On 23 February 2022, the European Commission published its much-anticipated proposal for a “Directive on Corporate Sustainability Due Diligence” (the “Proposed Directive”).

In recognition of “the connection of the EU economy to millions of workers around the world through global value chains” the Proposed Directive aims to tackle human rights and environmental impacts across those global value chains by requiring the implementation of enhanced due diligence into corporate governance, decision-making and management systems.

The impact of the Proposed Directive on companies based in the EU and operating in the EU meeting the required thresholds will be significant. Companies will need to reassess their core business activities, or risk facing civil liability, fines and, potentially, criminal offences.

The Proposed Directive is expected to impact approximately 13,000 EU companies and 5,000 non-EU companies. Few of these will currently meet the enhanced due diligence requirements of the Proposed Directive. Companies that fall within the scope of the Proposed Directive should take proactive steps now to meet the upcoming legal requirements. These steps should include companies auditing their business and supply chains for potential human rights and environmental violations; preparing or re-evaluating existing systems and controls to detect and mitigate human rights and environmental violations; putting in place robust and effective due diligence practices; and preparing for enhanced governance and reporting requirements.

By taking proactive steps before the Proposed Directive is transposed into national laws, companies will mitigate the risks posed by the Proposed Directive before they arise.

Overview

What is the proposal?

The legislation would impose new and extensive obligations on certain businesses to establish, implement and monitor appropriate and commensurate due diligence processes throughout their value chain (including direct and indirect business relationships, partners, suppliers, and subcontractors).

Why?

The European Commission aims to minimise and remediate potential and/or actual adverse impacts on human rights and the environment caused by business’ value chains. By applying to businesses operating in the EU, irrespective of their place of registration, it also aims to harmonise corporate due diligence requirements and to ensure that all companies doing business in the EU are on a level playing field. This aims to mitigate unfair competitive advantages of non-EU countries resulting from lower protection standards and “social and environmental dumping in international trade”.

Who will the new rules affect?

The new rules shall apply to both EU and non-EU companies meeting the required thresholds (Article 2). An EU company is a company incorporated and governed by the laws of a Member State. A non-EU company is a company incorporated and governed by the laws of a third country, a country that is not a Member State.

As explained below, the Proposed Directive shall apply to large EU companies meeting the required thresholds or smaller EU companies that operate in ‘high-risk’ sectors meeting the required thresholds. Non-EU companies will be affected if they are active and operating in the EU and generate significant turnover there (the applicable thresholds are lower for non-EU companies operating in high-risk sectors).

EU Companies:

• Companies based in the EU with more than 500 employees and a net worldwide turnover of more than EUR150 million during the last financial year.
• Companies based in the EU with more than 250 employees and a net worldwide turnover of more than EUR40 million in the last financial year, if at least half of that turnover was generated in high-risk sectors (namely textiles, agriculture and trade or extraction of resources).

Non-EU Companies (companies registered under the laws of a third country):

• Companies established outside the EU with a net turnover in the EU of more than EUR150 million during the financial year preceding the last financial year.
• Companies established outside the EU with a net turnover in the EU between EUR40 million and EUR150 million, if at least 50% of the net worldwide turnover was generated in a high-risk sector (namely textiles, agriculture, and trade or extraction of resources).

Small and medium enterprises (SMEs) are not directly in the scope of the Proposed Directive, but may be impacted if they operate within the value chains of large companies that are.

What are the key requirements?

In summary, the legislation requires companies within its scope to:

• Maintain corporate policies on due diligence (Article 5)
• Conduct due diligence and monitoring (Articles 6 and 10)
• Prevent and mitigate adverse impacts (Articles 7 and 8)
• Establish and maintain complaints procedures (Article 9)
• Monitor the effectiveness of their due diligence policies and measures (Article 10)
• Publicly report on due diligence (Article 11)

The proposals apply not only to a company’s own operations, but also those of its subsidiaries and value chains (including indirect and direct business relationships provided they do not represent “a negligible or merely ancillary part of the value chain” (Article 3(f))).

How are directors affected?

Directors of companies would be responsible for setting up and overseeing the due diligence requirements set out above, in particular with respect to corporate policies on due diligence (Article 26).

Directors of EU companies would also need to take into account the consequences their decisions might have on “sustainability matters”, including with respect to human rights and the environment (Article 25). This would include, where applicable, human rights, climate change, and other environmental consequences in the short, medium and long term.

What are the consequences of non-compliance?

The legislation would provide a new liability regime – allowing individuals and communities (from any country) to seek compensation for damages if non-compliance results in their harm. Companies may be sued for non-compliance outside the EU, opening the possibility for civil claims being brought by individuals and communities in the English courts, if it can be established that England is the proper place for the proceedings (applying the principle of forum non conveniens).

The legislation also empowers national authorities of Member States to investigate companies suspected non-compliance and to impose large administrative fines, sanctions, and criminal offences for non-compliance. The sanctions provided for in Article 20 shall be “effective, proportionate and dissuasive” and pecuniary sanctions shall be “based on the company’s turnover.”

EU-based companies covered by the Proposed Directive would be supervised by the Member State in which they have their registered office. A non-EU company would be supervised by the Member State in which it has its branch. If a company does not have a branch in a Member State, or has more than one branch in different Member States, it will be supervised by the Member State in which it generates the most turnover within the EU.

Next steps

The EU published the Proposed Directive on 23 February 2022. Once adopted by the European Parliament and the European Council, there will be a two-year transposition period during which Member States must transpose the measures into their national laws (Article 30).

This timescale provides the opportunity for businesses to anticipate the far-reaching changes and prepare for them ahead of time. That said, businesses should be mindful that some Member States such as France and Germany are already pushing forward legislative proposals to strengthen their national human rights due diligence laws and are already adopting (at least in part) enhanced due diligence requirements. Key changes are expected well in advance of the end of the two-year transposition period.

For more information on the Proposed Directive and how it might impact your business, please contact Tim Elliss, Daniel Levy or Anna Brownrigg.