Introduction
Violations of environmental rights
Environmental due diligence obligations
Environmental best practice measures
Enforcement measures and consequences of environmental violations
In 2021, the German Parliament passed the Supply Chain Act, which will come into force on 1 January 2023. It addresses negative impacts on human and environmental rights caused by global supply chains. The overall ratio of the Supply Chain Act is to prevent human rights or environmental risks and to stop the violation of human rights or environmental obligations.
Companies that have their head office, administrative seat or statutory seat in Germany or companies that have a branch office in Germany are included within the scope of application of the Supply Chain Act. In addition, certain headcount thresholds have to be met – namely, from 1 January 2023, companies with at least 3,000 employees and, from 1 January 2024, companies with at least 1,000 employees are subject to the Supply Chain Act. Group companies are included within the calculation of employees.
This article discusses the environmental provisions of the Supply Chain Act with which companies must comply.
Violations of environmental rights
Generally speaking, the Supply Chain Act requires companies to make appropriate efforts to ensure that there are no violations of specific environmental rights in their own business operations and in the supply chain. Obligations under the Supply Chain Act are mere "best effort obligations" – that is, they do not require companies to actually achieve prevention of environmental protection violations, but to do their best to prevent such violations.
An environment-related obligation is violated if one of the following prohibitions has been breached:
- the prohibition of the production of mercury-added products and the use of mercury in manufacturing processes;
- the prohibition of the production and use of certain chemicals (including persistent organic pollutants (POP)); and
- the prohibition against the export and import of poisonous waste.
There is no general clause regarding the protection of legal positions protected under environmental treaties.
These prohibitions are based on international treaties, including the Stockholm Convention on Persistent Organic Pollutants and the Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and Their Disposal.
Environmental due diligence obligations
The Supply Chain Act provides for a number of due diligence obligations for companies. Such due diligence obligations can include the implementation of risk analysis systems, prevention/remedial measures, risk management, compliance with documentation and reporting obligations as well as the establishment of a complaints procedure.
The Supply Chain Act implements a "tiered" system of due diligence obligations. The obligations apply without restriction to the company's own business operations and to direct suppliers (known as "tier 1 suppliers"). The due diligence obligations apply to a limited extent to indirect suppliers (known as "tier 2 suppliers").
Risk analysis and risk management
Companies have to implement appropriate risk management and risk analysis processes in their business operations. As the basic step of their corporate due diligence system, they have to conduct a risk analysis to determine which measures they have to take in order to ensure compliance with the prohibitions set out in the Supply Chain Act. Such risk analysis has to be carried out on an annual basis and when appropriate (ie, in relation to the occurrence of events that disclose new or increasing risks).
A "risk" is defined as a situation in which there is a reasonable probability that protected environmental rights (including the prohibition of the production and use of mercury-added products, the prohibition of the production and use of certain chemicals as well as the export and import of poisonous waste) may be violated on the basis of factual circumstances.
In this regard, the legislature proposes a two-step procedure. First, it will usually be appropriate to cluster risk factors within a company's business operations categories (eg, business areas, locations, (countries of origins of) products or political framework conditions). Second, detected risks should be evaluated and prioritised based on the nature and scope of the anticipated risk.
Preventive measures/remedial measures
Once risks have been detected, companies have to take appropriate preventive and remedial measures that, in the best case, would end the violation. For example, on the basis of the Supply Chain Act, violations of direct suppliers can oblige companies, as ultima ratio, to terminate their business relationship and their respective agreements. Typical measures to prevent such violations would be, for example, the implementation of codes of conduct, the selection of reliable suppliers and ongoing supplier monitoring or the implementation of training courses.
Documentation and reporting requirements
Companies are subject to an internal documentation obligation and an external reporting obligation. The purpose of such due diligence obligations is to enable the competent authority to monitor compliance with the provisions of the Supply Chain Act.
Companies must publish an annual report on the company's website on existing environment-related risks and whether supply chain obligations have been violated. The report also has to describe preventive and remedial measures companies have taken and evaluate the effectiveness of such measures. However, in doing so, companies are not obliged to disclose business and trade secrets.
The report shall be submitted to the Federal Office of Economics and Export Control.
Complaints procedure
Companies have to implement an appropriate complaints procedure (including respective rules of procedure) internally or can make use of external complaints systems and grant access to such complaints procedure in a comprehensible and barrier-free manner. Access has to be granted not only to the company's employees (eg, whistle-blowers), but also employees of suppliers (or indirect suppliers) as well as other persons that are potentially affected by environmental risks. In addition, the Supply Chain Act provides that whistle-blowers enjoy confidentiality and must not become the victim of reprisals.
Implications regarding indirect suppliers
As mentioned above, the Supply Chain Act provides for a "tiered" system of obligations. Therefore, due diligence obligations are less strict with regard to indirect suppliers compared with direct suppliers. In particular, the company merely has to carry out a risk analysis and initiate preventive or remedial measures in case there are factual indications that an environmental obligation has been violated. Most importantly, companies do not have to identify any risks preventively. The specific preventive and remedial measures companies have to take regarding indirect suppliers are also less strict than those in its own business area or regarding direct suppliers. The termination of business relations, for example, is not compulsory regarding the supply chain relationship with indirect suppliers.
Environmental best practice measures
As the Supply Chain Act has not yet come into force, it naturally is too early to speak of best practices. Therefore, best practices may evolve after the Supply Chain Act comes into force. In addition, administrative rules or guidelines will be introduced by the competent authorities in order to put the often vague provisions of the Supply Chain Act into more concrete terms. However, such administrative rules or guidelines have not yet been published. In addition, the Supply Chain Act explicitly obliges the Federal Office of Economics and Export Control to support companies in complying with the due diligence obligations and providing such support.
Nonetheless, taking into consideration that the Supply Chain Act will enter into force rather soon and the implementation of processes may take considerable time, companies are recommended to prepare the measures listed above. The risk management measures regarding environmental risks does not necessarily deviate from other risks. However, the risk analysis as such will often be complex and therefore will need to be carried out with the assistance of environmental experts. The same applies to audits conducted at sites of (indirect) suppliers. The assessment of technical details will often be subject to the assessment of environmental experts.
Enforcement measures and consequences of environmental violations
The Supply Chain Act expressly states that it does not intend to set out new claims for civil law liability apart from general civil law principles. The legislature emphasises that the central instruments to enforce the Supply Chain Act shall be administrative and administrative offence law. Accordingly, the Supply Chain Act provides for extensive administrative enforcement mechanisms by the authorities and postulates a strict penalty regime.
Civil enforcement
The Supply Chain Act provides that a breach of the obligations under the Act shall not give rise to civil liability. However, civil liability established independently of this Act is expressly unaffected.
Civil law actions could firstly come from customers claiming a material defect, challenging sales contracts due to fraudulent misrepresentation or asserting claims arising from precontractual liability. Secondly, claims in relation to suppliers are conceivable – for example, recourse claims for reputational damage on a contractual basis or contractual termination rights in the event of violations. Thirdly, competitors could sue for injunctive relief, removal and damages due to inaccurate reporting. Finally, claims by third parties are conceivable, especially from general tort liability if corresponding duties of care have been violated.
Civil enforcement may, in particular, become relevant in cases in which violations of environmental rights cause harm to employees or other affected persons for example:
- accidents or long-term health effects in connection with the production of mercury-added products and the use of mercury in manufacturing processes; or
- long-term health effects caused by the export or import of poisonous waste.
Violations of obligations under the Supply Chain Act can be brought in front of German courts. However, since the facts of the case regularly cross national borders, the question arises as to the applicable law. The relevant conflict of laws rule for claims under tort law is, in principle, article 4 of the Rome II Regulation.(1) This means that the law of the country in which the damage occurred is generally applicable.
Administrative enforcement
In case of detected incidents of non-compliance with the Supply Chain Act, authorities are entitled to order improvement measures and, specifically, may issue orders to prevent or remedy breaches of due diligence (while having broad discretion to determine individual measures), enter company premises or order the disclosure of certain documents to gather information in this regard.
Therefore, the enforcement mechanism of the Supply Chain Act combines instruments of administrative control and private self-control.
Penalty regime
The Federal Office of Economics and Export Control can impose fines if companies have not or not sufficiently observed the due diligence requirements. Negligence is sufficient to constitute an infringement. Companies may face administrative fines of up to €8 million or up to 2% of the company's worldwide annual turnover. Serious non-compliance may also result in exclusion from public procurement for a maximum period of three years.(2) The respective company will also be added to the German competition register. Thus, the affected company can no longer enter into agreements with public sector partners. This can lead to a severe loss in profit and sales, dependent on the customer structure of the affected company.
For further information on this topic please contact Marc Ruttloff or Eric Wagner at Gleiss Lutz by telephone (+49 711 8997 0) or email ([email protected] or [email protected]). The Gleiss Lutz website can be accessed at www.gleisslutz.com.
Endnotes
(1) Regulation (EC) No. 864/2007.
(2) The exclusion from public procurement requires a legally established violation with a fine of at least Euro 175,000.