The European Commission's proposals signal a changing approach, with businesses being expected to actively look for and address the social and environmental impact of their operations
The European Commission's proposal for corporate sustainability due diligence will involve changing practical expectations for businesses operating in the EU. While the Directive itself has road to travel before coming into effect, and then the hurdles of Member State implementation to clear, the proposal gives another strong steer as to where the EU is heading on sustainability due diligence.
As currently proposed, the Directive would place a duty on companies to undertake due diligence checks to identify actual and potential adverse impacts of their activities on human rights and the environment. Potential impacts will need to be prevented or mitigated and actual impacts will need to be minimised or stopped. These include child labour and the exploitation of workers and the environment, irrespective of whether the activities occur in the company’s own operations, their subsidiaries or in their value chain.
To whom would the new rules apply?
- All EU limited liability companies with 500+ employees and €150m in net worldwide turnover (Group 1);
- Other EU limited liability companies with 250+ employees and €40m in net worldwide turnover which operate in defined high impact sectors (Group 2). Group 2 companies will have two more years to adapt to the Directive before the legal effects come into force; and
- Non-EU companies active in the EU, which have a turnover generated in the EU that meets the Group 1 or Group 2 thresholds.
What would qualifying companies be required to do?
Integrate due diligence into policies
A company's due diligence policy would have to be updated annually. This policy would have to include:
- the company's approach to due diligence;
- a code of conduct describing rules and principles to be followed by employees and subsidiaries; and
- a description of processes put in place to implement due diligence.
Identify actual or potential adverse human rights and environmental impacts
This relates to actual or potential impacts from both companies' operations and those of their subsidiaries. This requirement would also extend to the operations businesses that form part of the supply chain.
Prevent or mitigate potential impacts
Companies would be required to:
- develop and implement a prevention action plan in consultation with affected stakeholders;
- seek contractual assurances from business partners with direct relationships;
- have "contractual cascading" (where contractual assurances from business partners could in turn require them to seek their own assurances from their own business partners) throughout the value chain and make necessary investments to meet this requirement (along with measures to verify compliance); and
- support small and medium enterprises (SMEs) with which they have established relationships where complying with the code of conduct or action plan would be too costly, or collaborate with other entities where appropriate.
Where potential adverse impacts would not be prevented or sufficiently mitigated by such measures, companies would have to refrain from entering into new business and, where legally possible, temporarily suspend their commercial relationship (or terminate it altogether if the potential adverse impact is severe). Member States will be required to adapt their contract law to make this possible.
End or minimise actual adverse impacts
Companies would need to take steps to prevent the occurrence of potential adverse impacts, or to reduce the probability of their happening, and stop or minimise actual adverse impacts. Where the adverse impact cannot be immediately brought to an end, the company would have to implement a corrective action plan.
As with "potential" impacts, a company could be required to seek contractual assurances from business partners, with "contractual cascading" limited to activities relevant to the supply chain.
Investment could also be required from companies to bring actual adverse impacts to an end. Companies could additionally be required to provide support to affected SMEs and collaborate with other entities.
Companies could also be required to refrain from entering into further business with a non-compliant company, suspend their collaboration, or fully terminate their business relationship. They could also be required to pay damages to affected persons and provide financial compensation to affected communities. Payments would be proportionate to the significance of the adverse impact and to the company's conduct.
Establish and maintain a complaints procedure
Companies would have to allow interested parties (that is, affected persons, trade unions, and relevant civil society organisations) to submit complaints to them. Companies would also have to establish a procedure for dealing with such complaints. Complainants would be entitled to request appropriate follow-up on a complaint and to meet with the company's representatives. What "appropriate follow-up" means is not yet clear.
Monitor the effectiveness of these measures and policies
Companies would have to carry out periodic assessments of their operations and measures. This requirement would also extend to the operations and measures of their subsidiaries, as well as those of their established business relationships where related to their own value chains.
Publicly communicate on their due diligence efforts
Companies would have to publicly report on due diligence on their website.
Member States would be required to amend their laws on breaches of directors' duties to ensure that, when fulfilling their duty to act in the best interests of the company, directors of EU-based companies take into account the sustainability consequences of their decisions. This would include, where applicable, human rights, climate change, and other environmental consequences in the short, medium and long term.
The proposal will be presented to the European Parliament and the Council for approval. Once adopted, Member States will have two years to transpose the Directive into national law.
Once introduced, Member States will establish sanctions for non-compliance with national provisions, which are to take the form of remedial action to be taken by the non-compliant company within an appropriate period of time and/or financial penalties based on the turnover of the company. Guidelines for financial penalties have not yet been published.
Is the UK following the EU approach?
In short, no. The Queen's Speech, delivered on 10 May 2022, set out amendments the UK government intends to make to the section 54 Modern Slavery Act corporate reporting requirement. The main proposals are (as largely foreshadowed by its consultation response in 2020):
- broadening the categories of content that need to be included in the statement (making a number of currently voluntary content topics mandatory), and broadening the obligation to public bodies as well as private organisations;
- requiring organisations to publish their statements on a government-run registry (which they can already do on a voluntary basis); and
- introducing civil penalties for organisations that do not comply with the requirements.
Osborne Clarke comment
The Commission's proposal is the latest indicator that the expectations on corporate responsibility for sustainability in supply chains are changing. While to date the focus has often been on transparency, and many businesses have fallen short of that passive goal, now the dial is shifting to something more proactive, to businesses being expected to actually look for and address the social and environmental issues which underpin their business operations.
For those not directly caught, they may still expect to come under contractual or commercial pressure to act from customers who are subject to such obligations (leaving aside other ESG pressures that businesses may wish to, or feel they have to, respond to). For those not in such supply chains, it may still be advisable to consider if there are benefits to embracing this change rather than waiting to be pushed.
From a UK perspective, it appears from the Queen's Speech that the long-delayed update to section 54 of the Modern Slavery Act 2015 will not be used to impose practical obligations on organisations to actually undertake human rights due diligence. Although backed by civil sanctions, the proposed enhancements to the corporate reporting requirements look like more of the same, rather than the more pro-active approach being taken by the EU. However, on an issue where the ethical, commercial and reputational drivers are often pushing organisations beyond their legal obligations, it may be that the EU approach sets a standard for what "good" looks like that many UK organisations will be keen to follow.