EC Sustainable Corporate Governance Initiative
The proposed legislation is part of the EC's focus on sustainable corporate governance and due diligence as an essential part of its recovery package and growth plan, in the context of the COVID-19 pandemic, as well as the rapidly developing climate emergency, sustainability crisis and widespread global diversity loss.
The EC initially presented a study on options for regulating due diligence requirements through the supply chain in February 2020, which highlighted that voluntary regimes across Europe had failed to change the way businesses managed their corporate governance responsibilities. The study was followed by an announcement in April 2020 by the European Commissioner for Justice that the EC would introduce new legislation on mandatory human rights and environmental due diligence for companies and a subsequent consultation which ended in February 2021 (see our previous alerts here and here).
The proposed legislation is not the EU's first foray into environmental, social and governance regulation. However, a mandatory, inter-sectorial and enforceable due diligence law has the potential to have a transformative impact on companies and stakeholders across Europe, creating a harmonised standard, legal certainty and a level playing field through increased supply chain transparency.
European Parliament Recommendations
The European Parliament's proposed draft directive makes a number of important recommendations:
Large undertakings governed by the law of an EU Member State or established in EU territory, regardless of whether they are private or state-owned, would be in scope of the legislation, as well as all publicly-listed small and medium-sized undertakings and high-risk small and medium-sized undertakings.
Where such undertakings are not established in the EU and governed by third country law, they would still be within scope when they provide goods or services in the internal market.
Value chain due diligence should be proportionate and commensurate to the likelihood and severity of potential or actual adverse impacts, taking into account each specific value chain and undertaking.
Broad definition of human rights and environmental damage
The draft directive covers "potential or actual adverse impact(s) on human rights" that may impair full enjoyment of human rights by individuals or groups and "potential or actual adverse impact(s) on the environment", meaning any violation of EU or internationally recognised environmental standards. Both human rights and environmental standards shall be set out in annexes and regularly reviewed.
Duties and obligations
Undertakings would be obliged to take all efforts to identify and assess potential or actual impacts on human rights, the environment or good governance caused by, contributing to or linked to their operations or business relationships, using a risk-based monitoring methodology that takes into account the impact, nature and context of the undertaking's operations. Undertakings must also review business relationships for the same risks.
Undertakings must publish a statement, including the risk assessment, data and methodology, where they conclude they do not cause, contribute to or are directly linked to such adverse impacts. Where an undertaking is unable to make this statement, they should establish and implement a due diligence strategy, reviewed annually. Business strategies and policies should be in line with this due diligence strategy. Voluntary action plans may be introduced at national and EU level, reducing the burden of undertakings establishing a bespoke strategy.
The draft directive encourages transparency and stakeholder engagement, requiring undertakings to communicate due diligence strategies with workers' representatives, trade unions and business relations. Undertakings will also be required to regularly verify that their subcontractors and suppliers comply with their obligations.
Investigations / sanctions / penalties
Member States will have discretion to set proportionate, turnover-based sanctions in accordance with national law. Sanctions may also include temporary or indefinite exclusion from public procurement processes, state aid and public support schemes, and culminate in seizure of commodities. Each Member State shall set up or designate at least one authority responsible for supervision of the application of the directive. They will also have the power to investigate undertakings on a risk- or information-based approach to verify compliance with the directive, including interviewing stakeholders or their representatives.
Where an undertaking's failure to comply with the directive could lead to irreparable harm, interim measures or a temporary suspension of activities may be ordered by the relevant authority. This may imply a ban on operating in the internal market for undertakings governed by third party law.
Undertakings will be held liable and be made to provide remediation for harm arising out of actual or potential adverse human rights and environmental impacts. There is no provision in the draft directive relating to individual director or criminal liability.
Undertakings that respect their due diligence obligations are not absolved of liability, unless they can prove they took all due care to avoid the specific harm, or the harm would have occurred anyway. Reasonable limitation periods for civil liability claims will also apply.
Access to justice for victims
To allow stakeholders to voice reasonable concerns on potential or actual adverse impacts, undertakings must provide a grievance mechanism, acting as an early-warning mechanism for risk-awareness, and as a mediation system. This will not prevent claimants from accessing further judicial mechanisms, and victims will not be required to seek extra-judicial remedies before claiming in court.
The European Parliament's report and proposed draft directive represents a strong signal of support for the imposition of mandatory human rights and environmental supply chain due diligence obligations for companies operating across sectors in the EU.
Enhanced due diligence requirements and monitoring obligations have the potential to create a harmonised standard for due diligence and legal certainty across the board. However, they will also lead to increased regulatory obligations and associated costs for companies with complex global supply chains, who will need to review and adapt their processes accordingly. Companies should begin preparing for these impending new requirements by regularly reviewing and auditing their supply chains for adverse human rights and environmental impacts and implementing robust and effective supply chain due diligence practices to mitigate potential financial, legal and reputational risks before they arise.
Whilst the directive is still in draft form and the EC's legislative proposal is due in Q2 this year, it is already evident that the new measures have the potential to have a transformative impact on companies' due diligence obligations and supply-chain risk management practices.
Please do not hesitate to contact us if you have any questions regarding the European Parliament's recommendations or the development of the EC's forthcoming legislation.