Proposed Directive on Corporate Sustainability Due Diligence – Large Businesses Subject to Value Chain Due Diligence

The European Commission issued a proposal for a Directive on Corporate Sustainability Due Diligence (“Proposed Directive”) on 23 February 2022. The Proposed Directive is the result of the European Parliament’s legislative initiative calling for a directive proposal on mandatory supply chain due diligence for the purposes of securing human rights and preventing climate change and adverse environmental impacts.

The Proposed Directive calls for large businesses and their subsidiaries operating in the internal market to be obliged to respect human rights and the environment not only in their own activities, but also in their value chains and through the activities of the operators with which they have established business relationships.

Moreover, companies affected by the Proposed Directive would have to implement comprehensive mitigation processes for any adverse effects on human rights and the environment that occur in their value chains, integrating sustainability into corporate governance and management systems, and framing business decisions in terms of their impact on human rights, the climate and the environment.

The Proposed Directive forms an integral part of the European Union’s corporate social responsibility legislation and complements several sustainability regulations and proposals recently issued by the European Union. Some of these are a proposal for a Corporate Sustainability Reporting Directive, the Sustainable Finance Disclosure Regulation, and the Taxonomy Regulation.

In particular, the Proposed Directive is in line with the European Climate Law and emphasises the European Union’s climate neutrality targets by expressly including a provision for combatting climate change. Under the Proposed Directive, businesses would have to adopt a plan to ensure that their business models and strategies are compatible with the transition to a sustainable economy and with the limitation of global warming to 1.5 °C as agreed in the Paris Agreement.

The scope suggested for the Proposed Directive is considerably narrower than originally planned by the European Parliament in terms of the size of the businesses involved. Nevertheless, the Proposed Directive would apply to both EU-based and non-EU based businesses operating in the European Union and encompass approximately 13,000 EU companies and 4,000 third-country companies.

For EU-based companies, the threshold would be more than 500 employees on average and more than EUR 150 million in annual turnover, or alternatively 250–500 employees on average and more than EUR 40 million in annual turnover when at least 50% of that turnover is generated from certain specific sectors, including textiles, agriculture, forestry, food manufacturing, mineral resources (oil, gas, coal, metals, ores and non-metallic minerals) and metal products. As the stated purpose of the Proposed Directive is to provide a level playing field and legal certainty for businesses operating in the European Union, it can be questioned as to whether this chosen limit would actually help the EU achieve this objective.

Pursuant to the Proposed Directive, businesses would be obliged to conduct human rights and environmental due diligence by implementing the following measures:

Under the Proposed Directive, companies would be obliged to integrate due diligence into all corporate policies and have a specific due diligence policy in place. The proposed due diligence obligation would, as such, be extensive in scope for the businesses it applies to as it would cover all relevant direct and indirect company affiliates both upstream and downstream with which the affected company has established a business relationship.

Established business relationships would mean direct and indirect business relationships that are or are expected to be long-lasting in terms of their intensity and duration and which do not represent a negligible or ancillary part of the value chain. Whether the affected company’s business relationships could be considered established should be reassessed periodically, and at least every 12 months.

It is clear that value chain due diligence will require affected companies to draft and update several company policies and implement new processes to gather and analyse information about their supply chains and any adverse impacts. Companies would also be expected to address, monitor, and report any issues related thereto.

Pursuant to the Proposed Directive, the affected businesses would be obliged to provide a complaints procedure that allows stakeholders to express their legitimate concerns regarding any actual or potential adverse impacts on human rights, climate change, and the environment. Complaints could be submitted by persons that are affected or have reasonable grounds to believe that they could potentially be affected by an adverse impact, in addition to trade unions and civil society organisations.

In order to guarantee effective remedies, the Proposed Directive would oblige the Member States to adopt sanction mechanisms as well as civil liability regimes to ensure that companies will be held liable for their actions. The proposed civil liability provision is significant as it makes businesses potentially liable for the actions of their value chain partners if the business in question has not acted appropriately in identifying risks or taking appropriate preventative and mitigating actions.

Noteworthily, the Proposed Directive specifically addresses directors’ duty of care and their liability. The Proposed Directive calls upon Member States to ensure that the directors of companies take into account the consequences that their decisions will have in terms of sustainability matters when fulfilling their duty to act in the best interests of the company, including human rights, climate change, and environmental consequences in the short, medium and long term.

Further, boards of directors must oversee the company’s due diligence measures as well as its due diligence policy and core due diligence approach, including adopting corporate strategies to address actual and potential impacts. This approach, if adopted, would mean that financial performance would no longer be the only key responsibility of directors and that ensuring the sustainability of their business would now also form an integral part of their duty of care.

The legislative process in Finland will continue with the preparation of Finland’s position on this matter, and stakeholders will be consulted during this preparation process by the Ministry of Economic Affairs and Employment. At the European Union level, the Proposed Directive will be discussed between the Member States. If adopted, the Directive is proposed to be implemented by the Member States within a period of two years after it enters into force.

Borenius’ lawyers are available to assist in addressing any questions you may have regarding the above or due diligence inspections relating to human rights, climate change, the environment, and director liability in general.