The European Commission published a Proposal for a Directive on Corporate Sustainability Due Diligence in February 2022.
In pursuit of a “just and sustainable economy”, companies will be required by law to be proactive in ensuring that their global value chains respect the environment and human rights.
The Proposal is one prong in the European Union’s programme to increase its regulatory focus on environmental and human rights due diligence through the implementation of measures that companies can take to prevent or reduce the adverse impacts of a company’s organisational structure or its supply chain on human rights and environmental concerns.
Companies will be required to identify and, where necessary, prevent, end or mitigate any adverse impacts of their activities on human rights and on the environment.
Obligations will be placed on certain larger companies to ensure that their business practices are compatible with the goal of the Paris Agreement to limit global warming to 1.5°C. Additional duties of care for directors to oversee effective due diligence measures will also be introduced.
Many companies are already engaged in scrutiny of their environmental, social and governance (ESG) practices – for their own purposes and due to demand from customers and investors.
The stated mission of the Proposal is to:
To achieve these objectives, companies are expected to integrate due diligence into policies and identify and prevent or mitigate actual or potential adverse human rights and environmental impacts. Companies that fall within the scope of the Proposal will have to establish a complaints procedure and monitor the effectiveness of their due diligence policy and measures put in place.
EU companies and non-EU companies.
EU LIMITED LIABILITY COMPANIES
500+ employees and more than €150 million of turnover*
250+ employees and more than €40 million of turnover*, operating in defined high impact sectors such as textiles, agriculture, extraction of minerals. The rules will apply to this group two years later than to group 1.
Non-EU companies active in the EU with turnover threshold aligned with Group 1 and 2 generated in the EU.
SMEs do not fall within the scope of the Proposal, but supporting measures for SMEs that may be indirectly affected are provided for.
*Worldwide turnover for EU companies, and EU-wide turnover for non-EU companies
The definition of a "company" is broad and includes public and private companies limited by shares or guarantee, as well as partnerships, limited partnerships and unlimited companies. It also includes regulated financial undertakings, regardless of their legal form, such as credit institutions, alternative investment funds and UCITS.
Companies will be required to adopt a plan to ensure that their business activities and strategies are compatible with the aim of the Paris Agreement to limit global warming to 1.5°C.
The plan must identify if climate change is a risk for the company’s operations and the extent that it is relevant. Where climate change is identified as a risk, the company must then include emission reduction objectives in its plan. This will be significant for the board of directors of companies as relevant companies will be required to ensure that the fulfilment of these obligations is taken into account when companies are setting variable remuneration, if variable remuneration is linked to the contribution of a director to the company’s business strategy and long-term interests and sustainability.
Companies must conduct due diligence for human rights and environmental impacts that relate to the business activity of the company itself, its subsidiaries and even on its value chains. The due diligence must be integrated into all corporate policies. There must be a due diligence framework that includes details of the company’s approach to due diligence and a code of conduct to be followed by employees and subsidiaries.
The Proposal sets out a corporate due diligence duty to “identify, prevent, bring to an end, mitigate and account for adverse human rights and environmental impacts”. Such an aim was previously thought to be beyond the scope of a company’s concerns and more within the remit of the state.
Adverse impacts include, but are not limited to, human rights issues such as forced labour, child labour, inadequate workplace health and safety conditions and environmental impacts such as pollution and ecosystem degradation.
Measures to Identify and Prevent Adverse Impacts
Companies will be required to take appropriate measures to identify any potential adverse human rights and environmental impacts that may be related to the operations of the company or their subsidiaries and, where related to their value chains, from their established business relationships.
Once any potential adverse impacts are identified, the company is required to prevent such risks and act to mitigate those adverse impacts. In order to prevent or mitigate such risks, companies will be required to take action which may have an impact on some of the business relationships of a company. Some of the measures that a company will need to take include:
The most potentially far-reaching impacts of the Proposal is the requirement for a company to bring to an end or minimise "actual impacts". In practice, this means that if an adverse impact is identified, which cannot be brought to an end or mitigated, the company will be prevented from entering into business relations with the business or person in connection with which the impact has arisen. In this instance, a company is required to temporarily suspend commercial relations with the business or person in question while pursuing measures to mitigate the adverse impact. If the adverse impact identified is severe, then a company must terminate the business relationship.
Companies must provide a means for the submission of complaints in relation to any potential or actual adverse impacts. Companies are required to facilitate complaints from persons who are affected or have reasonable grounds to believe that they might be affected by an adverse impact, trade unions and other workers’ representatives representing individuals working in the value chain concerned.
Companies that are not already subject to the reporting requirements set out under the Non-Financial Reporting Directive (Directive 2014/95/EU) will now be required to report on the matters covered by the Proposal and publish an annual statement on their website covering compliance with the obligations during the previous calendar year.
Companies will be required to periodically assess the implementation of their due diligence measures in order to verify that adverse impacts are properly identified and to determine the extent adverse impacts have been prevented or brought to an end.
Directors will be responsible for establishing and overseeing the implementation of due diligence activities and embedding them into their business strategy. The duties owed by directors to the company pursuant to section 228 of the Companies Act 2014 will be supplemented: when fulfilling their duty to act in the best interest of the company, directors will be required to consider the human rights, climate change and environmental consequences of their decisions.
Member States will designate a national supervisory authority to ensure the compliance of companies with their new due diligence obligations and to oversee the enforcement of the Proposal. The supervisory authority will be granted powers and resources, which will include the ability to initiate investigations.
The European Commission will also establish a European Network of Supervisory Authorities, which will bring together representatives of the national bodies to ensure a coordinated approach across the EU.
Non-EU companies will be required to appoint an authorised representative in the EU to be the point of contact by the relevant supervisory authority regarding compliance and enforcement.
A person or company that believes that a company is not in compliance, may submit substantiated concerns to a supervisory authority for assessment and potentially further investigation.
The supervisory authority of each Member State will be responsible for enforcement. Enforcement measures will include a combination of civil liability provisions and sanctions, including fines and compliance orders.
Member States will determine the appropriate nature and level of the sanctions applicable to infringements. Any pecuniary sanction will be based on the company’s turnover and any sanction imposed by the supervisory authority must be published.
Member States must also ensure that victims receive compensation for damages resulting from compliance failures - if any adverse impact that ought to have been identified by the company occurs and resulted in damage, harm or loss to an individual or company.
As we await the final version of the Directive, provisions in the Proposal remain subject to change. But in the near future, companies operating in the EU will be obligated to implement human rights and environmental due diligence in all entities in their organisation and their supply chains.
When it is operational, the Directive will alter the regulatory framework that applies to companies that fall within its scope . In addition, directors of companies should be on notice of the additional duties that will apply to them in the performance of their responsibilities.
The Proposal has to be approved by the European Parliament and the Council. When it has been adopted, Member States will have two years to implement the Directive into national law.
CORPORATE SUSTAINABILITY REPORTING DIRECTIVE (CSRD)
In a related development, on 21 June 2022 political agreement was reached between the European Council and European Parliament on the proposal for a Corporate Sustainability Reporting Directive. It was adopted by the European Commission in April 2021 and now remains to be formally adopted by Parliament and the Council.
The CSRD will extend existing sustainability reporting requirements in the EU, under the
Non-Financial Reporting Directive (NFRD), to include a broader range of companies and will require more detailed disclosures on a wider range of issues. Large companies will be required to report on sustainability issues such as environmental rights, social rights, human rights and governance factors. The CRSD will be introduced on a staggered basis to different types of companies, but it is expected that it will apply to some companies from January 2024.
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