EU proposed Directive on Corporate Sustainability Due Diligence
20 April 2022
20 April 2022
On 23 February, the European Commission adopted a proposal for a directive on corporate sustainability due diligence. Under the directive 'in scope' companies would be required to:
Before coming into force, the proposed directive will likely be amended through the EU legislative process and will need to be approved by the EU Parliament, which could potentially alter its scope. However, the introduction of mandatory supply chain due diligence will require a significant change in behaviour for most in scope companies and the draft directive offers a good indication of steps that companies will be required to take in preparation. The intention is for these obligations to apply to relevant companies within two years of the directive entering into force, and for smaller companies in certain high-risk sectors within four years.
While the impact of this legislation is a few years away, it takes time to design and implement effective human rights and environmental due diligence processes, particularly in large international companies and companies with long or complex value chains. As such, we would encourage companies with a presence in the EU to consider if they are likely to fall within the scope of the directive and, if so, start preparing for the actions they are likely to have to take.
While the proposed directive focuses on EU companies, it will also catch non-EU companies (including UK corporates) which generate a net turnover in the EU of either:
In this context, the term 'company' includes certain regulated financial undertakings, however the identification requirements for such companies are limited to identifying adverse impacts prior to providing services.
And, of course, companies which are not themselves in scope but form part of an in scope company's value chain are likely to be affected indirectly by the actions taken by in scope companies to mitigate human rights and environmental impacts.
Under the directive, companies are required to conduct human rights and environmental due diligence across the whole of their business (including any subsidiaries) and any value chains which are, or are expected to be, 'lasting'. Broadly, companies will only need to take measures that reflect the severity and likelihood of an adverse impact, and are reasonable for the company to undertake.
Specifically, in scope companies will be required to comply with obligations in seven key areas:
The directive allows for company cooperation, use of industrial schemes and multi-stakeholder initiatives to reduce the cost of compliance.
There is an expectation that the obligations set out in the draft legislation will change as it makes its way through the European legislation process. Once the final obligations are clear, we will issue a further update and provide an analysis of how such obligations interact with other EU and UK reporting requirements.
The proposed directive also places obligations on directors to:
In scope, non-EU companies will need to designate an authorised representative which is established or domiciled in an EU company in which the business operates. Supervisory authorities will be designated by each Member State, and will communicate with authorised representatives on compliance and enforcement matters.
Non-compliance with the directive could result in:
This directive goes beyond the current and proposed due diligence requirements in the UK which have specific objectives. For example, the Modern Slavery Act 2015 requires certain commercial organisations to report on due diligence undertaken to ensure that slavery and human trafficking is not taking place in their business and supply chains.
A recent addition to this body of law, which has not yet come into force, is the Environment Act's prohibition on the use of certain commodities associated with illegal deforestation. To achieve this aim, companies are required to undertake due diligence on their supply chains to identify the illegal production of 'forest risk commodities'.
In light of the level playing field agreement arising out of Brexit alongside the growing ESG pressure on both nations and corporates, more comprehensive obligations could be introduced in the UK. In any event, in practice, the complexity of value chains and the desire of multi-national companies to have consistent standards across their business may result in the EU's due diligence requirements effectively become a voluntary standard in the UK.
Companies with a net turnover in the EU in the region of EUR 40 million or more should take the time before the directive enters into force to identify whether they are within scope and what steps the business will need to undertake to ensure compliance.
Steps that a business might take now include:
Companies may also choose to liaise with business partners on these matters and consider its future obligations when entering into new or renewing existing contracts. This could include the introduction of specific compliance obligations and the adoption of climate conscious drafting to limit carbon footprints.
For those interested in the impact of the proposed directive on EU companies, please read Draft EU Directive on sustainability-related Due Diligence Obligations of Companies published by our Frankfurt-based Head of Corporate Governance, Florian Drinhausen, and Astrid Keinath.
The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
Readers should take legal advice before applying it to specific issues or transactions.