Proposal for a Corporate Sustainability Due Diligence Directive: extensive due diligence requirements
On 23 February 2022, the European Commission adopted its proposal for a Corporate Sustainability Due Diligence Directive (the "CSDD Directive"). The proposal has been called a game-changer in the way companies operate their business activities throughout the global value chain, and sets out extensive sustainability due diligence requirements as well as introducing new corporate governance obligations for in-scope companies.
Anumber of EU Member States have already introduced national rules on due diligence in relation to human rights, including Germany and France. In Norway, human rights due diligence is prescribed by the new Transparency Act which enters into force on 1 July 2022. The EU proposal on a CSDD Directive purports to bring legal certainty and a level playing field across the EU as regards sustainability due diligence. As the Directive is marked as EEA relevant it will also have to be incorporated into Norwegian law, if adopted.
Note that it usually takes around 18 months for a Commission proposal to be formally adopted under the ordinary legislative procedure. The proposal is also politically sensitive. It is therefore not likely that the directive will be adopted until mid 2023, at the earliest, and after its adoption it will take another two years before it will be applicable to in-scope companies.
There are however, good reasons for paying close attention to the scope and content already at this stage. Firstly, as there is a thematic relationship and partly overlap with the Norwegian Transparency Act, the two sets of rules might, for regulatory or practical reasons, need to be harmonized when incorporating the directive into Norwegian law. Ensuring enough flexibility when setting up the companies' compliance systems already at this stage could be one way of avoiding doing twice the work. Secondly, the CSDD Directive is closely related to other already adopted and planned EU regulations, such as the Corporate Sustainability Reporting Directive (CSRD), the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy. Disclosing ESG information enable companies to meet the interests of e.g. stakeholder, investors, and business relations in getting information that is transparent, comparable and substantive. The sustainability due diligence is a vital part of this information flow-system by ensuring the information collection. This means that performing a sustainability due diligence could be a relevant and useful exercise also for companies not covered by the proposal.
As proposed, the CSDD directive shall apply only to EU and non-EU companies of a considerable size and economic power. The proposal does not apply directly to SMEs, as defined in the EU.
Covered EU companies include:
- Group 1: All EU limited liability companies (private and public limited liability companies) with more than 500 employees and more than EUR 150 million in net turnover worldwide
- Group 2: Other limited liability companies (private and public limited liability companies) operating in defined high impact sectors, which do not meet both Group 1 thresholds, but have more than 250 employees and a net turnover of EUR 40 million worldwide and more.
Non-EU companies which are active in the EU with turnover threshold aligned with Group 1 and 2, generated in the EU, are also subject to the directive.
Companies that fall under the scope of the directive would be required to:
- integrate due diligence into their company policies and have in place a due diligence policy;
- identify actual and potential adverse human rights and environmental impacts;
- prevent or mitigate potential adverse impacts, and bring to an end or minimise actual impacts;
- establish and maintain a complaints procedure;
- monitor the effectiveness of the due diligence policy and measures; and
- publicly communicate what they are doing on due diligence
The directive also sets out several corporate governance provisions, including directors' duties to set up and oversee the implementation of due diligence and to integrate it into the corporate strategy. For further information on the proposal, see here and here.
The CSDD Directive and the Norwegian Transparency Act
Many Norwegian Companies are currently in the process of implementing the Transparency Act. The proposed CSDD Directive shares many similarities with the Transparency Act. Both build on international soft law standards such as the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises. They also have partly overlapping objectives and prescribe similar due diligence processes.
There are however some interesting differences:
- The threshold for application under the proposed CSDD Directive is higher than under the Transparency Act, meaning that many companies which are subject to the Transparency Act would not be subject to the directive. The Transparency Act applies to all larger enterprises, defined as those covered section 1-5 of the Accounting Act (including public limited liability companies), or those which exceed the threshold for two of the following three conditions:
- sales revenues: NOK 70 million
- balance sheet total: NOK 35 million
- average number of employees in the financial year: 50 full-time equivalent
- The proposed CSDD Directive establishes a corporate sustainability due diligence duty to address negative human rights impacts as well as negative environmental impacts. The Transparency Act does not relate to environmental impacts but purports to promote enterprises' respect for fundamental human rights and decent working conditions.
- Notably, the CSDD Directive sets out that a company shall be liable for damages arising due to its failure to comply with the due diligence obligations under specific conditions. Further, it sets out a directors' duty of care to take into account sustainability consequences of decisions (more on this below). Such provisions are not contained in the Transparency Act.
- The Transparency Act has more extensive transparency requirements than the proposed CSDD Directive. According to the Transparency Act, any person has the right to information from an enterprise regarding how the enterprise addresses actual and potential adverse impacts pursuant to section 4 on due diligence.
- As regards the due diligence process, the CSDD Directive makes it explicit that it in general covers both upstream and downstream value chains (with some exceptions related to e.g. financial undertakings). For example, as regards downstream relationships, this includes established direct and indirect business relationships, that use or receive products, parts of products or services from the company up to the end of life of the product. Further, the proposed CSDD Directive only applies to "established business relationships", which is defined as a business relationship, which is, or which is expected to be lasting, in view of its intensity or duration and which does not represent a negligible or merely ancillary part of the value chain. The Transparency Act does not limit its applicability to business relationships of a certain intensity or duration. Furthermore, in the preparatory works to the Transparency Act it is underlined that the act does not cover negative impact that the product or service may have in future relations, that is, after the company has sold the product or delivered the service.
The CSDD directive and other EU legislation
The CSDD directive will complement current EU legislations imposing duties to report and disclose information on sustainability issues by adding a substantive corporate duty to perform due diligence to identify, prevent, mitigate and account for external harm resulting from adverse human rights and environmental impacts in the company’s own operations, its subsidiaries and in the value chain.
There is a close relationship with the CSDD initiative and the draft CSRD, where the CSDD proposal will lead to companies' reporting being more complete and effective. First, a proper information collection for reporting purposes under the proposed CSRD requires setting up processes, which is closely related to identifying adverse impacts in accordance with the due diligence duty set up by the CSDD proposal. Second, the CSRD will cover the last step of the due diligence duty, namely the reporting stage, for companies that are also covered by the CSRD. Third, the CSDD proposal mandates in-scope large companies to adopt a plan to ensure that the company's business model and strategy are compatible with the transition to a sustainable economy, including limiting global warming to 1.5 °C in line with the Paris Agreement on which the CSRD requires to report. The plan must identify the extent to which climate change is a risk for, or an impact of, the company’s operations and include emission reduction objectives in its plan if the answer to the former is yes.
In the same way, the CSDD, the SFDR and the Taxonomy Regulation are closely interrelated and will lead to synergies. Under the SFDR, financial market participants and financial advisers are required to publish, among others, a statement on their due diligence policies with respect to principal adverse impacts of their investment decisions on sustainability factors on a comply or explain basis (some on a voluntary basis, and for companies with more than 500 employees the publication of such a statement is mandatory).
Likewise, the Taxonomy reporting covers minimum safeguards that refer to procedures companies should implement to ensure the alignment with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organization on Fundamental Principles and Rights at Work and the International Bill of Human Rights when carrying out an economic activity categorized as “sustainable”. Like the proposal for CSRD, the Taxonomy Regulation does not impose substantive duties on companies other than public reporting requirements. By requiring companies to identify their adverse risks in all their operations and value chains, the CSDD proposal may help in providing more detailed information to the investors.
Directors' duty of care to take into account sustainability consequences of decisions
Pursuant to the proposal, Member States have an obligation to introduce certain duties for members of the board of directors of the relevant companies. The proposal is that Member States shall impose a duty for such board members to always, when adopting decisions in the company, "take into account the consequences of their decisions for sustainability matters, including, where applicable, human rights, climate change and environmental consequences, including in the short, medium and long term". Member States shall ensure that members of the board of directors can be held liable for breach of the said duties.
The proposal will have wide-reaching consequences for board members, as their business judgment can no longer be exercised freely. The proposal also implies a risk of excessive litigation against board members.