European Commission proposes a Directive on Corporate Sustainability Due Diligence
Following intense debate, the proposed Directive on mandatory human rights and environmental due diligence ("mHREDD") would establish far-reaching requirements for large companies operating in the EU.
Yesterday, the European Commission published its long-awaited proposal for mHREDD legislation. The Proposal takes the form of a draft Directive, which means that if adopted, the requirements of the Directive would need to be transposed into the laws of each Member State.
The key elements of the proposed Directive are set out below:
Scope of application
The Directive would apply to:
- Large EU companies: Companies with more than 500 employees on average and a worldwide net turnover of more than €150 million (previous FY);
- Mid-size EU companies in "high-impact" sectors: Companies with more than 250 employees on average and a worldwide net turnover of more than €40 million (previous FY), provided that at least 50% of this net turnover was generated in one or more "high-impact" sector(s) (discussed below);
- Certain non-EU companies: non-EU incorporated companies with (i) EU-generated net turnover of more than €150 million (previous FY) or (ii) EU-generated net turnover between €40 million and €150 million (previous FY), provided that at least 50% of its net worldwide turnover was generated in one or more high-impact sector(s).
High-impact sectors include, amongst others, textiles and clothing, extraction of and trading in mineral resources (including oil and gas, metals and other non-metallic minerals, and quarry products), agriculture and forestry, fisheries and food manufacture, and wholesale trade in raw materials, animals, wood, food and beverages.
The proposed Directive also confirms that regulated financial undertakings which meet thresholds for large companies are in scope.
The European Commission estimates that the Directive would apply to around 13,000 (1% of all) EU companies and about 4,000 non-EU companies.
SMEs have been "completely excluded" from scope but may be exposed to the Directives' effects through measures taken by in-scope companies with which they do business.
Due diligence obligations
The proposed Directive sets out due diligence obligations for companies with respect to:
- their own operations;
- the operations of their subsidiaries; and
- the value chain operations carried out by entities with whom the company has an established business relationship.
The terms 'business relationship', 'established business relationship' (direct or indirect business relationships that are 'lasting' in view of intensity or duration) and 'value chain' are defined in Article 3. 'Value chain' (defined broadly) covers activities related to the production of goods or provision of services (including the use and disposal of products) and related activities of upstream and downstream established business relationships. For financial services businesses, this includes activities of clients receiving financing or other financial services.
The due diligence requirements, set out in Articles 4-11, include actions to:
- identify “actual and potential” adverse impacts on human rights and the environment (Article 6);
- take appropriate measures to prevent or - where prevention is not possible, or not immediately possible – adequately mitigate potential adverse human rights impacts that have been or should have been identified (Article 7); and
- take appropriate measures to bring to an end adverse impacts which have or could have been identified, or where they cannot be brought to an end, minimise the extent of their impact (Article 8).
Companies are required to integrate due diligence into all of their corporate policies. A corporate due diligence policy should describe the company's due diligence approach and include a code of conduct for employees and subsidiaries.
Companies are also required to establish complaints procedures for affected persons, trade unions and civil society organisations, in order to address legitimate concerns regarding such actual or potential adverse human rights or environmental impacts.
Adverse human rights and environmental impacts
An annex to the proposed Directive lists international instruments defining the rights, obligations and prohibitions to be taken into account for human rights and environmental due diligence obligations in the Directive.
Guidance and support
The proposed Directive envisions guidance and support to companies for implementation of the Directive's obligations, including through voluntary model contractual clauses for use in business relationships (see Articles 12 – 14).
Monitoring, assessment and reporting
Companies are required to periodically assess the implementation of their due diligence policy and to publish an annual statement under, or in line with, the (proposed) Corporate Sustainability Reporting Directive, see our briefing.
Combatting climate change
The proposal contains various provisions relating to climate change requiring large EU and non-EU companies to:
- adopt a plan to ensure the business model and strategy are compatible with the transition to a sustainable economy and limiting of global warming to 1.5 °C in line with the Paris Agreement;
- include indicative emission reduction objectives in the plan where climate change is identified as a principal risk); and
- ensure that, where directors' remuneration is linked to the directors' contribution to business strategy and long-term interests and sustainability, that fulfilment of the above climate-related obligations is duly taken into account.
Directors' duties – human rights, environment and climate
The proposed Directive states that, when fulfilling their existing duty to act in the best interest of the company, directors of EU companies should take into account the human rights, climate and environmental consequences, including in the short, medium and long term, of their decisions (Article 25).
Setting up and overseeing due diligence
Member States will ensure that directors are responsible for setting up and overseeing due diligence policies and processes required by the Directive, according due consideration to stakeholder input and to adapt corporate strategy to take account of human rights and environmental impacts (Article 26).
Supervision and enforcement
Member States will designate supervisory authorities with powers to investigate and impose sanctions for failures to comply with the new obligations. Monetary penalties must be based on companies' turnover.
Member States will also ensure that companies applying for public support certify that no sanctions have been imposed on them for a failure to comply with the obligations of this Directive.
Member States are required to ensure that companies organised under their laws can be held liable for damages (by the person(s) suffering harm) if failures to comply with due diligence obligations in Articles 7 and 8 result in an adverse impacts and led to damage.
In respect of "established indirect business relationships," a company should not be liable if it carried out specific due diligence measures (unless it would have been unreasonable to expect that such measures would be adequate to prevent, mitigate, bring to an end or minimise the adverse impact). However, the liability provisions in the proposed Directive do not replace stricter civil liability rules that may otherwise apply under EU or national laws.
What happens next?
The European Commission's proposal will now pass to the European Parliament and Council for adoption according to the ordinary legislative procedure. That process can last from 18 months to several years. We expect robust debate in both EU institutions with significant amendments likely.
Subject to adoption by the European Parliament and the Council, the Directive must be transposed into national laws. The proposed Directive foresees that Member States will have 2 years from the date the Directive enters into force to implement the requirements relating to large companies, and 4 years for mid-size companies.
The provisions of the proposed Directive are complex and raise some interpretational questions around scope and mode of application. Update: The European Commission is collating feedback on the draft directive until 23 May 2022. We have published a detailed briefing on the draft directive and a recording of our joint webinar with GBI held on 8 March 2022 discussing the directive.
We are hosting a second webinar on the EU Corporate Sustainable Due Diligence proposal which is focused on managing environmental impacts. The webinar will take place on 31 May 10:30 CET / 09:30 BST. You can register your interest here and we will send further details closer to the time.