Seven months after the adoption of the Supply Chain Due Diligence Act (LkSG), the EU Commission published its long-awaited draft directive on corporate due diligence in the area of sustainability on February 23. What new obligations will German companies have to prepare for in the medium term? In this article, we compare the EU directive with the German LkSG.
The new directive, known as the Directive on Corporate Sustainability Due Diligence, has many similarities as well as some significant differences from the Supply Chain Act. However, the essence of both regulations is to prevent the violation of human rights and environment-related obligations, to mitigate negative impacts of human rights or environment-related violations, and to put an end to such violations. The Annex to the Directive provides a list of comprehensive rights and obligations, which includes far more environment-related obligations than the LkSG.
Scope of the EU Due Diligence Directive
The EU Due Diligence Directive applies to all companies located in the territory of the Union with an average of more than 500 employees and a worldwide net turnover of more than 150 million euros, in each case based on the previous year. For companies that generate at least 50% of their sales in one or more of the three so-called high-risk sectors (textiles, fisheries, forestry and agriculture, and mineral resources), the thresholds are lowered to an average of 250 employees and net sales of 40 million euros.
Companies based outside the EU must also comply with the directive's requirements if they generate annual net sales of more than EUR 150 million in the territory of the Union. This turnover limit will be lowered to 40 million euros if they operate in one or more of the high-risk areas and generate at least 50% of their net sales there worldwide.
The scope of application of the EU Directive thus goes significantly beyond that of the LkSG.
Scope of due diligence obligations: Indirect suppliers also affected
As in the LkSG, the corporate due diligence obligations under the EU Directive relate to the company's own business operations as well as those of Group companies.
The LkSG primarily includes direct suppliers in the circle of addressees. Only in exceptional cases are indirect suppliers also affected by the LkSG. The situation is different with the EU Directive: It is not the criterion of "directness" that is relevant, but whether the business relationship is an established direct or indirect one, characterized by being of a certain intensity and duration and not merely an insignificant or subordinate part of the value chain.
According to its explanatory memorandum, the guideline is based on the assumption that the established business relationship with a direct supplier also automatically applies to its supplier. This is unlikely to be the case for all companies, as they are generally only aware of a fraction of the upstream indirect suppliers and this knowledge may be denied to them by their direct suppliers, for reasons including competition law considerations.
Further uncertainty arises from the fact that the directive uses the term value chain. This is intended to cover all upstream and downstream direct and indirect business relationships, including the disassembly of the product, its recycling, composting or landfilling. What remains unclear is the extent to which the directive requires companies to monitor direct and indirect purchasers of their products and services. The due diligence obligations of the LkSG, on the other hand, already end with the transfer of the product to the end customer.
Duties of care
With regard to the scope of corporate duties of care, the EU Directive is almost identical to the LkSG. Due diligence obligations are to be integrated into all relevant internal policies and summarized in a due diligence policy. Like the policy statement under the LkSG, this should also provide an outlook on the corporate due diligence obligations to be applied in the long term. Furthermore, companies should develop, implement and maintain preventive and remedial measures.
Both regulations aim to ensure that these measures are passed on contractually not only to the immediate supplier but also by the supplier in turn to its suppliers. At this point, the directive also provides for a direct agreement between companies and their indirect suppliers to prevent, mitigate or terminate potential or actual violations of human rights and environmental obligations. The extent to which such agreements are realistic and practicable cannot yet be foreseen.
If agreements of this kind are reached with SMEs, they should be fair, reasonable and non-discriminatory. The costs of any necessary third-party review of the measures agreed with SMEs should be borne by the company.
Both the LkSG and the EU Due Diligence Directive provide for the implementation of a complaints mechanism, whereby the group of potential whistleblowers is not limited to employees, but should include trade unions and civil society organizations along the value chain.
Both the EU Directive and the LkSG stipulate that the effectiveness of the due diligence measures taken must be reviewed regularly, at least annually or on an ad hoc basis, and if necessary the due diligence policy mentioned at the beginning must be adapted accordingly.
Finally, the Directive, like the LkSG, provides for an annual reporting obligation. Companies that fall within the scope of non-financial reporting under the CSR Directive Implementation Act are obliged to report on the fulfillment of their due diligence obligations within this framework. The reporting criteria for all other companies are still being drafted by the Commission. Here, in the further legislative process, coordination with the Corporate Sustainability Reporting Directive would be desirable, which reforms the area of non-financial reporting and is to come into force as early as January 1, 2024.
Unlike the LkSG, the directive does not provide for the appointment of a responsible person, such as a human rights (and environmental) officer. Documentation is also not mentioned as a due diligence obligation in the directive, although documentation of the measures taken is mandatory in order to be able to successfully defend against civil claims for damages or government sanctions, if necessary.
Compensation for damages
In contrast to the LkSG, the directive provides that affected parties can assert claims for damages against companies if they have been harmed because required preventive and/or remedial measures were not taken.
Both regulations provide the responsible supervisory authorities with sanction options for a lack of or inadequate implementation of due diligence obligations. It can be assumed that supervision will lie with the Federal Office of Economics and Export Control (BAFA), as provided for in the LkSG, with the same set of instruments for investigating and sanctioning corporate misconduct.
Liability of management
In contrast to the LkSG, the directive creates a separate liability issue for management if it fails to take into account the short-, medium- and long-term impacts of corporate activities on human rights, climate change, the environment and other sustainability issues in its decisions.
Further obligations of the management
According to the EU Directive, member states should ensure that management is required to report to their supervisory bodies on the implementation of due diligence and to adapt the corporate strategy to avoid adverse impacts of business activities on human rights and the protection of the environment.
The directive breaks new ground by requiring companies with an average of more than 500 employees and a global net turnover of more than 150 million euros to draw up a plan to ensure that the company's business model and strategy are in line with the Paris Agreement to limit global warming to 1.5 degrees Celsius.
If climate change is one of the company's identified key risks or has a material impact on business operations, the plan should provide for emissions reductions.
Finally, the fulfillment of the aforementioned targets is also to become the subject of the variable remuneration of the Executive Board.
Implementation in national law
The present draft will now be coordinated between the EU Commission, the Council and the Parliament. If this is the case before the European Parliament elections in spring 2024, the directive could be transposed into national law after the two-year transition period in 2025/2026 and lead to amendments to the LkSG. Until then, the LkSG as adopted in June 2021 will continue to apply.
You can view the draft Directive on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937 here.