EU agreement on corporate due diligence rules to safeguard human rights and environment
On 14 December 2023, the European Parliament and the European Council informally agreed on a new directive on corporate sustainability due diligence (the "CS3D" or the "directive") obliging firms to integrate their human rights and environmental impact into their management systems. The directive has been called a historic breakthrough in the way companies are now responsible for potential abuse in their value chain. Subsequent to the negotiations, the Lead MEP said that this was a starting point for shaping the economy of the future.
The new directive, building on the proposal from the Commission of 23 February 2022 (see our previous newsletter here), follows in the wake of consistent calls from the European Parliament for a wider reaching corporate accountability and mandatory due diligence legislation. Indeed, in the aftermath of the negotiations, the Lead MEP said that this was a starting point for shaping the economy of the future; "one that puts the well-being of people and the planet before profits and short termism". The CS3D must also be understood in a broader context, as it complements existing and upcoming legislative acts, such as the deforestation regulation, (EU/2023/1115) the conflict minerals regulation, (EU/2017/821) and the draft regulation prohibiting products made with forced labour. For a more detailed description of this, see e.g here. The CS3D is also intricately linked to the Corporate Sustainability Reporting Directive (CSRD). While the CS3D mandates companies to assume environmental and social responsibilities, the CSRD mandates transparency for European companies regarding these responsibilities.
The agreed draft law requires formal approval by the Legal Affairs Committee and the European Parliament as a whole, in addition to the Council, before it can enter into force. In practice however, significant material changes are less common at this later stage, and there are therefore good reasons to pay close attention to the scope and content of the CS3D even now.
In essence, the provisional agreement outlines the scope of the directive, elucidates the responsibilities of non-compliant companies, provides clearer definitions for various penalties, and supplements the list of rights and prohibitions that companies are expected to adhere to. However, the text of the CS3D is not yet published (as of 21 December 2023), and there are certain discrepancies in the sources relating to the precise content and applicability of the CS3D. Once the final text is published, we will have further clarity on scope and key content, as well as sanctions, responsibility and supervision. Below is an overview of these key areas as can currently be gleaned from various official EU sources (e.g. Corporate due diligence rules agreed to safeguard human rights and environment (europa.eu) and Corporate sustainability due diligence: Council and Parliament strike deal to protect environment and human rights - Consilium (europa.eu)).
As proposed, the directive will apply to EU and non-EU companies of a considerable size and economic heft.
- Firstly, the legislation will apply to EU companies, and their parent companies, with a workforce exceeding 500 employees and a global turnover in excess of 150 million euros.
- Second, the legislation will apply to EU companies and their parent companies, that have at least 250 employees and a turnover exceeding 40 million euros, provided that a minimum of 20 million euros is generated within a "high impact sector" – as closer outlined in the directive. Examples of such sectors include agriculture, fisheries, extraction of mineral resources, construction and textiles.
- Furthermore, the legislation will apply to non-EU companies with a turnover in the EU exceeding certain thresholds. There are some discrepancies in the relevant press releases regarding the applicable thresholds, varying from an EU turnover of 150 to 300 million euros.
A controversial topic worth noting is that the compromise agreement reportedly excludes the core business of financial actors, namely their investment and lending activities, from the scope of the directive. Nevertheless, a review clause has allegedly been incorporated to assess the potential inclusion of the financial downstream sector in the future, contingent upon a sufficient impact assessment.
The CS3D contains two key obligations.
First, the new directive sets out obligations for the relevant companies to integrate a due diligence regime into their policies and risk management systems. Companies will have to identify, assess, prevent, mitigate, bring to an end and remedy their negative impact on human rights and the environment, and that of their upstream business partners and for downstream activities such as distribution or recycling.
Reportedly, the proposal includes a list of certain rights and prohibitions which would constitute adverse human rights impacts if abused or violated. The list makes reference to relevant international instruments that have been ratified by the EU Member States, that will help to clarify the obligations by referring to internationally recognised standards.
The CS3D also elucidates the scope of environmental impacts. The definition in the proposal includes any measurable environmental degradation, such as harmful soil change, water or air pollution, damaging emissions, excessive water consumption or other harmful impacts on natural resources. Similar to human rights, adverse environmental impact arises from the infringement of specific enumerated rights and prohibitions.
Second, companies of substantial size and economic heft (i.e. meeting threshold (1) above) will have to adopt a plan to ensure that their business models align with the goal of restricting global warming to 1.5°C.
Sanctions, responsibility and supervision
Upon implementation, the due diligence obligations will be enforceable primarily through two distinct mechanisms.
- Civil liability: Non-compliant companies can be met with civil liability, as the CS3D establishes a five-year timeframe where those who are affected by an adverse impact can file compensation claims for damages. Furthermore, companies can as a last resort be obliged to terminate business relationships when such identified adverse impact cannot be prevented or rectified in any other way.
- Penalties: Every EU Member State will have to appoint a supervisory authority responsible for overseeing companies' adherence to these obligations. Such entities will have the authority to initiate inspections and investigations, as well as to levy penalties on non-compliant companies. These penalties can for example consist of public exposure ("naming and shaming") and/or fines amounting to a maximum of 5% of the global net turnover in the company.
However, it is also worth noting that the proposal establishes that compliance with due diligence obligations could be considered as a component in criteria used for awarding public and concession contracts. Hence, the proposal also stimulates compliance through positive and financial incentives.
How will your business be affected?
The directive is likely to be adopted during the course of 2024. The CS3D will then have to be transposed into national law by the various Member States before companies are required to abide by it. The proposed directive has been marked as EEA relevant, and in Norway, alignments with the Transparency Act will likely be required before the directive is implemented into Norwegian law.
Companies that have already conducted human rights due diligence in line with the Norwegian Transparency Act and the OECD Guidelines for Multinational Enterprises will be well positioned to meet the requirements under the CS3D relating to human rights. However, there are differences in scope, for example relating to downstream activities, which means that companies will likely have to expand their due diligence focus.
Another significant distinction, in comparison to the Transparency Act, lies in the incorporation of environmental concerns. Specifically companies will be required to acquaint themselves with the environmental regulations and constraints outlined in the CS3D, thereby expanding the scope of due diligence exercises to encompass these aspects as well.
The legal framework in this area of law is expanding significantly, and becoming increasingly complex to navigate. For any questions regarding the current framework or the proposed changes, and how they may affect your business, our team of ESG and compliance experts is always ready to assist.
Our newsletters are provided as general information and do not constitute legal advice.