EU Council Waters Down Corporate Sustainability Due Diligence Directive (CS3D)

On March 15, 2024, following weeks of political wrangling, the Corporate Sustainability Due Diligence Directive (CS3D) was endorsed by the EU Council. The make-or-break vote was the last opportunity for the CS3D to be adopted in its current form before the June 2024 European parliamentary elections.

The final text, as voted by the Council, is a heavily watered-down version of earlier proposals—themselves already diluted through the legislative process. In particular, it covers fewer companies and fewer activities, and provides for a more gradual phasing in, than originally envisaged.

Surprisingly, these last-minute concessions—summarized below—were brokered in the Council after a provisional agreement on the text had already been reached with the Parliament. The latter must now approve the Council’s compromise text, with a plenary vote likely to take place in April 2024. While parliamentary approval had not been expected to pose any obstacle to the CS3D’s final adoption, given the extent of the changes made by the Council, this is no longer certain. All eyes are now on the Parliament to see whether it takes the position that any agreement is better than no agreement.

Background

The proposal for the CS3D was published by the European Commission on February 23, 2022.^[1] On November 30, 2022, the Council announced its negotiating position on the proposal, introducing a number of key changes.^[2] This was followed, on June 1, 2023, by the Parliament presenting its amendments to the proposal.^[3] Further to inter-institutional negotiations, on December 14, 2023, the Parliament and the Council reached their provisional agreement on the text.^[4]

A “qualified majority” of some 15 Member States representing 65% of the EU population was needed for the CS3D to pass in the Council. After Germany, which controls 18.72% of the votes, announced its intention to abstain and a number of other States declared they would follow suit, the vote was pulled from the Council’s February 9, 2024, agenda. It thereafter reappeared but was quickly removed from the February 14 agenda, before finally being put to a vote on February 28. With one opposition and 13 abstentions, the vote failed.

On March 6, 2024, the Belgian presidency circulated a compromise text. A vote was expected on March 8, but was postponed after Germany indicated it would continue to abstain. A last-ditch compromise text making even further concessions was circulated on March 13,^[5] and a vote scheduled for March 15.

Key Changes

The key changes contained in the text as voted by the Council on March 15, 2024, are set out below.^[6]

Scope

• The qualifying thresholds for EU companies are now fixed at 1,000 employees (compared to 500 in the provisional agreement) and EUR 450 million net worldwide turnover (compared to EUR 150 million in the provisional agreement and EUR 300 million in the concession text circulated on March 6). This is expected to cover around 5,000 companies in the EU, compared to almost 13,000 under the original proposal—a reduction in scope of around 60%.
• Non-EU companies will now only have to comply with the directive if they generate a net turnover of EUR 450 million inside the Union (compared to EUR 150 million in the provisional agreement).
• Lower employee and net turnover thresholds for EU and non-EU companies operating in high-impact sectors (defined to include, e.g., textiles, clothing, footwear, agriculture, forestry, fisheries, food & beverages, extraction of mineral resources and construction) have been scrapped. The need for a high-risk sector approach has, however, been added to the review clause in the compromise text, ensuring that the issue can be revisited at a later stage (no later than six years after the date of entry into force of the directive, and every three years thereafter).^[7]
• The thresholds for franchises (that is, EU or non-EU companies that have entered into franchising or licensing agreements in the Union with third parties in exchange for royalties) have been increased. Only franchises with a net worldwide turnover of EUR 80 million (compared to EUR 40 million in the provisional agreement) and EUR 22.5 million in royalties (compared to EUR 7.5 million in the provisional agreement) are now caught.
• The calculation of thresholds continues to be provided for at a company group level, based on the group’s consolidated EU annual financial statements.
• Employee and net-turnover thresholds continue to be listed as one of the issues included in the review clause of the compromise text, ensuring that these also can be revisited subsequently.

“Chain of activities”

• Whereas the due diligence requirement under the Commission’s original proposal extended to companies’ upstream and downstream activities across their value chains, the provisional agreement opted for a narrower concept of “chain of activities,” covering only specifically listed parts of the value chain.
• This definition has now been further narrowed, by excluding:
  • downstream activities performed by indirect business partners (such that only activities performed directly “for the company or on behalf of the company” remain in-scope); and
  • downstream activities at the product disposal stage (such as dismantling, recycling, composting and landfilling).

Financial institutions

• The provisional agreement was stated to cover only the upstream but not the downstream activities of financial institutions (thus excluding the investment and lending activities of such institutions).
• However, the Parliament and the Council had agreed on a joint political statement concerning the necessity to develop additional appropriate sustainability due diligence requirements for regulated financial undertakings. The Council has now withdrawn this statement.
• As under the provisional agreement, the review clause of the compromise text nonetheless continues to provide that the Commission shall prepare, within two years of the directive’s adoption, a report on the need for additional due diligence requirements tailored to the financial sector.

Groups of companies

• As per the provisional agreement, ultimate parent companies are responsible for meeting the due diligence obligations of the directive, save where the parent company’s main activity is holding shares in operational subsidiaries—and now, pursuant to an additional exemption introduced in the concession text, where the parent company does not engage in taking “management, operational or financial decisions” affecting the group or its subsidiaries. The parent company must also now apply to the competent supervisory authority for any such exemption.
• In case of such an exemption, the obligations of the ultimate parent company must now be performed in its stead by a designated subsidiary established in the Union (by contrast, the provisional agreement required the obligations to be assumed by the “subsidiary closest to the ultimate parent company in the chain of control that is not a company having as its main activity the holding of shares in operational subsidiaries”).

Civil liability

• The provisional agreement had already limited companies’ liability exposure by stipulating that a company should not be held liable for damage caused solely by the company’s business partners in the company’s chain of activities.
• The civil liability regime has now been further adjusted by making it clear that Member States are free to decide the conditions under which trade unions, non-governmental organizations or national human rights institutions can initiate collective redress mechanisms on behalf of victims. In particular, language referring to the ability of such a body to bring a claim “in its own capacity” has been deleted and the possibility for third-party intervention in support of victims in lieu of direct representation explicitly provided for.
• Further, it is now specified that the provisions of the directive should not be interpreted as requiring Member States to extend their national laws on representative actions to claims under the directive.^[8]

Climate change

• As per the provisional agreement, the obligation to adopt a climate transition plan continues to apply, including to the financial sector. To avoid duplication, companies already subject to the Corporate Sustainability Reporting Directive^[9] (CSRD) remain exempt from this obligation.
• However, a requirement for companies with 1,000+ employees to offer financial incentives for managers linked to “promoting the implementation of” climate transition plans has now been dropped.
• A provision imposing a duty on company directors to take into account the consequences of their decisions on sustainability matters, including climate change, had already been removed from the provisional agreement.

Application

• Finally, a staggered timeline for the phasing-in of the new rules has been introduced.
• EU companies will now have between three and five years to comply, as follows:
  • Group 1—5,000+ employees and EUR 1,500 million net worldwide turnover: three years;
  • Group 2—3,000+ employees and EUR 900 million net worldwide turnover: four years; and
  • Group 3—1,000+ employees and EUR 450 million net worldwide turnover: five years.
• Non-EU companies will now likewise have between three and five years to comply, as follows:
  • Group 1—turnover in the Union of EUR 1,500 million: three years;
  • Group 2—turnover in the Union of EUR 900 million: four years; and
  • Group 3—turnover in the Union of EUR 450 million: five years.
• Franchises will now have five years to comply.
• Companies not already subject to the CSRD will have to communicateinformation on their due diligence process, potential and actual adverse impacts identified, and appropriate measures and actions taken, for financial years starting on or after:
  • Group 1 companies (above)—January 1, 2028; and
  • Group 2 & 3 companies (above) and franchises—January 1, 2029.
• As per the provisional agreement, this information will have to be published on companies’ websites in the form of an annual statement.

Comment

While the compromise text will disappoint many proponents of the CS3D, it still represents a significant advancement of the regulatory framework for sustainable corporate governance in Europe. The new rules preserve the core idea of mandatory sustainability due diligence, requiring companies to identify—and to prevent, end or mitigate—adverse impacts on human rights or the environment of their activities across their worldwide “chain of activities,” with consequences including pecuniary penalties and civil liability for non-compliance. Not only companies headquartered in the Union but also non-EU companies operating within the bloc and meeting the applicable turnover thresholds will be required to comply, further ensuring the effects of the directive will be felt beyond European borders.

News that the CS3D has, following the Council’s vote, edged closer to the finish line will also be welcomed by the many companies that have advocated for its adoption, on the basis that it provides greater legal certainty and helps to create a level playing field across the EU.

Further Information

We will continue to monitor developments and will provide further updates and analysis in due course. Please do not hesitate to contact the authors with any questions.