The European Commission recently adopted a proposal for a new directive on corporate sustainability due diligence (Proposed Directive). The intention of the Proposed Directive is to introduce a harmonised EU-wide regulatory framework on sustainable corporate governance.

Organisations within the scope of the Proposed Directive will be required to identify, prevent, mitigate and account for their “adverse impacts” on human rights and the environment. Adverse impacts are defined by reference to violations of prohibitions, obligations and rights enshrined in the international conventions listed in the Annex to the Proposed Directive. The Proposed Directive is intended to complement those international conventions and other existing and proposed EU laws and policies on human rights issues. These include forced labour, child labour, inadequate workplace health and safety, and exploitation of workers. They also extend to environmental issues such as greenhouse gas emissions, pollution, biodiversity loss and ecosystem degradation.

Scope of the Proposed Directive

The Proposed Directive will apply to the following categories of companies, which is broadly defined and includes regulated financial undertakings (In Scope Companies):

Large companies

• EU companies having more than 500 employees, including part-time and temporary agency workers, and a net worldwide turnover of greater than €150 million in the last financial year for which annual financial statements have been prepared
• Non-EU companies which generated a net turnover of more than €150 million in the EU in the financial year preceding the last financial year

Designated sector companies

• EU companies with more than 250 employees and a net worldwide turnover of greater than €40 million in the last financial year for which annual financial statements have been prepared, provided that at least 50% of that net turnover was generated in one or more of a specified list of high-impact sectors (Designated Sectors)
  
• Non-EU companies which generated a net turnover of more than €40 million but not more than €150 million in the EU in the financial year preceding the last financial year, provided at least 50% of its net worldwide turnover was generated in one or more Designated Sectors

Obligations of In Scope Companies

The due diligence obligations of In Scope Companies include:

Corporate policies

In Scope Companies will be required to integrate due diligence into their corporate policies and to adopt a due diligence policy, including a code of conduct for employees and subsidiaries. They must keep it under review and up to date.

Adverse impacts

In Scope Companies will be required to take “appropriate measures” to (i) identify, (ii) prevent and mitigate and (iii) bring to an end all adverse impacts arising from their own operations, those of their subsidiaries and those of the entities:

• In their “value chains” ie carrying on activities related to the production of goods or the provision of services, and
  
• With which they have an “established business relationship” ie a relationship which is or is expected to be lasting in view of its intensity or duration and is not a negligible or ancillary part of the value chain

“Appropriate measures” will vary on a case-by-case basis having regard to the severity and likelihood of the adverse impact. However, they can be far-reaching and may result in significant expense and administrative burden for an In Scope Company. They may include, for example, a requirement for an In Scope Company to:

• Develop and implement prevention and/or corrective action plans
  
• Seek contractual assurances from the business partners with which it has an established business relationship to ensure compliance with the In Scope Company’s code of conduct and any prevention and/or corrective action plans. They must also monitor compliance with those contractual assurances.
  
• Make necessary investments, for example into management or production processes and infrastructures
  
• Provide targeted and proportionate support to SMEs with which it has an established business relationship where compliance by the SME with the In Scope Company’s code of conduct and any prevention and/or corrective action plans would jeopardise the viability of the SME
  
• In the case of identified actual adverse impacts, pay damages and financial compensation to affected persons and communities, and
  
• Suspend or terminate relevant business relationships where adverse impacts are severe and have not been prevented, adequately mitigated or brought to an end by other measures
  

Complaints

In Scope Companies will need to establish a process for submission of complaints by affected persons, trade unions or workers’ representatives and civil society organisations in relation to legitimate concerns regarding the organisation’s adverse impacts.

Monitoring

At least once every 12 months, In Scope Companies will need to assess the effectiveness of their own operations and measures in connection with the Proposed Directive. They will also need to assess those of their subsidiaries and those entities in its value chain with which they have an established business relationship.

Communication

Whilst many In Scope Companies will already be subject to reporting obligations under the Non-Financial Reporting Directive, or the proposed successor legislation, all other In Scope Companies will be required to report on their compliance by 30 April in each year.

Additional obligations of large companies

It is proposed that each Large Company will have an additional broad obligation to adopt a plan to ensure that its business model and strategy are compatible with the transition to a sustainable economy and the limiting of global warming to 1.5 degrees in line with the Paris Agreement. Each Large Company will need to consider the extent to which climate change is a risk for, or an impact of, its operations and, if there is any such principal risk or impact, set out its emission reduction objectives.

Supervision and enforcement

Each member state will be required to designate a national supervisory authority and grant to it powers to supervise, investigate and enforce compliance by In Scope Companies with their obligations. This includes following the submission of substantiated concerns from natural or legal persons. In Scope Companies will be required to designate an authorised representative for the purpose of engagement with the relevant national supervisory authority.

Infringements may be dealt with by way of:

• Orders to refrain from particular conduct and/or to take necessary and proportionate remedial action
• Effective, proportionate and dissuasive pecuniary sanctions, including fines based on the turnover of the In Scope Company, and
  
• Civil penalties in the form of damages.
  

Obligations of directors

Directors have a general obligation as a matter of company law to act in the best interests of the company. The Proposed Directive will introduce an express positive obligation on the directors of an In Scope Company, in considering the best interests of the In Scope Company, to think about the consequences of their decisions for sustainability matters including human rights, climate change and the environment.

Impact on SMEs

SMEs have been specifically excluded from the scope of the Proposed Directive. However, the Proposed Directive recognises that SMEs in established relationships with In Scope Companies will inevitably be impacted by the legislative changes. It proposes certain measures intended to ensure SMEs are supported and do not experience any disproportionate or unreasonable cost or administrative burden.

Next steps

The Proposal will now be examined by the European Parliament and the Council of the EU. If the Proposed Directive is adopted, either in its current form or with amendments, each member state will have two years to transpose it into national law. Designated Sector Companies will have an additional two years following the transposition of the Proposed Directive before becoming subject to obligations under the relevant national law.

Conclusion

There is increasing market pressure on organisations of any size and in any sector to act sustainably. Whilst it may be some time yet before the proposed due diligence obligations take effect in our national law, it is never too soon for organisations to start focusing on their sustainability objectives.

Further updates will follow as the Proposed Directive progresses through the EU legislative process. If you are concerned about the impact of the proposed legislative changes on your organisation, contact a member of our Corporate Governance & Compliance team.

The content of this article is provided for information purposes only and does not constitute legal or other advice.