EU Directive on Corporate Sustainability Due Diligence
The European Commission’s proposal for a Directive on Corporate Sustainability Due Diligence (the ” Directive”) was published on 23 February 2022. The long-awaited Directive sets out a proposed EU standard for human rights and environmental due diligence. What is the proposed Directive about? Is your company within its scope? What do you need to do – and when?
The behaviour of companies is key to succeeding in the EU’s transition to a green economy and delivering on the UN Sustainable Development Goals, including on its human rights and environment-related objectives. As voluntary action does not appear to have resulted in large-scale improvement, new legislation has been considered necessary within the EU.
The proposed Directive would require companies to identify, prevent and cease adverse environmental and human rights impacts across their own organisations and the value chain operations carried out by entities with whom the company has an established business relationship.
Although the Directive remains subject to further discussion and approval, it provides already now an insight into the prospective EU legislation based on the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for multinational companies.
Scope
The Directive would apply to:
EU companies that have:
- more than 500 employees and a net worldwide turnover of more than EUR 150 million; or
- more than 250 employees and a net worldwide turnover of more than EUR 40 million, provided that at least 50% of this net turnover is generated in a “high-risk” sector (including textiles, clothing and footwear, agriculture, forestry, fisheries, food and extractives)
Non-EU companies that have:
- a net turnover of more than EUR 150 million in the EU; or
- a net turnover of more than EUR 40 million but not more than EUR 150 million, provided that at least 50% of this net worldwide turnover is generated in one of the “high-risk” sectors mentioned above
According to current estimates, around 13,000 EU companies and 4,000 non-EU companies would fall within the above criteria. In Finland, the number of companies falling within the same criteria would be around 300 companies.
Even though small and medium-sized enterprises (SMEs) would be excluded from the due diligence obligations set out in the Directive, it is clear that, as a part of the value chain, they would bear the burden of the new legislation. It is therefore fair to say that understanding the proposed Directive is crucial for companies of all sizes.
“It is fair to say that understanding the proposed Directive is crucial for companies of all sizes.”
Due diligence
In terms of specific due diligence obligations, Member States would need to require companies to:
- Integrate due diligence into company policies and ensure such policies are updated annually;
- Identify actual or potential adverse human rights and environmental impacts arising from their own operations and those of their subsidiaries, and from their established business relationships in their value chains;
- Prevent potential adverse impacts and bring actual adverse impacts to an end;
- Establish and maintain complaints procedures that enable third parties to submit complaints relating to potential or actual adverse impacts;
- Monitor the effectiveness of their due diligence periodically and at least every 12 months; and
- Communicate annually the relevant due diligence measures taken by the company
The Directive would define an “established business relationship” as a direct or indirect relationship that is expected to be lasting and “which does not represent a negligible or merely ancillary part of the value chain”. This could include, for example, contractors, subcontractors and other entities in the value chain.
It should be noted that the duties to prevent and to cease adverse impacts would require companies to prepare action plans and invest in legal work. For example, companies would need to seek auditable contractual assurances from their partners to prevent or correct adverse impacts.
“The duties to prevent and to cease adverse impacts would require companies to prepare action plans and invest in legal work. For example, companies would need to seek auditable contractual assurances from their partners to prevent or correct adverse impacts.”
Directors’ duty of care
In order for the duty of due diligence to be effective, Member States would need to ensure that directors of companies have a duty of care to:
- Take into account the consequences of their decisions for sustainability matters, including human rights, climate change and environmental consequences;
- Ensure and oversee that the company puts in place and implements required due diligence actions, and report to the board of directors on such efforts;
- Adapt the corporate strategy to take into account identified potential and actual adverse impacts; and
- For relevant companies within the scope, adopt a plan to ensure that the company’s business model and strategy are compatible with the transition to a sustainable economy and with limiting global warming to 1.5˚C in line with the Paris Agreement
Member States would further need to ensure that their laws providing for a breach of directors’ duties also apply to the duty of care provisions of the Directive.
Sanctions
The Directive would provide for Member States to enforce sanctions for non-compliance with the obligations set out in the Directive. Such sanctions should be “effective, proportionate and dissuasive” and could include financial penalties based on a company’s turnover. National administrative authorities appointed by Member States would be responsible for supervising the new rules.
The Directive would also introduce a new civil liability regime. Companies would be liable for damages if a failure to comply with the mandatory due diligence obligation leads to damage. This would give potential victims better opportunities for legal action, and it could mean an increase in human rights and environment-related litigation.
Timing and next steps
The Directive is currently being discussed by the European Parliament and the Council. Several changes can be expected before the Directive is fully finalised.
Once it is adopted, Member States will have two years to transpose the Directive into national law.
The Directive would apply to:
- EU and non-EU companies with a net turnover of more than EUR 150 million 2 years after the entry into force of the Directive; and
- EU and non-EU companies with a net turnover of EUR 40 million in “high-risk” sectors 4 years after the entry into force of the Directive
Even though it will take years to see the actual implications of the Directive, the mandatory environmental and human rights due diligence is undoubtedly coming, and companies should be prepared for the upcoming legal obligations.