Corporate Due Diligence Review: EU Directive & German LkSG
The European Commission has finally published its proposal for a directive on Corporate Sustainability Due Diligence (EC Draft). This is the first step in an extensive legislative process that will ultimately regulate how companies are obliged to take responsibility for their impacts on society, the environment, and future generations.
The announcement was previously postponed several times after some stakeholders raised concerns about possible negative consequences it might have; however, these fears were allayed when further consideration led to its announcement on 23 February 2022.
The European Commission has been tasked with crafting new legislation to improve the security of companies in Europe. The two laws they focus on are Articles 50 and 114, which deal specifically with corporate due diligence laws between member states.
Several countries had already enacted national corporate due diligence systems before any initiative at an international level – France and Netherlands were the first to adopt the directive at the national level.
Germany, another European Union member state to implement national legislation in business and human rights, has gazetted its Supply Chain Act (LkSG) through parliament in the last legislative period while aware of ongoing European regulatory efforts.
The German legislative process resulted in a business-friendly law that fell short of the already publicly available European Parliament Draft (EP Draft). If this directive comes into force with its proposed content, Germany's Supply Chain Act will have to be much more stringent.
Regardless, the EU directive and Germanys LkSG promote corporate due diligence as a broader agenda that requires companies to pay attention and take crucial measures in protecting human rights and the environment throughout their global supply chain.
Similarities in Corporate Due Diligence Scope
The core elements of the German LkSG and EU Directives are similar in several scopes, which demand businesses conduct due diligence obligations towards their activities and supply chains on an ongoing basis.
The similarities of the core elements between both due diligence provisions are listed below:
- Companies must avoid or at least mitigate adverse environmental and human rights impacts.
- Companies must develop a prevention action plan with clearly defined timelines with clear indicators.
- Companies must end or minimise the actual adverse impacts.
- Companies must establish a complaints procedure that covers the entire value chain.
- Companies must monitor the effectiveness of the due diligence policy and measures annually and on an ad hoc basis using appropriate indicators.
- Companies must communicate publicly about their due diligence. This includes publishing a statement on their website by 30 April each year on matters covered by the directive.
- Companies must designate a person authorised to receive notifications from the supervisory authorities.
- Companies must provide the authorised representative with the necessary powers and resources to cooperate with the supervisory authorities. This builds on the tasks of the human rights officer under the German LkSG.
Differences in Corporate Due Diligence Scope
Meanwhile, the German LkSG and EU Directive are different in a particular scope which includes value chain, application of the provision, implementation of the law, the penalty and civil liability. The differences are explained in detail below:
- Scope of the Value Chain
In the value chain scope, German LkSG applies a duty standard to the company's business and suppliers only when there is "substantiated knowledge" of violating an environmental obligation. Compared with the EU directives, it entirely covers all activities relating to the production of goods or services by subjecting them to held obligations regarding due diligence obligations applicable within one country as well externally if they engage contractors across borders.
2. Application of the Provision
The environmental requirements of the EU directive do not apply to all companies, irrespective of their legal form. It applies to companies that fall under its definition of "company", which is limited to explicitly specified legal conditions (for example, stock companies and limited liability companies under the respective member state legislation) and regulated financial undertakings.
Meanwhile, the German LkSG environmental due diligence provision applies to companies with at least 3,000 employees (or, from 1 January 2024 onwards, 1,000 domestic employees), irrespective of their turnover.
- Companies with more than 500 employees and a worldwide annual turnover of more than EUR 150 million
- Companies with more than 250 employees and a worldwide annual turnover of more than EUR 40 million provided that at least 50% of the turnover was generated in specific sectors with increased risks for human rights and the environment. These include, for example, the textile sector, agriculture, the food industry and mineral resources, and primary and intermediate mineral products.
Unlike the German LkSG, the EU directive also applies to companies from third countries with
- Yearly turnover in the Union of more than EUR 150 million
- Yearly turnover in the Union of more than EUR 40 million, provided that at least 50 % of the worldwide turnover comes from the risk sectors mentioned above.
Regardless of the non-EU companies having a branch in the EU, the directive is irrelevant and not applicable to non-EU businesses. In contrast, the German LkSG applies and is mandatory for foreign companies having a branch in Germany.
3. Implementation of the Due Diligence Obligation
The EU directive provides for further environmental obligations for companies depending on their categorisation. It is expected to publish sector-specific guidance on environmental due diligence compliance.
In company policy matters, companies to which the directive applies must integrate environmental due diligence into their policies, including writing a strategy for meeting the environmental due diligence requirements and updating it annually. It goes further than the policy statement required by the LkSG.
Companies must consider and identify the possibility of environmental and human rights impact in more detail from their business activities and suppliers. The EU directive lists the protected objects that extend beyond what is covered under German LkSG, which provides further guidance on how to protect these interests while still operating within restrictions set forth within international law.
4. Penalty & Civil Liability
The new EU regulations provide a handsome fine, with the penalty amount and competent national authority still designated by member states. Penalised companies may be banned from accessing state aid - this is something to keep an eye on!
Nonetheless, the German LkSG does not create a new basis for civil liability for the breach of environmental due diligence obligations. It explicitly leaves any liability established independently of the German LkSG unaffected.
On the other hand, the EU directive provides expressly for civil liability for due diligence violations to prevent potential or bring to end actual adverse impacts. Liability is not limited to the company's violations; it is also conceivable in the case of violations by subsidiaries and suppliers.