18 January 2023 – need2know

The German Supply Chain Act has been applicable to companies falling under its scope since January 1, 2023. Similarly, at the EU level, companies will be accountable for complying with obligations to protect human rights and the environment along their supply chain in the near future. After the European Commission published a proposal for a supply chain directive (Corporate Sustainability Due Diligence Directive) on February 23, 2022, the European Council of Ministers defined its negotiating position on the supply chain directive in December 2022 (“Draft CSDD”). On this basis, the final version of the Corporate Sustainability Due Diligence Directive will be negotiated with the European Parliament this year.

The Draft CSDD obliges companies in particular to

• Implement compliance strategies and introduce appropriate complaints procedures,
• Identification, prevention, elimination or compensation of negative impacts on human rights and the environment (e.g. through prevention plans or through contractual assurances, etc), and
• Support for SMEs and for cooperation with other companies.

Scope of the Corporate Sustainability Due Diligence Directive

The Draft CSDD applies to:

“Large companies” that in the last fiscal year

• had more than 500 employees on average
• and whose worldwide sales exceeded 150 million euros.

“Medium-sized companies” that in the last fiscal year

• had between 250 and 500 employees,
• achieved global sales of between 40 million and 150 million euros, and
• that generated sales of at least 20 million euros in a resource-intensive sector (e.g. manufacture of textiles, agriculture, forestry or fisheries, or the extraction of mineral resources). Until recently, there was political controversy as to whether companies offering regulated financial services (e.g. banks or investment firms) would should also be covered by the Corporate Sustainability Due Diligence Directive. The Draft CSDD provides for a political compromise and delegates this decision to the Member States.

In addition to all EU companies, the Draft CSDD also covers companies from third countries that reach the relevant sales thresholds within the EU. This is intended to counteract any competitive disadvantages of EU companies compared to comparable non-EU companies operating on the EU market. The European Commission assumes that approximately 13,000 EU companies and 4,000 companies from non-EU countries are covered by the scope of the directive.

Depending on the specific size of the companies, the Corporate Sustainability Due Diligence Directive is expected to be applicable in three to five years from its entry into force.

Future obligations arising from the Corporate Sustainability Due Diligence Directive

The Draft CSDD aims to compel companies to ensure that

• they,
• their customers and
• their suppliers

respect human rights and the environment. In particular, this involves safeguarding fundamental workers’ and human rights, biodiversity and ecosystems, water and breathable air, and combating climate change.

Specifically, the Draft CSDD provides for the following corporate due diligence requirements:

• Integration of due diligence into their policies and risk management systems

Companies must set out in due diligence policy, to be updated annually, how they comply with their due diligence obligations. To this end, a code of conduct must developed defining the relevant rules and principles to be observed by employees and subsidiaries. In addition, the due diligence policy shall describe the process for implementing due diligence, including measures taken to verify compliance with the code of conduct and for extending its application to business partners.

• Duty to identify adverse impacts

Large Companies shall take appropriate measures to identify actual and potential adverse impacts on human rights and the environment arising from their own activities or those of their subsidiaries or business partners, where related to their chains of activities.

Medium-sized Companies will have to identify actual and serious potential negative human rights and environmental impacts relevant to the sector.

• Duty to prevent adverse impacts

Companies must prevent identified adverse impacts on human rights and the environment, or at least reduce them appropriately.

Depending on the circumstances of the individual case, the companies shall be required to take the following actions:

• Develop a prevention plan in consultation with affected stakeholders, including, in particular, qualitative and quantitative metrics to measure improvement;
• Seek contractual assurance from direct business partners that they will ensure compliance with the company’s code of conduct and, if necessary, a prevention action plan. With regard to potential negative impacts that could not be avoided or adequately mitigated by the above measures, the company may also seek to contract with an indirect partner. Compliance with the contractual assurance may be monitored by suitable industry initiatives or by independent third-parties;
• Invest in management or production processes and infrastructures;
• Provide targeted and proportionate assistance to small and medium-sized enterprises (SMEs) where compliance with code of conduct would jeopardize the economic viability of the SME;
• To cooperate with other entities in compliance with antitrust regulations in order to prevent or mitigate adverse impacts.

If negative effects cannot be avoided or adequately reduced, companies are obliged as a last resort not to enter into new business relationships or not to expand existing relationships.

• Obligation to bring actual adverse impacts to an end

Companies must take appropriate measures to bring actual adverse impacts to an end or at least minimize adverse impacts. This includes among appropriate measures set out above, if necessary, providing a remedy in the form of appropriate compensation commensurate with a company’s responsibility.

• Complaints procedures

Companies will be required to provide all persons in the supply chain who may be affected by and adverse impact with an appropriate complaints procedure. In addition, trade unions and other workers’ representatives as well as human rights and environmental civil society organizations shall also have a right to submit complaints.

Complainants should not only have the right to meet with company representatives to discuss serious adverse impacts, but companies should also take appropriate follow-up action based on the complaint.

• Combating climate change mitigation

Large Companies shall define a plan to ensure that their business model and strategy are consistent with the transition to a sustainable economy and limiting global warming to 1.5°C. This plan should identify the extent to which climate change poses a risk to, or impacts on, the company’s operations, based on adequate information.

Obligations of the management under the Corporate Sustainability Due Diligence Directive?

The Commission’s draft originally provided that, in fulfilling their duty to act in the best interests of the company, directors must consider the consequences of their decisions in relation to sustainability concerns, including human rights, in the short, medium and long term, and are personally responsible for implementing and monitoring due diligence measures.

Due to the strong concerns of the Member States that this would represent an inappropriate interference with national legislation on board and director responsibility, the provision was deleted from the Council’s draft. It remains to be seen if direct management obligations will be found in the final text of the directive after the negotiations with the European Parliament.

Sanctions and enforcement of supply chain due diligence obligations

• Civil liability

The Draft CSDD provides for civil liability rules in the event of a breach of specified duties of care. The liability rules shall also apply if the relevant legal relationship is subject to the law of a third country.

In short, companies will be liable for damages caused by unlawful and culpable violations of the obligations to prevent and eliminate negative impacts.

This new civil liability provision requires implementation in the national law of the member states and will still give rise to discussions. In the Council’s draft, the right of victims of human rights and/or environmental damage to full compensation has in any case been explicitly stipulated.

• Penalties

The Draft CSDD provides for dissuasive turnover-related fines. The specific calculation of penalties as well as the competent national authority will have to be regulated more specifically by the Member States. Similar to antitrust law, cooperation with the authorities as well as the company’s own processing of adverse effects are to be taken into account accordingly in any sanctions imposed.

Evaluation and outlook

The Council’s Draft CSDD has helped to clarify the terminology used, the scope of application and the civil liability regime. The already mentioned Proposal to allow gold-plating in relation to financial services merits highlighting again.

Now the ball is in the European Parliament’s court.

In Austria, there is as yet no national regulation similar to the German Supply Chain Act. According to the current state of discussion in Austria, liability of the domestic company vis-à-vis those affected by human rights violations committed abroad by subsidiary or supplier companies is therefore predominantly rejected in the absence of special circumstances.

However, in view of the impending civil liability consequences as well as the threat of sanctions, companies should start preparing to comply with their obligations and anchor them accordingly in their compliance systems at the latest when the Corporate Sustainability Due Diligence Directive comes into force.

Author:
Gerhard Fussenegger, Sebastian Reiter

If you have any questions, please contact:
Gerhard Fussenegger
Sebastian Reiter

Practice group:
Competition 

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Note: This article is intended as general information and provides a brief overview of a complex topic. For this reason, this article is not exhaustive and is no replacement for individual legal advice. If you have any questions, do not hesitate to contact us. We look forward helping you.

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