years after its entry into force (Art 29). That review will evaluate the effectiveness of the directive and will assess:

• Whether the thresholds regarding the number of employees and net turnover need to be lowered.
• Whether the list of high-impact sectors needs to be changed.
• Whether the Annex needs to be modified, including in light of international developments.
• Whether Articles 4 to 14 should be extended to adverse climate impacts.