The EU is about to take corporate responsibility to respect human rights and environmental protection to the next level. Faced with growing demand from the civil society, companies have been strongly and increasingly encouraged to comply with human rights standards and consider the impact their activity might have on them over the last decade.
This has led several European countries to impose due diligence obligations on companies in an effort to prevent and remedy any adverse impact on human rights and the environment. France was the first state to incorporate a human rights due diligence obligation with "Law No. 2017-399 of 27 March 2017 on the duty of vigilance of parent companies and ordering companies". A dozen other European countries have subsequently considered at the national level the adoption of legislation on expected human rights and environmental due diligence. Most recently and significantly, Germany has joined the movement with the Act on Corporate Due Diligence in Supply Chains of 11 June 2021.
In this context where the transition to a sustainable economy has become critical, the European Commission launched on 26 October 2020 a major consultation on corporate responsibility with regard to environment, social and human rights. Numerous stakeholders engaged in the debate.
In parallel, the European Parliament adopted the resolution of 10 March 2021 containing recommendations to the Commission on the duty of vigilance and corporate responsibility. Members of the European Parliament called on the European Commission to introduce legislation to ensure that companies are held accountable for the adverse effects on human rights, the environment and good governance that they have caused or contributed to.
After being presented as a priority by the French Presidency of the Council of the European Union, the European Commission eventually published, on 23 February 2022, a proposal for a Directive on Corporate Sustainability Due Diligence, aiming to introduce a harmonised human rights due diligence requirement for large companies operating in the EU.
Scope of application
The Proposed Directive provides that new due diligence rules will apply to both EU and non-EU companies, i.e. in more detail:
- Companies incorporated in a Member State which either have more than (i) 500 employees and a net turnover in excess of EUR 150 million generated worldwide (the “Group 1”) or (ii) 250 employees and a net turnover in excess of EUR 40 million generated worldwide, if at least 50% of their net turnover is generated in a high-risk sector, such as textile industry, food industry, and mining (the “Group 2”).
- Third-country companies active in the EU which (i) generate a net turnover in excess of EUR 150 million in the EU (the “Group 1”) or (ii) generate a net turnover in excess of EUR 40 million in the EU, if at least 50% of their net worldwide turnover is generated in the abovementioned high-risk sectors (the “Group 2”).
Small and medium-sized enterprises (SMEs), including micro-companies, are excluded from the due diligence duty. Besides, indirect effects on them will be mitigated: when working with a company falling within the scope of the Directive, SMEs cannot be placed under the burden of due diligence obligations.
Content of due diligence requirements
The Proposed Directive provides that companies must:
- integrate due diligence into their corporate policies and have in place a due diligence policy that is to be updated annually. These policies should among other things contain a description of the company’s approach to due diligence, a code of conduct to be followed by the company’s employees and subsidiaries as well as a description of the processes put in place to implement due diligence;
- identify actual or potential adverse human rights and environmental impacts arising in the operations carried out throughout the entire value chain. Group 2 companies are only required to identify actual and potential severe adverse impacts relevant to their respective sector;
- prevent and mitigate potential adverse impacts, end or minimize actual adverse impacts. In order to comply with these obligations, companies may have to prepare a detailed prevention or corrective plan in response to the situation. If a preventive action can no longer be considered because adverse impacts are actual, companies may have to temporarily suspend commercial relationships with the partner where the impact in the value chain has arisen or even terminate the business relationship if the potential adverse impact is severe;
- establish and maintain a complaint procedure, allowing any person to submit a complaint where they have legitimate concerns that they might be affected by actual or potential adverse human rights impacts and adverse environmental impacts with respect to their own operations, the operations of their subsidiaries and their value chains. These complaints should be managed appropriately;
- monitor the effectiveness of their due diligence policy and measures, with periodic assessments conducted at least every 12 months and whenever it is reasonable to believe that significant new risks of adverse impacts may arise;
- publicly communicate on due diligence. If they are not already subject to reporting requirements under Directive 2013/34/EU, they must publish on their website an annual statement about due diligence.
Guidelines are to be expected whereby the Commission will explain further how companies may fulfil their due diligence obligations. Member States should also provide information and support to companies and their business partners – in particular SMEs – to fulfil the obligations resulting from the Directive.
Plan to fight climate change
In addition, Group 1 companies will have to 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 to 1.5 °C in line with the Paris Agreement”.
At national level, compliance with the obligations set out in the Directive after its implementation into national law will be monitored by independent national authorities. Member States will have to ensure that these supervisory authorities have adequate resources, infrastructure, expertise and premises.
These authorities will have the power to conduct investigations, of their own motion or on the basis of “substantiated concerns” submitted by any natural person or legal entity. They will also be granted power to issue sanctions: if an authority identifies a failure to comply with these obligations, an appropriate period of time to take remedial action should be given to the company but the authorities may eventually impose a sanction in case of non-compliance.
Member States can freely determine the sanctions that may be imposed for not complying with the obligations laid down in the Directive, e.g. injunction to cease or remedy the infringement, fines calculated on the basis of the company's turnover or interim measures to avoid severe and irreparable harm. The Directive offers that these sanctions shall be effective, proportionate and dissuasive and an effective judicial remedy against them should be available.
Civil liability and contractual implementation
The Directive also opens the door to companies being held liable for damages that could have been avoided by appropriate due diligence measures: a company subject to the Directive will be held liable if (1) the company failed to prevent and mitigate potential adverse impacts and to bring to an end or minimize actual adverse impacts and (2) as a result of this failure, an adverse impact has occurred and caused damage.
If appropriate measures have been taken to prevent potential adverse impacts, the company will not be responsible for damage caused by an adverse impact resulting from the activities of an indirect business partner (even though the company has an established business relationship with such partner). In particular, this applies if the company has obtained contractual assurance of its direct business partner that ensure compliance with the company's code of conduct by also obtaining the corresponding contractual assurance from its partners (contractual cascading). However, the company cannot avoid liability for the activities of its indirect partners if it was unreasonable to believe that the measures adopted by its business partner to comply with its due diligence obligations would effectively prevent damage.
In this respect it is to be expected that contractual assurances across the various levels of the supply chain will have a strong relevance in the future. The contractual implementation of regulatory requirements is already playing an increasingly important role in contractual practice. This importance will continue to increase and will also become the focus of regulatory authorities.
The Proposed Directive provides that the company’s efforts to avoid or mitigate damage and to cooperate with the supervisory authority should be taken into account when assessing and, where appropriate, determining the extent of liability.
It also outlines that any action brought against a company under the provisions of the Directive does not exclude:
- its subsidiaries or business partners to be held civilly liable;
- civil liability action based on EU or national rules related to adverse human rights or environmental impacts, in situations not covered by the Directive or if these rules provide for stricter liability.
The Proposed Directive introduces the obligation for Member States to ensure that the liability is not denied on the sole basis that the law applicable to such claims is not the law of a Member State.
Directors’ duty of care
The European Commission explains that directors need to be involved to ensure that due diligence “becomes part of the whole functioning of companies”; that is why Articles 25 and 26 of the Proposed Directive impose a duty of care on directors and forces them to act in accordance with due diligence requirements. They are notably responsible for putting in place and overseeing the due diligence actions referred to in the Directive and for reporting to the board of directors in that respect. The Proposed Directive also provides that when fulfilling their duty to act in the best interest of the company, directors must take into account human rights, climate change and environmental consequences of their decisions.
Before it can eventually enter into force, the Proposed Directive will have to be approved by the European Parliament and the Council of the European Union. Member States will have two years to implement the Directive following its entry into force. The Directive will apply to EU companies within two years after it enters into force and within four years to non-EU companies.
International businesses wishing to stay ahead of the curve would do well to start preparing and revisit existing human rights and environmental due diligence processes and consider whether they are in line with the Directive as it will reduce the risk of being involved in an adverse human rights and environmental impact and associated litigation as well as bad publicity.
Please get in touch with a member of Hogan Lovells’ Business and Human Rights as well as Environmental groups or your usual Hogan Lovells contact if you wish to discuss this development. We stand ready to assist companies from all industry sectors to assess how to assess and adjust their processes and operations and associated litigation risks in this context.
Authored by Christelle Coslin, Liam Naidoo, Patrick Ayad, Detlef Hass, Christian Ritz, Margaux Renard and Kevin O'Connor