EU PROPOSES MANDATORY HUMAN RIGHTS AND ENVIRONMENTAL DUE DILIGENCE WITH CIVIL LIABILITY FOR NON-COMPLIANCE

At a time when all eyes of the world were on Ukraine, in late February the European Commission published its highly anticipated proposed directive on corporate social and environmental due diligence. The Proposal for a Directive on Corporate Sustainability Due Diligence (the “Proposed Directive”) follows a March 10, 2021 European Parliament resolution calling for adoption of such rules.

The Proposed Directive represents the first proposed imposition by the Commission of a general human rights and environmental due diligence obligation for companies across their global value chains. Of note, the Proposed Directive imposes far-reaching and potentially costly penalties for companies and company directors for non-compliance, as well as a civil liability regime to allow victims to sue companies in relation to harm which occurred due to the company’s failure to comply with its due diligence obligations.

Affected EU and Non-EU Companies

The Proposed Directive applies to EU companies meeting either of the following thresholds:^[1]

• Entities with more than 500 employees on average and a net worldwide turnover of more than EUR 150 million in the last financial year (Article 2.1(a)); and
• Any other entities with more than 250 employees on average and a net worldwide turnover of more than EUR 40 million in the last financial year, provided that at least 50 percent of this net turnover was generated in certain “high-impact” sectors, including textiles, agriculture, forestry, fisheries, the manufacture of food products, and mineral resources (including oil, gas and coal) (Article 2.1(b)).

Of note, non-EU companies with significant operations in the EU are also covered. More specifically, the Proposed Directive applies to third-country companies which generated, in the financial year preceding the last financial year, a net turnover in the EU of:

• More than EUR 150 million (Article 2.2(a)); or
• More than EUR 40 million but less than EUR 150 million, provided that at least 50 percent of the company’s net worldwide turnover was generated in one of the high-impact sectors described above (Article 2.2(b)).

Companies incorporated outside the EU will need to designate an authorized representative in the EU to liaise with the competent authorities of Member States (Article 16).

Core Standards

The Proposed Directive guards against adverse impacts on:

• human rights, resulting from the violation of one of the rights or prohibitions under the international human rights agreements listed in Part I of the Annex to the Proposed Directive (including the International Covenant on Civil and Political Rights, the Universal Declaration of Human Rights, and the International Covenant on Economic, Social and Cultural Rights); and
• the environment, resulting from the violation of one of the prohibitions or obligations under the international environmental conventions listed in Part II of the Annex to the Proposed Directive (including the 1992 Convention on Biological Diversity, the Convention on International Trade in Endangered Species of Wild Fauna and Flora, the Basel Convention, and the Montreal Protocol).

Core Requirements

Due Diligence Requirements

Pursuant to the Proposed Directive, covered companies must:

• Integrate human rights and environmental due diligence into all their corporate policies, and have in place a due diligence policy, which must be updated annually (Article 5);
• Identify actual or potential adverse human rights and environmental impacts arising from their own operations or those of their subsidiaries, as well as from their “established business relationships” across their value chains (Article 6);
  • “Established business relationships” are a company’s direct or indirect relationships with contractors, subcontractors or other entities:
    • with which the company has a commercial agreement or to which the company provides financing or insurance, or
    • that perform business operations related to the company’s products or services for or on behalf of the company,

  provided the relationships are lasting in view of their intensity or duration and not a negligible or merely ancillary part of the company’s value chain (Article 3).

• Prevent and mitigate potential adverse impacts, and bring actual adverse impacts to an end, while minimizing their extent (Articles 7 & 8);
• Establish and maintain a complaints procedure, allowing persons and organizations (including trade unions or civil society organizations) to submit complaints where they have legitimate concerns regarding actual or potential adverse human rights or environmental impacts (Article 9);
• Monitor the effectiveness of their due diligence policy and measures, as well as those of their subsidiaries and established business relationships, at least once every 12 months (Article 10); and
• Publicly communicate on due diligence, including by publishing on their website an annual statement in a language customary in the sphere of international business, by not later than April 30 each year (Article 11).^[2]

Other Requirements

Additional obligations complement the due diligence requirements. They include, for EU and non-EU companies meeting the large-company thresholds specified above, proposed requirements:

• To adopt a plan to ensure that the company’s business model and strategy are compatible with limiting global warming to 1.5°C in line with the Paris Agreement (Article 15.1);
• To include emission reduction objectives in the company’s plan, where climate change is or should have been identified as a principal risk or impact of the company’s operations, (Article 15.2); and
• To take into account a director’s contribution to the fulfilment of the above obligations when setting directors’ variable remuneration (Article 15.3).

More generally, for covered EU companies, the general duty of care of directors will be expanded to take into account the consequences of directors’ decisions on sustainability matters, including, where applicable, human rights, climate change and the environment, including in the short, medium and long term (Article 25).

Liability

Civil Liability

The Proposed Directive will require Member States to lay down rules governing the civil liability of companies for damages arising from a failure to carry out adequate due diligence. It is further stipulated that civil liability will arise even where the law applicable to the relevant claim is the law of a non-EU State.

A company will not be held liable as regards damages occurring at the level of an indirect business relationship if the company:

• sought contractual assurances to ensure compliance with the company’s policies and action plans (including through contractual cascading), and
• put in place appropriate measures to verify compliance.

However, these actions will not shield the company if it was unreasonable to expect that the action taken would be adequate to address the adverse impact.

A company’s liability will further be assessed taking into account the company’s:

• efforts to comply with any remedial action required of it by a national supervisory authority, and
• investments made and support provided to other entities to address adverse impacts in its value chains.

Administrative Sanctions

Companies will be given a reasonable time to remedy non-compliance before sanctions are imposed. Sanctions may include:

• fines proportionate to a company’s turnover;
• orders to cease or abstain from repeating conduct;
• orders to undertake remedial action; and
• interim measures.

Member States may choose to provide for additional types of sanctions, such as exclusion from public procurement. Decisions imposing sanctions must be published.

Next Steps

The adoption of the Proposed Directive coincided with other important developments in the EU ESG space. Also on February 23, 2022, the Commission published its Communication on Decent Work Worldwide, promoting decent work in global value chains and reaffirming the EU’s commitment to eliminate child labor and forced labor—including, at a later date, a proposal to ban products made by forced labor from entering the EU. This was followed, on February 28, 2022, by the EU Platform on Sustainable Finance publishing its Final Report for the development of a social taxonomy, spelling out what constitutes a “social” investment (in the same way as has been done in the case of environmental investments under the EU Taxonomy Regulation).

The Proposed Directive will next be examined by the European Parliament and by the Council. The speed of adoption will depend, among others, on the extent of discussions on amendments.

If adopted, the Proposed Directive gives Member States two years to transpose the Directive’s obligations on large companies into their national laws, and another two years in the case of the obligations relating to the smaller “high risk” companies.

Further Information

Shearman & Sterling’s Environmental, Social & Governance (ESG) team provides advice and advocacy to companies across multiple ESG impact areas. We would be pleased to answer any questions or to provide any further analysis of the above.