EU Commission presents proposal for European supply chain directive

Yesterday, the Commission presented a proposal announced long ago for a Directive on corporate sustainability due diligence that provides for expanded due diligence duties for companies in regard to supply chains.

Current applicable German law

In June 2021, the German legislator passed the German Supply Chain Due Diligence Act (Lieferkettensorgfaltspflichtengesetz – Supply Chain Act), which will enter into force on 1 January 2023 (see also New German Law on Duty of Care in Supply Chain Organization enters into force on 1 January 2023).

The Supply Chain Act initially applies to all industry sectors and to companies with 3,000 or more employees. As of 1 January 2024, it will also apply to companies with 1,000 or more employees. The prerequisite is that the company’s administrative centre, head office, headquarters, place of effective management, economic domicile or statutory registered office is located in Germany. The Supply Chain Act also applies to branch offices of foreign companies that have reached or surpassed the abovementioned employee numbers.

Such companies are subject to due diligence duties to respect human rights and environment in global value chains. Section 3(1) Supply Chain Act provides for a list of due diligence duties, which include establishing a risk management system, conducting regular risk assessments, submitting a policy statement on the company’s human rights strategy, taking preventive and mitigating steps and establishing a complaints procedure. These due diligence duties apply primarily to the company’s own business operations and with respect to direct suppliers.

Failure to comply with these due diligence duties is punishable by considerable fines. However, the Supply Chain Act does not provide for any civil law liability.

Proposal for a Directive on corporate sustainability due diligence

At EU level, companies are already subject to sectoral due diligence duties in regard to their suppliers as relates to conflict minerals and the lumber industry. For years, the Commission and the European Parliament have also been working towards passing a cross-sectoral supply chain law in the form of a directive that creates a level playing field for EU companies. The intent is to prevent non-uniform competition conditions arising from differing national supply chain laws. In addition to Germany, France has also passed a supply chain law; other countries are also planning their own laws.

In March 2021, the European Parliament passed an initiative resolution that sent requests and recommendations to the Commission regarding a corresponding proposal for a directive. This proposal contained much that corresponded to the approach taken in the Supply Chain Act but also went beyond it to a large extent. In particular, even small and medium enterprises (SMEs) were to be subject to the directive. With this resolution, the European Parliament called upon the Commission to draw up a draft law. In a formal sense, only the Commission has this right to make proposals.

However, the Commission’s draft was slow in coming and was postponed more than once. The reasons for the delay included the ambitious plans of the EU Commissioner of Justice at the time, Didier Reynders, which encountered resistance from business.

The Commission has now presented an extensive proposal with more than 70 recitals and 32 articles.

Scope of applicability

The proposal for an EU directive presented yesterday provides for a broader scope of applicability than that of the Supply Chain Act.

Specifically, all EU companies that have at least 500 employees and €150 million+ in net turnover worldwide (Group 1) are to be subject to the directive.

The new provisions are also to apply to other companies with more than 250 employees  and a net turnover of €40 million worldwide and more that achieve at least 50% of their net turnover in defined high impact sectors (Group 2). Such sectors include agriculture, textiles and minerals. The provisions do not apply to this second group of companies until two years after they enter into force for Group 1.

In addition, non-EU companies active in the EU with a turnover threshold aligned with Groups 1 and 2 generated in the EU are likewise to be subject to the directive. Small and medium enterprises (SMEs) with fewer than 250 employees are not directly affected by the direct area of applicability of the proposed directive.

The Commission estimates that around 13,000 companies in the EU and around 4,000 non-EU companies will be covered by the directive’s scope of applicability.

More due diligence duties

The scope of the proposed directive is also to be broadened in that it is to apply not only to companies' own operations, but also to their subsidiaries and their entire value chains, i.e. their direct and indirect established business relationships. Until now, the Supply Chain Act has in principle only provided for due diligence duties in a company’s own business operations and in relation to direct suppliers.

The proposal provides for companies’ due diligence duties to identify, prevent, end or mitigate adverse impacts of their activities on human rights and on the environment and be accountable for them. As is the case with the Supply Chain Act, the specific measures to implement this due diligence duty are derived from the OECD “Due Diligence Guidance for Responsible Business Conduct” and correspond to a large extent to the list of measures in the Supply Chain Act. Like the Supply Chain Act, the directive also provides for an annual review of their risk assessment and other measures. Companies are also required to report on the matters covered by the directive and publish an annual statement on their websites.

Companies in Group 1 are also required to have a plan to ensure that their business model and strategy are compatible with the limiting of global warming to 1.5 °C in line with the Paris Agreement.

The company’s management is to be responsible for compliance with the due diligence duties. Bonus payments can also be made contingent on compliance with these duties.

Civil law liability planned

Breaches of the due diligence duties in the supply chain are to possibly entail not only fines but also civil law liability.

Individuals who are injured by the business operations of a company are to receive the option of bringing an action for damages against a company before a Member State’s competent courts. This civil law liability presupposes that the damage could have been identified and prevented or mitigated by means of suitable due diligence preventive measures.

However, in the relationship to indirect business associates, the company has the option of complying with its due diligence duties in the form of contractual assurances from a direct partner with whom they have an established business relationship that it will ensure compliance with the company’s code of conduct or prevention action plan.

Import prohibition planned in separate legal act

The directive proposal does not include any mechanism to prohibit the import of products manufactured using forced labour. However, in its “Communication on decent work worldwide” (COM(2022) 66 final) issued today, the Commission stated that it is preparing a new legislative initiative which will effectively prohibit the placing on the EU market of products made by forced labour. The initiative will cover both domestic and imported products. The new instrument will build on international standards and is to complement the Directive on corporate sustainability due diligence and existing horizontal and sectoral EU initiatives.

Such import prohibitions already exist in the USA and Canada.

Outlook

The Commission’s proposal marks the first step in the EU legislative process. The next step is its discussion in the European Parliament, which can be expected to become a controversial debate. On the one hand, the Commission’s proposal falls short of the Parliament’s proposal from March 2021 in scope of applicability and due diligence duties. Nevertheless, resistance against the planned expansion of these two aspects has arisen in business, especially from medium enterprises. For this reason, it is to be expected that changes will be made in the course of the legislative process. The approval of Parliament and the EU Council of Ministers is required to pass the directive.

Thus, a final decision regarding the European Supply Chain Directive is not to be expected before 2023 or 2024.

Because this is an EU directive that has no direct effect, the German legislator will have to transpose the requirements into the Supply Chain Act within an implementation period once the directive has been passed. The directive proposal provides for an implementation period of two years. However, until that occurs, the current provisions of the Supply Chain Act continue in effect.