Update on the Corporate Sustainability Due Diligence Directive

As we have noted previously, the European Commission initially proposed a Corporate Sustainability Due Diligence Directive (the Diligence Directive) on 23 February 2022. The proposed directive then spent several months going through the EU’s legislative process. In the final weeks of 2023, the proposed directive hit a significant milestone: on 14 December 2023 it was announced by press release by both the Council and the European Parliament that political agreement had been reached on the proposed directive.

At the time of writing this article, the agreed text was not yet available although it is expected that it will be published in the coming weeks. This summary is therefore drawn from the European Parliament's and Council's press releases.

Obligations

The Diligence Directive will, in summary:

• impose obligations on in-scope companies to “identify, assess, prevent, mitigate, bring to an end and remedy” adverse human rights and environmental impacts, by applying due diligence to their own operations, and those of their upstream and downstream partners “including production, supply, transport and storage, design and distribution”. It is specifically noted that companies that identify adverse impacts on human rights or the environment by some of their business partners may have to terminate relationships where these impacts cannot be prevented or ended
• require companies to “communicate meaningfully” with those affected by their actions, including by introducing a complaints mechanism in relation to their due diligence policies and monitoring their effectiveness
• oblige companies to adopt and put into effect a transition plan for climate change mitigation in line with the Paris Agreement to keep man-made global warming to below 1.5˚C, with companies with over 1,000 employees required to ensure that their management receive financial benefit for implementing this plan

Scope

The Diligence Directive will apply to EU companies that have over 500 employees and a net worldwide turnover of at least €150 million. This approach is different to that taken under the Corporate Sustainability Reporting Directive (the Reporting Directive) and will result in far fewer companies being within scope of the Diligence Directive – it is estimated by the Commission that around 13,000 EU companies will be within scope of the Diligence Directive. This will include companies with more than 250 employees and a net turnover of at least €40 million, provided at least €20 million of turnover is generated in “high-risk” sectors including the manufacture and wholesale of textiles, agriculture, food, extraction and wholesale trade of mineral resources and related products and construction. Non-EU companies will be within scope of the Diligence Directive if they generate at least €150 million of turnover in the EU. Obligations are expressed to apply to such non-EU companies three years from the Diligence Directive coming into operation, and to assist with certainty the Commission will publish a list of affected companies. This is expected to affect in the region of 4,000 non-EU companies.

While the above criteria for companies to be brought within the scope of the Diligence Directive are broadly less onerous than the Reporting Directive criteria, smaller companies may nevertheless be affected as the Diligence Directive will require in-scope companies to consider the operations of subsidiaries and business partners. It should also be noted that independently of the Diligence Directive, the Reporting Directive requires entities to undertake due diligence to assess the materiality of relevant impacts, risks and opportunities and to report on those assessments.

Financial sector caveat

Controversially, financial sector companies will be included within scope although they will benefit from a caveat: they will only be in-scope in relation to their own operations and upstream supply chains and not downstream activities. Having said that, it is stated that the compromise text will “include a review clause for a possible future inclusion of the financial downstream sector based on a sufficient impact assessment”. The inclusion of financial sector companies has been a particularly fraught point, with the European Parliament wishing to include downstream financial sector activities from the outset, but for now the EU Council’s position has prevailed subject to the “review clause” proviso. Of course, financial sector companies may very well act as business partners to companies that are themselves in-scope with the result that diligence may be performed on their activities in any event.

Enforcement

It is intended that compliance with Diligence Directive obligations will be enforced by supervisory authorities designated in each Member State which will have powers of inspection and investigation. The Diligence Directive is intended to have teeth with penalties including both “naming and shaming” as well as fines of a “minimum maximum of 5%” of net worldwide turnover for non-compliance. Compliance with the Diligence Directive may also be used as part of the award criteria for public and concession contracts.

A further point of controversy is the inclusion of civil liability for breaching companies to “their victims”, specifically intended to include trade unions or civil society organisations. Affected parties will have five years in which to bring claims for damages, and the Diligence Directive will limit requirements for disclosure of evidence, injunctive measures and costs of proceedings for such claimants. The manner in which these measures are implemented by Member States, where civil liability for environmental claims does not typically exist, will require careful analysis by affected corporates and their advisors.

Looking ahead

The provisional agreement is not binding until formally adopted among the EU’s institutions. It is anticipated that the agreed text of the Diligence Directive will be available in the coming weeks. Once it is published in the OJEU, the Diligence Directive will come into force 20 days from that date, with Member States having two years to enact transposing legislation. It is not certain when the obligations under the Diligence Directive will begin to apply but the scope of what is proposed is sufficiently complex that organisations likely to be within scope should be taking the time to digest the implications of the proposal for their own operations and those of their business partners and identifying any pain points sooner rather than later.

When the final text is available, we will prepare a fulsome client alert on the detail of the Diligence Directive.

For more information in relation to this topic, please contact Liam Murphy, Senior Knowledge Lawyer or any member of ALG’s Corporate and M&A team.

Date published: 9 January 2024