Human Rights and the Environment – EU publishes draft Corporate Sustainability Due Diligence Directive

The 23 February 2022 was the European Commission released its eagerly awaited draft corporate sustainability directive and due diligence directive (the Draft DirectiveAfter several delays (see our), he finally got it. Previous Blog). The Draft Directive proposes a standard EU for human rights and environmental due care (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.[1]In light of the obligations therein.

The Draft Directive will be presented to the European Parliament for approval. After the Directive is adopted, Member States have two years to make it national law. The message is clear: mandatory HREDD will soon be implemented (see our Past Blogs about national HREDD movements in). Germany The NetherlandsFor example, companies should anticipate HREDD legal obligations for the future and respond to increasing stakeholder expectations.

The Draft Directive

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:
  • Net turnover exceeding EUR 150 million in the EU
  • net 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 to note that the Draft Directive does not include small and medium-sized enterprises (SMEs).

The Draft Directive’s extraterritorial reach is particularly important. Non-EU businesses that meet the EU turnover criteria will be included. Even if they are not physically present in the EU, they can still participate. This could have serious implications for multinational companies based in the US or UK that 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

The Draft Directive stipulates that Member States must require companies to comply with due diligence obligations.

• Integrate due diligence in company policies and ensure that they 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).
• Avoid potential adverse effects and reduce actual adverse consequences (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).
• Review their due diligence policies at least once every 12 months to monitor their effectiveness (Article 10)
• Publicize an annual statement (Article 11) on your website. This will communicate the relevant due diligence steps taken by the company in the preceding calendar year.

The Draft Directive requires companies within scope to implement HREDD policies that cover 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 emphasizes the need for companies to seek contractual assurances from partners with whom they have a business relationship (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

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

The Draft Directive provides a mechanism that allows Member States to impose sanctions against those who do not comply with the obligations in the Draft Directive (Article20-). Such sanctions shall be “effective, proportionate and dissuasive” and may include financial penalties based on a company’s turnover.

New Civil Liability Regulation

Article 22 of the Draft Directive creates a new civil liability system. In particular, companies within the scope of the Directive will be liable for damages if they fail to comply with the mandated duty of due diligence (especially to identify, prevent and mitigate adverse human rights and environmental effects), and fail to pay compensation. This new system could lead to an increase in environmental and human rights related litigation (e.g. Civil society organisations may bring suit. This regime may also have implications on existing national due diligence laws (e.g. The German Supply Chain law

Guidance and Model Clauses

The Draft Directive states, among other things, that the European Commission will issue guidance on voluntary model contract clauses. It may also issue guidelines to help companies comply with the obligations set forth 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.

Implementation and timing

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 organization prepare for the requirements of the Draft Directive?

The Draft Directive’s outline of due diligence obligations gives a good indication about the scope and expected expectations for the design and implementation a human rights/environmental due diligence program. Companies should align their existing policies and procedures with the requirements in the Draft Directive (especially those in Articles 5-11). This will help identify gaps and areas for improvement and improvement before the Draft Directive is adopted. 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.

Businesses can also position themselves for the Draft Directive or other mandatory HREDD legislation at a national level by:

1. Integrating human right into group policies, strategic planning, and other processes
2. How human rights considerations are integrated in strategies, policies, and procedures
3. Conducting a human rights impact assessment, taking proportionate counter-measures and communicating internally and externally about the measures taken.
4. Revision and reinforcement of complaints mechanisms and talk-up programs;
5. Ensuring the business is well equipped to deal with ‘crises’;
6. Examining the ability of their board to address supply chain risk;
7. It is important to review the role, expertise and resources of the legal-compliant functions in order to address these new challenges.