EU Finally Approves Game-Changing Corporate Sustainability Due Diligence Directive Impacting EU and Non-EU Companies
After lengthy and difficult negotiations, on 24 April 2024, the EU Parliament finally approved the Corporate Sustainability Due Diligence Directive (the ‘CSDDD' or the ‘Directive'). This milestone paves the way for its eventual adoption by the EU once the remaining formalities are satisfied (approval by the European Council and subsequently publication in the Official Journal of the EU). The CSDDD is expected to enter into force in Q3 2024 and represents a significant shift in the EU's approach to ESG regulation. It is by far one of the most significant pieces of legislation in the EU's expanding corpus of ESG regulation, and is expected to have a significant impact on companies and their supply chains which are based not just in Europe but elsewhere around the world.
By way of context, it is worth noting that the EU's legislative action follows long-standing international standards which have been on the radar of major businesses for over a decade. Many major corporates have already expressly endorsed the UN Guiding Principles on Business and Human Rights (UNGPs) and assess their operations by reference to other established standards on human rights and the environment, such as the OECD Guidelines for Multinational Enterprises. The CSDDD's contribution to this landscape reflects an increasing crystallisation of soft law international norms into hard-edged legal obligations. Indeed, the CSDDD is closely aligned to these standards, adopting the same language of the UNGPs which requires companies to “identify, prevent and mitigate…adverse human rights impacts.” As a directive, each EU Member State will in due course need to transpose the Directive into their national law, which will establish certain minimum standards across the Union but also introduce potential complexity in the regulatory landscape applying to companies.
The scope of the Directive is wide. One of its most important features is its extraterritorial effect: it is not solely focussed on companies which are established or headquartered in EU countries. Non-EU companies which have a significant turnover in the EU (i.e. net EUR 450 million) will also fall in-scope, as will others meeting specific criteria. Moreover, companies which are caught by the CSDDD must also take into account the potential for adverse human rights impacts and environmental harm throughout their value chain, meaning a company's non-EU overseas subsidiaries or business relationships would need to be considered too. The expected phase-in, however, will take place over time. The largest companies (those with over 5,000 employees and a turnover of EUR 1,500 million) will be subject to obligations within three years from the Directive's entry into force, with smaller companies having more time (up to five years) to comply with the corresponding requirements.
At the heart of the CSDDD are – as its name suggests – due diligence obligations. Art 4 of the Directive provides that companies must conduct human rights and environmental due diligence, with the precise requirements of this due diligence set out in detail throughout the Directive. Those obligations will apply both to the upstream and downstream aspects of a company's supply chain. Among other things, companies will necessarily need to put in place appropriate policies, but also preventative action plans and systems to enable them to comply with these due diligence requirements in their value chain. In addition, the Directive will also push companies to take robust action on climate: businesses will be expected to put in place climate transition plans which include emission reduction objectives, including with respect to Scope 1, 2 and 3 emissions, compatible with the 1.5°C temperature goal set out in the Paris Agreement.
Systems, adequate controls, robust processes: all will be necessary if companies are to comply with the Directive's requirements. Companies which fail to adapt do so at their peril. The Directive contemplates that non-compliant companies may be subject to severe financial penalties: administrative fines could reach up to 5% of a company's global turnover and other sanctions imposed by national enforcement authorities. The discovery of potential adverse human rights and environmental impacts within a company's supply chain also entails significant reputational risk for businesses and the potential for other civil suits.
In that regard, the liability regime introduced by the CSDDD is likely to herald a potential new wave of supply chain litigation, meaning that affected companies should begin to assess their operations with litigation risk squarely in mind. Failures of due diligence have already found expression in legal claims in Europe such as those involving breaches of duties of care or equivalent obligations under national law (such as pursuant to the French Duty of Vigilance or Germany's Supply Chain Due Diligence Act, the LkSG). Some of this national legislation is likely to be amended to conform with the CSDDD's requirements, but there are already indicators that corporates are increasingly being held to account in the civil courts for adverse human rights or environmental impacts in their extended supply chain; that trend is only likely to grow, particularly since Art 22 of the Directive expressly requires EU Member States to ensure that there exists a civil liability regime for failure to comply with certain of their obligations under the Directive.
The CSDDD has been described in many quarters as a ‘game changer' and a ‘landmark' piece of legislation. While its exact impact remains to be seen, it is clear that the Directive will undoubtedly have a wide-reaching effect and is already requiring many companies to change their approach to supply chain risk and management. Proactive movers should reap the benefit of the time before the Directive's implementation to adapt, develop and tailor their operational policies and framework accordingly.
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