On 23 February 2022 the European Commission published their eagerly awaited report Draft Corporate Sustainability and Due Diligence Directive (the Draft DirectiveAfter several delays (see our), he finally got it. Previous Blog). The Draft Directive proposes an EU standard for environmental due diligence and human rights (HREDD).
This includes an obligation for companies to take appropriate measures to identify actual and potential adverse human rights and environmental impacts arising from their own operations or those of their subsidiaries and, where related to their value chains, from their “established business relationships”. The Draft Directive also provides a mechanism for sanctions to be imposed for non-compliance with the due diligence obligations and provides for director responsibility and accountability in relation to a company’s HREDD programme.
Whilst the Draft Directive remains subject to further legislative scrutiny and approval, it provides the most detailed insight yet as to the scope and form of the prospective EU HREDD obligations, and it provides a helpful template for corporates to continue developing their due diligence policies and procedures designed to identify, assess and mitigate adverse human rights and environmental impacts – both in their operations and in their supply chains.
Banks, insurers, and other financial institutions will be affected by the Draft Directive. They will have to conduct additional due diligence on clients, as well as their subsidiaries, to whom they extend loans, credits, and other financial services.1These obligations are important.
The Draft Directive will now go before the European Parliament and Council for approval. The Directive will be adopted by the Council and Member States will have two year to implement it in their national laws. The overall message is clear: mandatory HRDD is coming. (See our Past Blogs to learn more about national HREDD movement in GermanyAnd The NetherlandsFor example, companies should anticipate HREDD legal obligations for the future and respond to increasing stakeholder expectations.
The Draft Directive
The key takeaway: The Draft Directive will not only cover large EU companies but also have an extraterritorial impact. Non-EU companies that meet certain turnover criteria in the EU will be covered even if they don’t have a physical presence within the EU. Multinational companies based in the US or UK could be affected if they meet the turnover test.
Scope
The Draft Directive is applicable to certain large EU and non EU companies that meet the criteria (per Article 2):
- EU-companiesThese include:
- More than 500 employees, a worldwide turnover exceeding EUR 150 million and more than 500 employees;
- more than 250 employees and a net worldwide turnover of more than EUR 40 million – provided that at least 50% of this net turnover was generated in a “high-risk” sector (which includes textiles, clothing and footwear, agriculture, forestry, fisheries, food and extractives).
- Non-EU companiesThese include:
- Onet turnover exceeding EUR 150 million in the EU
- onet turnover of more than EUR 40 million but not more than EUR 150 million, provided that at least 50% of its net worldwide turnover was generated in one of the “high-risk” sectors noted above.
It appears that about 13,000 EU-based companies and 4,000 non EU-based companies would meet the above criteria. It is important that small and medium-sized businesses (SMEs) are not subject to the due diligence obligations outlined in the Draft Directive.
It is important to note the extraterritorial scope in the Draft Directive: Non-EU companies that meet EU turnover criteria will be included in the scope Even if they don’t physically exist in the EU, it doesn’t matter.. Multinational groups with headquarters in the USA, UK or Asia could be affected if they meet the turnover test. Article 15 also requires that non-EU companies appoint an EU representative to maintain contact with EU supervisory authorities.
Due diligence obligations
Key takeaway: Fundamentally, the Draft Directive requires in scope companies to implement HREDD measures that cover their entire supply chains, looking beyond Tier 1 suppliers to include “established business relationships” throughout the value chain. This includes subcontractors, contractors, and other entities in a supply chain. This will increase the complexity of supply chain risk assessments and ongoing supply chains risk management in practice.
The Draft Directive stipulates that Member States must require companies to comply with due diligence obligations.
- Incorporate due diligence into company policies, and ensure that these policies are updated annually (Article 5)
- Identify any potential adverse human rights or environmental impacts that may arise from their operations, those of their subsidiary companies, and their business relationships throughout their value chain (Article 6).
- Prevent potential adverse outcomes and bring about positive changes (Articles 7-8)
- Establish and maintain a procedure for compliance that allows complaints to being submitted by affected persons, representatives of individuals working in the relevant values chain, and civil society organizations active in areas related the relevant valuechain (Article 9).
- Monitoring the effectiveness of their due diligence programs through reviews that occur at least once per 12 months (Article10)
- Publicize an annual statement on the company’s website, highlighting the company’s due diligence actions during the previous calendar year (Article11).
The Draft Directive mandates that companies in scope implement HREDD measures that include their entire supply chain. This goes beyond assessing Tier 1 suppliers to include assessing “established business relationships” throughout the value chain.
The Draft Directive defines 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 includes subcontractors, contractors, and other entities in a supply chain. The Draft Directive focuses on companies seeking contractual assurances from their direct partners (recital (34)). Seeking such assurances and conducting due diligence on all of these relationships in practice will add further complexity to companies’ supply chain risk assessments and ongoing supply chain risk management.
Directors’ Duties
Key takeaway: The Draft Directive explicitly provides for directors to take into account “human rights, climate and environmental consequences” in acting in the best interest of a company. This includes a requirement to ensure a company’s business model and strategy are compatible with the 1.5 °C goal of the Paris Agreement. This seems to be more extensive than the existing and anticipated national HREDD legislations.
The Draft Directive states that Member States must ensure that company directors are properly supervised by the Directive.
- In order to act in the best interest of the company’s interests, they should consider the impacts on climate and human rights.
- adopt a plan to ensure a company’s business model and strategy is compatible with the transaction to a sustainable economy and with limiting global warming to 1.5°C in line with the Paris Agreement; and
- are responsible for putting in place and overseeing the company’s due diligence programme, with due consideration of relevant input from stakeholders and civil society organisations.
Sanctions
Key takeaway: The Draft Directive provides that Member States enforce sanctions for non-compliance that are “effective, proportionate and dissuasive”.
The Draft Directive, as expected, provides a mechanism for Member States (Article 20 -) to impose sanctions on non-compliance with the obligations outlined in the Draft Directive. Such sanctions shall be “effective, proportionate and dissuasive” and may include financial penalties based on a company’s turnover.
New Civil Liability Regulation
KTakeaway: A new civil responsibility regime could open the door to increased litigation related to human rights and the environment..
The Draft Directive introduces a new civil responsibility regime (Article22). In particular, companies in scope will be liable if they fail comply with the mandated due diligence obligation (particularly to avoid, mitigate, and end adverse human and environmental rights and impacts). This new regime could result in an increase of environmental-related litigation (e.g. The new regime could lead to an increase in environmental and human rights related litigation (e.g., brought by civil society organizations). This regime could also have implications for existing national due-diligence laws, which do not currently allow for such a regime (e.g. The German Supply Chain law
Guidance and Model Clauses
Key takeaway
The Draft Directive states that the European Commission may issue guidelines regarding voluntary model clauses for contracts and may also adopt guidance to assist companies in meeting the obligations in the Draft Directive. Our Previous BlogThe ABA model clauses gives insight into the types and availability of voluntary clauses in a supply chain context.
Timing and implementation
The Draft Directive will now go before the European Parliament and Council for approval. After the Directive is adopted, Member States have two years to transpose it into their national laws and to communicate the relevant texts to Commission.
How can your organisation prepare to meet the requirements of the Draft Directive
The Draft Directive provides a clear indication of the scope of the due diligence obligations and the likely expectations of the design of and implementation of an environmental and human rights due diligence program. Before the Draft Directive is adopted, companies should align and leverage their existing policies to meet the requirements of the Draft Directive. For many large companies, designing and implementing appropriate systems and controls and embedding them into “business as usual” could be, in many cases, a multi-year multi-stakeholder exercise, and so it is imperative for companies to prepare for these new obligations in haste.
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Businesses can also position themselves for the Draft Directive or other mandatory HREDD legislation at a national level by:
- Incorporating human rights in group policies and strategic planning;
- How human rights considerations are integrated in strategies, policies, and procedures
- Conducting a human rights impact assessment, taking proportionate counter-measures and communicating internally and externally about the measures taken.
- Revision and reinforcement of complaints mechanisms and talk-up programs;
- Ensuring the business is well equipped to deal with ‘crises’;
- Examining the ability of their board to address supply chain risk;
- It is important to review the role, resources, and expertise of the compliance and legal functions in order to address these new challenges.
Read more of our Business and Human Rights perspectives here.