March 11, 2022
Click here to download the PDF
The European Commission (EC), was inaugurated on 23 February 2022.EC) published its long-awaited draft directive on Corporate Sustainability Due Diligence (the Directive),[1]This law imposes mandatory human rights and environmental due diligence obligations on corporates. It also includes a civil liability regime to enforce compliance of the obligations to prevent, minimize, and bring about adverse effects to an end.[2]
The Directive draft will now be subject to further review and discussion. It is likely that it will be adopted by the European Parliament, and then implemented into national legal systems by 2027.
This was hailed by the European Commission as an opportunity for uniform standards for corporates operating across Europe. It is a situation where many jurisdictions have been developing their own human rights, environmental due diligence, and reporting obligations (see our previous client advisory).
|
The Directive’s key features
|
Four key corporate due diligence obligations are introduced
The Directive establishes four key due diligence requirements regarding potential and actual events Human rights violations can have adverse effects adverse environmental impacts(both of which are defined in the Directive by reference to international conventions). Not only must due diligence be done in relation to the company’s operations, but also those of their subsidiaries. Established business relationships(direct or indirect) where these operations are related the company Value chains.[8]
Value chainBroadly speaking, it is defined as Activities related to the production or provision of services by a business include the development of the product/service and the use and disposal thereof as well as the associated activities of upstream or downstream established business relationships.. The Directive provides additional guidance for regulated financial service companies. It notes that the value chain is also included in the Directive. The activities of the clients who received the loan, credit or other financial services shall not be included..
Integrate environmental due diligence and human rights
FirstCompanies are required to incorporate human rights and environmental due diligence in all aspects of their corporate policies. a specific due diligence policyThis document contains: (i.e. a description about the company’s due diligence approach;(ii. a code of conduct for employees and subsidiaries of company; and (iii.) a description and description of processes that are in place to implement due diligence, including measures taken to extend it to. Established business relationships.
Identify any potential negative effects, both actual and possible
SecondAs mentioned above, companies must take the appropriate steps to protect their assets. Identify Actual and potential adverse environmental and human rights impacts arising from their own operations as well their subsidiaries’ operations and those of their business relationships in their value chain. (Certain corporations are limited to identifying only. SevereNegative effects.)[9]This is an ongoing and continuous obligation for all companies that fall within the Directive’s scope, except for financial institutions that only need to identify adverse impacts. BeforeProvide a service (e.g. credit or loan).
In terms HowTo identify adverse impacts, the Directive permits the use both qualitative and quantitative data. It also allows for information gathering through the complaints process (see below), as well as consultations with potential affected groups.
Reduce or prevent potential adverse effects
ThirdCompanies are required to PreventPotential adverse effects and, where possible, to adequately address them mitigateNegative impacts that were or should have been identified under the prior identification obligation. This can be achieved through a variety of strategies:
- Companies should develop and implement preventive measures when necessary. Prevention action planIn consultation with affected stakeholders, include timelines and indicators of improvement. Other measures include the obligation to invest in production or management processes and infrastructures.
- Companies should seek contractual assurances of their direct business partners in the event of direct business relationships. These assurances can include contractual assurances of their own partners to ensure compliance with the companys code and prevention plan. This is called “The Contractual Assured” contractual cascading.
- In the event of indirect business relationships, which have potential adverse effects that cannot be prevented or mitigated by the prevention plan and associated measures, the company might seek to enter into a contract with the indirect partner. This contract will aim at compliance with the company’s code of conduct, or a prevention plan..
- The company must not enter into new or extend existing relationships with partners if the potential adverse effects cannot be prevented or adequately managed by the use of contractual assurances or contracts and the prevention plan. The company must, to the extent allowed by local laws, suspend commercial relations with the partner concerned, while pursuing prevention or minimisation efforts (subject to reasonable expectation that these efforts will succeed in short-term), and (ii) terminate business relationships with respect of activities affected if the potential adverse effect is severe.
Reduce or eliminate actual adverse impacts
FinallyCompanies must end any negative impacts that have been identified or should have been. Companies should minimize the impact of adverse impacts if this is not possible. Companies must take the necessary actions to mitigate or minimize the adverse effect, including the payment of damages to those affected; (iii). implement a corrective plan with indicators and timelines; (iii). seek contractual assurances; (iv) make necessary investments. There are provisions that cover situations where the actual adverse impact cannot or will not be minimized.[10]
Standalone climate change obligation
Companies in Group 1 are required to develop a plan to ensure their business model and strategy are compatible with the Paris Agreement’s goal of limiting global warming below 1.5C. The plan should outline the extent to climate change poses a risk or has an impact on the company’s operations. In the contexts of variable remuneration to directors, where such remuneration depends on the directors contribution to long-terms and sustainable business strategy, it is important to ensure that the plan’s obligations are met.
Director duties expanded
The Directive introduces a Directors duty of careDirectors are required to consider the environmental and human rights implications of their decisions in the near, medium and long-term. Directors[11]They should oversee due diligence policies and procedures and adapt the company’s strategies if necessary. The Directive requires that all Member States ensure that their laws governing directors’ duties are compatible with the Directive. The Directive, as it stands now, does not impose personal responsibility on directors for non-compliance.
Practically, this will imply that boards must be transparent about how they comply with sustainability requirements. Boards should also document how they consider risks and incorporate them into all decisions, including strategic ones. Directors should ensure they are well-informed about the company’s reporting and due diligence processes, as well as how they are managed. ESG training should also be provided.
Industry-specific requirements will eventually dictate what the board must do, but it is important that the board shows that it is actively engaged with these issues.
Sanctions and enforcement
Non-compliance of the Directive’s substantive requirements can lead to civil liability and sanctions. Member states are required to ensure that companies are held liable for damages under the civil liability provision. This applies if they fail to prevent or mitigate potential adverse effects; and b) if an adverse effect that could have been prevented actually occurs and causes damage. A company cannot avoid liability by relying upon local law (for instance, where the adverse effect is not covered by the local law). However, where a company has taken the SuitableDue diligence measures identified in Directive, there should not be any such liability unless it is UnreasonableIn the circumstances, it is reasonable to expect that the actions taken (including in regards to verifying business partner compliance) will be sufficient to prevent, mitigate or bring to an end the adverse effect. This raises the question: What should be considered? UnacceptableWhat are the best measures? SuitableDirective, which does not provide clear answers. Further guidance regarding the scoping of expectations, and the nature of this directive. SuitableDue diligence is essential.
The Directive requires Member States establish supervisory bodies to monitor compliance. However, the Directive gives discretion regarding sanctions for non-compliance. These authorities will have the power to conduct investigations, issue orders stopping violations and publish their decisions.
In-scope companies that are not incorporated in the EU must also appoint a director Authorized representative, i.e. A natural or legal entity, domiciled or established in an EU Member State where the company generated the majority of its annual net turnover in that EU Member State. The authority must be authorized to act for the company in compliance with the Directive. They will also communicate with supervisory authorities and cooperate with them.
Next steps
The Directive draft will now be presented the Council of the European Union (or the European Parliament) to allow for agreement on the final text. The Directive will likely be subject to further discussions by a variety of industry, government, and NGO stakeholders. It remains to be seen if any material changes will occur. There are strong political tailwinds supporting EU-wide action on this topic.[12]Even more so, as EU countries continue to implement their own legislative measures, and the European Parlament has advocated for similar legislation. Current best estimates predict that the directive will be adopted around 2023 and then transposed into national legislation within two to four year. Companies will likely report to the proposed Directive as soon as possible for the financial years ending in 2025 or 2026.
The directive draft is ambitious and leaves many open questions about the scope of the duties. The Commission promised additional guidance on issues such the nature and scope of due diligence. This information will be crucial for corporates as they seek to understand and address their obligations in practical terms.
__________________________
[1]The European Commission published a Q&A publication as well as a factsheet on the same date. These provide additional background and colour to the draft Directive. These publications are available at the European Commissions. Corporate Sustainability Due Diligence Website.
[2]This follows a public consult period that was held between 26 Oct 2020 and 8 Feb 2021 and a draft directive of the EU Parliament on Corporate Due Diligence & Corporate Accountability published on 10 March 2021 (the EU Parliament draft Directive). See Our previous client alert addressed the 27 January 2021 report containing a proposed EU Parliament draft Directive.
[3]The definitions of companies go beyond corporate entities and include other types of enterprises that have separate legal personality. This is done by reference to the Accounting Directive 2013/34Regardless of their legal form, they are eligible to participate in certain regulated financial undertakings. See Article 2(iv), draft Directive (definition Company).
[4]See Article 2(2) in the draft Directive. The Directive’s parameters of application draw on thresholds and definitions from other EU sustainability and ESG-related regulations, such as the Non-Financial Reporting Directive or the proposed new Corporate Sustainability Reporting Directive.CSRD()), this threshold is related to turnover attributable High impact sectors This is a significant development.
[5]The reporting requirements for Articles 19a & 29a are outlined below Directive 2014/95/EU(The Non-Financial Reporting Directive), that will soon be replaced with the Directive on Corporate Sustainability Reporting).
[6]This is in contrast to the broader scope CSRD, which is expected capture approximately 50,000 entities.
[7]See Article 2(iv), the draft Directive (definition of Company).
[8]Directive Article 3 defines italicized terms.
[9]For example, Group 2 companies and non EU companies that generate a net turnover greater than EUR40million but less than EUR150 million in the EU during the previous financial year. This is provided that at least half of its global turnover was generated in a high-impact industry.
[10]As per Article 7, a company may seek to enter into a contract with an entity that it has an indirect relationship in order to comply with its code of conduct or corrective program (Article 7.4)). The company must also refrain from entering into new or extended relations with the partner in relation to or in the value chains where the impact has occurred. If the adverse effect is severe, the company must temporarily suspend commercial relationships and terminate the business relationship (Article 7.6).
[11]DirectorsThe draft Directive defines it broadly as the people who are part of the Administrative, management and supervisory bodies of a business, the CEO and any Vice CEO, as well other persons who perform similar roles. Board of directorsBroadly speaking, it is defined as The administrative or supervisory body that is responsible for supervising executive management of the companyOr those performing equivalent functions. See draft Directive, Articles 3, (o), (p).
[12]This proposal is also a result of a flurry in EU developments in ESG-related regulation. These developments include the presentation by the European Commission of the same date of a Communication on Decent Work Worldwide, and the most recent feedback and developments regarding proposed changes to CSRD from various European Parliament Committees, including the Permanent Representatives Committees. General approachConcerning the European Commissions proposed CSRD published on 18 February 2022 by European Parliaments Economic and Monetary Affairs Committeess (ECON). opinions and proposed changesTo the CSRD, published 28 February 2022.
Gibson Dunns lawyers can assist you with any questions regarding these developments. If you have any questions regarding these developments, please contact Gibson Dunn lawyers.
Susy Bullock London (+44 (0) 20 7071 4283, [email protected])
Selina S. Sagayam London (+44 (0) 20 7071 4263, [email protected])
Sophy Helgesen London (+44 (0) 20 7071 4261, [email protected])
Stephanie Collins London (+44 (0) 20 7071 4216, [email protected])
Ashley Kate Hammett London (+44 (0) 20 7071 4240, [email protected])
Feel free to contact these ESG practice leaders as well:
Susy Bullock London (+44 (0) 20 7071 4283, [email protected])
Elizabeth Ising Washington, D.C. (+1 202-955-8287, [email protected])
Perlette M. Jura Los Angeles (+1 213-229-7121, [email protected])
Ronald Kirk Dallas (+1 214-698-3295, [email protected])
Michael K. Murphy Washington, D.C. (+1 202-955-8238, [email protected])
Selina S. Sagayam London (+44 (0) 20 7071 4263, [email protected])
2022 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The materials enclosed are for informational purposes only. They do not constitute legal advice.