The European Commission has published its long-awaited Proposal for a directive on corporate sustainability due diligence (the Directive) to address the human rights and environmental impacts of global value chains. It represents a significant step towards achieving a primary objective of the European Green Deal, for sustainability to be "further embedded into the corporate governance framework".
It should not to be confused with the Proposal for a Directive on Corporate Sustainability Reporting, published last year, although it is part of that suite of sustainability legislation, which includes the Sustainable Finance Disclosure Regulation and the Taxonomy Regulation.
It is a detailed legislative proposal, which will impose onerous obligations on in-scope companies. The Commission estimates that 13,000 EU companies and 4,000 third-country companies would be within the scope of the Directive. The number of companies captured is substantially reduced compared to the recommended proposal adopted by the European Parliament in 2021. This has been met with disappointment by a number of NGOs and human rights organisations, such as the European Coalition for Corporate Justice and the Business & Human Rights Research Centre.
Aims of the Directive
According to the Explanatory Memorandum accompanying the Directive, it aims to:
- improve corporate governance practices to better integrate risk management and mitigation processes of human rights and environmental risks and impacts, including those stemming from value chains, into corporate strategies
- avoid fragmentation of due diligence requirements in the single market and create legal certainty for businesses and stakeholders as regards expected behaviour and liability
- increase corporate accountability for adverse impacts, and ensure coherence for companies regarding obligations under existing and proposed EU initiatives on responsible business conduct
- improve access to remedies for those affected by adverse human rights and environmental impacts of corporate behaviour
What is proposed?
- The Directive sets out a corporate due diligence duty to "identify, prevent, bring to an end, mitigate and account for adverse human rights and environmental impacts in the company's own operations, its subsidiaries and their value chains". Adverse impacts include, in particular, human rights issues such as forced labour, child labour, inadequate workplace health and safety, exploitation of workers, and environmental impacts such as greenhouse gas emissions, pollution, or biodiversity loss and ecosystem degradation.
It builds on the UN's Guiding Principles on Business and Human Rights and OECD Guidelines for Multinational Enterprises on Responsible Business Conduct Matters, and is in line with internationally recognised human rights and labour standards.
- In addition to corporate due diligence requirements, certain large companies will also need to have a plan to ensure that their business strategy is compatible with limiting global warming to 1.5 °C in line with the Paris Agreement.
- The Directive also introduces duties for directors, which include setting up and overseeing the implementation of the due diligence processes and integrating due diligence into the corporate strategy. In addition, when fulfilling their duty to act in the best interest of the company, directors must take into account the human rights, climate change and environmental consequences of their decisions.
What companies will have to comply?
The Directive applies to both EU and non-EU entities as follows:
Large EU-incorporated companies
Group 1: companies of substantial size and economic power (500+ employees and €150 million+ in net turnover worldwide).
Group 2: Other midcap companies with at least 50% net turnover generated in certain "high impact" sectors (such as manufacturing of textiles, extraction and agriculture) and with 250+ employees and €40 million+ in net turnover worldwide.
Non–EU companies: third-country-incorporated companies with turnovers aligned with Group 1 and 2, which have been generated in the EU.
Small and medium enterprises are not directly in scope of the Directive, but may be impacted if they operate within the value chains of the above companies.
The definition of "company" in the Directive is also very widely drawn. From an Irish perspective, it includes public and private companies limited by shares or guarantee, as well as partnerships, limited partnerships and unlimited companies (which satisfy the thresholds). It also includes regulated financial undertakings, regardless of their legal form (credit institutions, financial institutions, alternative investment funds, UCITS and insurance undertakings, to name but a few).
What will companies have to do?
The Directive's application is threefold. It applies to (i) the company's own operations, (ii) their subsidiaries, and (iii) their value chains (which means both direct and indirect established business relationships). In order to comply with their corporate due diligence duties, companies need to:
- integrate due diligence into corporate policies and have a due diligence policy in place
- identify actual or potential adverse human rights and environmental impacts arising from their operations or those of their subsidiaries, and from their established business relationships
- take "appropriate measures" to prevent and mitigate potential adverse human rights impacts and adverse environmental impacts
- bring to an end actual impacts (or minimise these where it's not possible to bring them to an end)
- establish and maintain a complaints procedure for certain prescribed persons and organisations
- monitor the effectiveness of the due diligence policy and measures (carry out qualitative and quantitative assessments at least every 12 months)
- publicly communicate on due diligence (companies not currently subject to the EU Non-Financial Reporting Directive will be required to publish an annual statement on their websites)
- 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 in line with the Paris Agreement
- designate a legal or natural person as its "authorised representative"
Suspension and termination of relationships
One of the most potentially far-reaching impacts of the Directive is the requirement for a company to bring to an end or minimise "actual impacts". In practice, this means that the company should refrain from extending or entering into new commercial relations with a business partner where the impact has arisen. The company must also, to the extent legally possible, suspend commercial relations with the partner while pursuing measures to prevent, mitigate, minimise or bring to an end the impact, and terminate the relationship if the potential or actual impact is considered severe. Financial institutions are not required to terminate a financial services contract where doing so may reasonably be expected to cause "substantial prejudice" to the counterparty.
It is unclear how businesses may comply with these provisions in practice. In some situations, suspending or ending a commercial relationship may lead to further human rights impacts which need to be assessed and managed (as noted in the UN Guiding Principles). Engagement is usually preferable, with termination as a last resort.
How will the new rules be enforced?
The rules will be enforced at Member State level through the establishment of a national supervisory authority.
Administrative supervision: The national supervisory authority will supervise companies and impose "effective, proportionate and dissuasive" sanctions, including fines and compliance orders. At European level, the Commission will set up a European Network of Supervisory Authorities, which will bring together representatives of the national bodies to ensure a coordinated approach.
Civil liability: Member States must also ensure that victims get compensation for damages resulting from the failure to comply with the obligations of the new proposals.
Directors: The rules on directors' duties are to be enforced through existing Member States' laws. The Directive does not include an additional enforcement regime for directors who do not comply with their obligations.
When will the Directive enter into force?
The legislative process is just beginning and it's unlikely to be concluded before mid-2023 (at the earliest). The road to publication of the Commission's proposal has already involved much debate and dissension and this is likely to continue.
Member States will have two years from the date of entry into force in which to introduce national implementing legislation, which will then apply to Group 1 companies. Group 2 EU companies (midcaps in high impact sectors) and third country companies will have an additional two years before the Directive applies to them.
Import ban – forced labour
The publication of the Directive coincided with the publication by the Commission of a Communication on Decent Work Worldwide. This sets out the Commission's commitment to eliminate child and force labour. It also includes plans for a new legislative instrument (as yet unknown) to ban products made by forced labour from entering the EU market.
We'll be closely monitoring these and other sustainability developments. Our Corporate and M&A team will be publishing further information in the coming weeks.
