The readers of this blog are aware of the pending proposal for a directive of the European Parliament and of the Council on corporate sustainability due diligence. The topic was dealt with in a post that can be found here, and in another post here, with reference to the recommendations by GEDIP, the European Group of Private International Law.
The proposed directive aims to foster sustainable and responsible corporate behaviour throughout global value chains. In-scope companies will be required to identify and, where necessary, prevent, end or mitigate adverse impacts of their activities on human rights.
The next steps for the directive proposal will be the trilogue discussions between the European Parliament, the Council of the European Union and the Commission.
The Views of the European Parliament
On 1 June 2023, the European Parliament, at 1st reading/single position, adopted amendments to the proposal. It could be summarized as follows.
Scope of application
Parliament addressed the threshold criteria to fall within the scope of the directive. The new rules will apply to EU-based companies, regardless of their sector, including financial services, with more than 250 employees and a worldwide turnover over EUR 40 million, as well as to parent companies with over 500 employees and a worldwide turnover of more than EUR 150 million. Non-EU companies with a turnover higher than EUR 150 million, if at least EUR 40 million was generated in the EU will also be included; the same for non-EU parent companies with a turnover exceeding EUR 150 million, from which at least EUR 40 was generated in the EU.
Parliament moves in broadening the definition of ‘value chain’, to include the sale, distribution, transport, and waste management of products.
Parliament, in Article 8b (new), specified that the directive should lay down rules on companies’ obligations regarding actual and potential negative impacts on human rights and the environment that they have caused, contributed to or are directly involved in, with regard to their own activities, and those of their subsidiaries.
Companies would be required to identify and, where appropriate, prevent, bring to an end or mitigate the negative impact of their activities on human rights and the environment, such as child labour, slavery, labour exploitation, pollution, environmental degradation and loss of biodiversity. They should also monitor and assess the impact of their business partners, not only suppliers, but also sales, distribution, transport, storage, waste management and other areas.
Integration of Due Diligence
Companies covered by the Directive should: integrate due diligence into their corporate policies, identify and, where necessary, prioritise, prevent, mitigate, remedy, eliminate and minimise potential and actual adverse impacts on human rights, the environment and good governance; establish or participate in a mechanism for the notification and out-of-court handling of complaints; monitor and verify the effectiveness of actions taken in accordance with the requirements set out in the Directive; communicate publicly on their due diligence and consult relevant stakeholders throughout this process.
Member States should ensure that parent undertakings can take action to help ensure that their subsidiaries falling within the scope of the Directive comply with their obligations.
Companies should apply a due diligence policy that is proportionate and commensurate to the degree of severity and the likelihood of the adverse impact and commensurate to the size, resources and capacities of the company, taking into account the circumstances of the specific case, including the nature of the adverse impact, characteristics of the economic sector, the nature of the company’s specific activities, products, services, the specific business relationship.
In conflict-affected and high-risk regions, companies should uphold their obligations under international humanitarian law and demonstrate heightened, conflict-sensitive due diligence in their operations and business relationships.
Prevention of Potential Negative Impacts
Companies would be required to take the following steps, as appropriate: consider establishing contractual arrangements with partners with whom the company has a business relationship, obliging them to comply with the company’s code of conduct and, where appropriate, a prevention action plan; take necessary modifications, improvements to, withdrawals of or investments in, the company’s own operations, such as into management, production or other operational processes, facilities, products and product traceability, projects, services and skills; adapt business models and strategies, including purchasing practices, including those which contribute to living wages and incomes for their suppliers, in order to prevent potential adverse impacts, and develop and use purchase policies that do not encourage potential adverse impacts on human rights or the environment; take appropriate measures to ensure that the composition, design and commercialisation of a product or service is in line with Union law and does not lead to adverse impacts, be it individual or collective. In this regard, particular attention shall be paid to potential adverse impact on children.
Mitigating Actual Negative Impacts
Where a company has caused or contributed to an actual adverse impact, it should take steps to remedy or contribute to the remedy of that adverse impact and any harm it has caused to people or the environment. Remedial measures, introduced by Parliament, would aim to restore the affected individuals, groups, communities and/or the environment to a situation equivalent to, or as close as possible to, that which existed prior to the adverse impact.
Exchanges with Stakeholders
The new rules would also require companies to engage in dialogue with those affected by their actions, including human rights and environmental defenders. Companies would also be required to regularly monitor the effectiveness of their due diligence policies. To facilitate investor access, information on a company’s due diligence policy should also be available on the European Single Access Point (ESAP).
Employees and their representatives should be informed by their company of its due diligence policy and its implementation.
To provide support to companies or to Member State authorities, the Commission, in consultation with Member States, the European cross-industry and sectoral social partners and other relevant stakeholders, should issue clear and easily understandable guidelines, including general and sector- specific guidance, in order to facilitate compliance in a practical manner. Each Member State should designate one or more national helpdesks for corporate sustainability due diligence.
Combating Climate Change
Companies should implement a transition plan to limit global warming to 1.5°C. Companies, with more than 1 000 employees on average according to Parliament, should have an effective policy in place to ensure that part of any variable remuneration for directors is linked to the company’s transition plan.
Non-compliant companies will be liable for damages and can be sanctioned by national supervisory authorities. According to Parliament, sanctions include measures such as “naming and shaming”, taking a company’s goods off the market, or fines of at least 5% of the previous net worldwide turnover. Non-EU companies that fail to comply with the rules will be banned from public procurement in the EU.
Single Market Clause
Parliament introduced the single market clause. According to the latter, the Commission and the Member States shall coordinate during the transposition of this Directive and thereafter in view of a full level of harmonisation between Member States, in order to ensure a level playing field for companies and to prevent the fragmentation of the Single Market.
Justice Costs, Injunctions and Third-party Intervention
Parliament require Member States in ensuring that: the limitation period for bringing actions for damages is at least ten years and measures are in place to ensure that costs of the proceedings are not prohibitively expensive for claimants to seek justice; claimants are able to seek injunctive measures, including summary proceedings (these shall be in the form of a definitive or provisional measure to cease an action which may be in breach of this Directive, or to comply with a measure under this Directive); measures are in place to ensure that mandated trade unions, civil society organisations, or other relevant actors acting in the public interest can bring actions before a court on behalf of a victim or a group of victims of adverse impacts, and that these entities have the rights and obligations of a claimant party in the proceedings, without prejudice to existing national law.
The Council’s General Approach of November 2022
Previously, on 30 November 2022, the Council of the European Union had adopted its negotiating position, or general approach. It included the following provisions.
In relation to companies concerned (see Article 2), the rules of the due diligence directive would still apply to large EU companies and to non-EU companies active in the EU. For EU companies, the criteria that determine whether a company falls within the scope of the directive are based on the number of employees and the company’s net worldwide turnover, whereas in the case of non-EU companies the criterion is related to the net turnover generated in the EU; if a non-EU company fulfils the criterion regarding net turnover generated in the EU, it will fall under the scope of the due diligence directive, irrespective of whether it has a branch or a subsidiary in the EU.
The Council’s text has introduced a phase-in approach regarding the application of the rules laid down in the directive. The rules would first apply to very large companies that have more than 1000 employees and €300 million net worldwide turnover or, for non-EU companies, € 300 million net turnover generated in the EU, 3 years from the entry into force of the directive.
The European Council’s draft limits the scope of the due diligence obligations identified by the Commission in the full life-cycle “value chain” approach towards a more narrowed “chain of activities”: the latter covers a company’s upstream and in a limited manner also downstream business partners as it leaves out the phase of the use of the company’s products or the provision of services and excludes the use of a company’s products by its consumers (see Article 3(g)); then, it leaves it up to the Member States to decide whether regulated financial undertakings (including fund managers) shall be included in the scope of the directive.
The Council’s text also strengthens the risk-based approach and the rules on the prioritisation of the adverse impacts to ensure that carrying out due diligence obligations is feasible for companies (see Article 3, points (e) and (f)).
Combating Climate Change
The text of the provision on combating climate change (see Article 15) has been aligned as much as possible with the soon-to-be-adopted Corporate Sustainability Reporting Directive (CSRD), including a specific reference to that directive, in order to avoid problems with its legal interpretation, while avoiding broadening the obligations of companies under this Article.
Due to the strong concerns of Member States regarding the provision proposed by the Commission linking the variable remuneration of directors to their contribution to the company’s business strategy and long-term interest and sustainability, this provision has been deleted (Article 15(3)). The form and structure of directors’ remuneration are matters primarily falling within the competence of the company and its relevant bodies or shareholders. Delegations called for not interfering with different corporate governance systems within the Union, which reflect different Member States’ views about the roles of companies and their bodies in determining the remuneration of directors.
The Council’s text provides more clarity to the conditions of civil liability (see Article 22) with a provision that ensures full compensation for damages resulting from a company’s failure to comply with the due diligence obligations, avoiding unreasonable interference with the Member States’ tort law systems.
The four conditions that have to be met in order for a company to be held liable – a damage caused to a natural or legal person, a breach of the duty, the causal link between the damage and the breach of the duty and a fault (intention or negligence) – were clarified in the text and the element of fault was included.
Furthermore, the right of victims of human rights or environmental adverse impacts to full compensation were expressly provided for in the compromise text. On the other hand, the right to full compensation should not lead to overcompensation, for example by means of punitive damages.
Further, clarifications of the joint and several liability of a company and a subsidiary or a business partner and the overriding mandatory application of civil liability rules were made.
All of these clarifications and precisions allowed to delete the safeguard for companies that sought contractual assurances from their indirect business partners after a strong criticism of this provision due to its heavy reliance on contractual assurances.
Due to the strong concerns expressed by Member States that considered Article 25 to be an inappropriate interference with national provisions regarding directors’ duty of care, and potentially undermining directors’ duty to act in the best interest of the company, the Council’s proposal deletes the director’s duties introduced by the Commission.
The Annex I to the proposed directive has undergone significant changes with the main objective of making the obligations as clear and easily understandable for companies as possible, while ensuring a legally sound base. The logic of the Annex I is to list specific rights and prohibitions, the abuse or violation of which constitutes an adverse human rights impact (see Article 3, point (c)) or adverse environmental impacts (see Article 3, point (b)). To better understand how these rights and prohibitions should be interpreted, the Annex I contains references to international instruments that serve as points of reference.
To ensure the legitimacy of referring to international instruments that are legally binding only on the States, and following the overall logic of the Annex I, the Annex I covers only those international instruments that were ratified by all Member States. Overall, the Annex I of the compromise text only refers to such obligations and prohibitions that can be observed by companies, not just by States.
As regards the human rights part of the Annex I, it covers only legally binding international instruments that are recognised as a minimum list of instruments in the international framework. Concerning the environmental part of the Annex I, a limited number of additional specific obligations and prohibitions under international environmental instruments have been added, the violation of which results in an adverse environmental impact.
Moreover, the definitions of adverse environmental and human rights impacts have been clarified. Furthermore, the so-called ‘catch-all clause’ included in the Commission’s proposal has been kept in order to safeguard the indivisibility of human rights, but it has been clarified thoroughly to ensure maximum predictability for companies.