Directive on corporate sustainability due diligence – What, who, 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.

“In a few years’ time, the Directive is expected to convert a range of international “soft law” treaties into “hard law” obligations, and give parties impacted by breaches of companies’ due diligence obligations the right to sue for damages.”

How to prepare? 1. Follow – and understand – regulations. Regulation regarding sustainability is increasing. Considering both the number of regulations and the complexity of requirements to be met by companies, it is important to find efficient ways to follow legislation. It is also necessary to understand which regulations are most relevant. For many companies, the Corporate Sustainability Reporting Directive and the EU Taxonomy are among key regulations, in addition to the proposed Directive. 2. Start with the basics. First, it is important to confirm that your company has defined what sustainability means to itself and that it addresses sustainability on a strategic level, too. To move towards compliance with the Directive, your company needs to put sufficient due diligence plans in place. As the Directive is rooted in the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for multinational companies, it is recommended to use these as a baseline. 3. Ask for help. We are happy to discuss any questions you may have regarding the Directive, as well as its expected implications. Together, we can draft an effective plan for the required due diligence activities, including necessary contractual elements to manage risks in the value chain. The time to get started is now. In a few years’ time, the Directive is expected to convert a range of international “soft law” treaties into “hard law” obligations, and give parties impacted by breaches of companies’ due diligence obligations the right to sue for damages.