Protecting human rights and the environment along supply chains

Starting this year, the protection of human rights and the environment along German companies' supply chains will become even more important not just in terms of impact on their reputations, but as a legal obligation as well.

The German Supply Chain Due Diligence Act

The Lieferkettensorgfaltspflichtengesetz – or LkSG – took effect on 1 January 2023. A last-minute effort by opposition parties to delay the law's entry into force appears to have failed. On 15 December 2022, the alliance of Christian Democrats/Christian Socialists (CDU/CSU) submitted a motion in the Bundestag to postpone the enactment of the LkSG by two years because of the strain the COVID-19 pandemic and the Ukraine war was putting on the Germany economy. The motion is scheduled to be discussed further this month, even though the LkSG has already taken effect. Under the new law, large companies with more than 3,000 employees based in Germany now have to comply with far-reaching due diligence obligations relating to the protection of human rights and certain environmental goods along their global supply chains. The obligations include a comprehensive risk assessment, implementation of a risk management system, publication of a senior management declaration on the company's human rights strategy, taking remediation measures where required, and the operation of a complaint mechanism. From 1 January 2024, the law will also apply to all companies with 1,000 or more employees in Germany.

As the new law includes fairly broad, complex and vaguely worded legal concepts, guidance on its implementation issued by the relevant government agency, the Federal Office of Economic Affairs and Export Control (BAFA), carries significant weight: that guidance has been intensely debated by German companies in recent months. So far, BAFA has published two handouts and a questionnaire. The handouts contain useful information for companies, but are unspecific on certain provisions of the law. To some extent, they adopt an interpretation of the law that is perceived as being unreasonably broad and challenging for affected companies. The questionnaire is designed to be used by companies for generating a complete report to be submitted to BAFA in order to fulfil their reporting obligations, as outlined in the law. Containing numerous closed or multiple-choice questions, the questionnaire is supposed to make the process easier for companies, but it also creates a risk: such a narrow structure cannot always do justice to the required nuances of implementation at a company-wide level. It remains to be seen how BAFA will deal with the (still considerable) legal uncertainty of how companies are supposed to achieve compliance with the law and whether this will be reflected in BAFA’s enforcement approach during the initial phase after it enters into force.

A proposed European Directive on Corporate Sustainability Due Diligence (CSDD)

In addition to requirements under national law, it is likely that human rights due diligence will also become regulated by EU law. In February 2022, the European Commission adopted a proposal for a directive on corporate sustainability due diligence to complement the existing legal framework, which is based predominantly on ESG reporting obligations such as those defined in the Corporate Sustainability Reporting Directive (CSRD). Recently, the Council adopted its position, which the European Parliament is expected to concur with in May 2023, paving the way for negotiations on the final language of the CSDD later this year.

The Commission and the Council are largely in agreement on the scope of the CSDD's application. Companies established under the laws of an EU member state are to be covered by the directive if they have an average of more than 500 employees and a worldwide net turnover of more than EUR 150 million in the previous business year. If they are active in so-called 'high impact sectors', companies with an average of more than 250 employees and an annual worldwide turnover of more than EUR 40 million can also fall within its scope. Non-EU companies incorporated under the laws of a third country will be obliged to comply with the CSDD if they had a net turnover in the Union of more than EUR 150 million in the previous financial year.

As it stands, the draft directive imposes far-reaching corporate due diligence obligations. Companies will be required to identify potential or actual negative impacts on human rights and the environment linked to their business activities, those of their subsidiaries and those of their direct and indirect business partners who are part of the "chain of activities" and they will have to avoid or eliminate them, respectively, as far as possible. The draft directive also provides for an obligation to establish and maintain a complaints procedure, as well as an obligation for companies to evaluate their own activities and actions regularly in addition to those of their subsidiaries.

In the event of violations, enforcement measures, including fines, will apply. In contrast to the LkSG, the proposed directive explicitly provides for civil liability if a company has not fulfilled its obligations.

German companies will have to devote significant resources in the coming years to ensure that they are compliant with the new regulatory framework for protecting human rights and the environment, to avoid regulatory enforcement and litigation risks, and to protect their reputations.