Corporate sustainability due diligence duty: gathering momentum | Practical Law

Corporate sustainability due diligence duty: gathering momentum | Practical Law

According to the European Commission, its draft directive on corporate sustainability due diligence will apply to around 17,000 EU and non-EU companies. It will create a substantive corporate duty to identify, prevent, mitigate and account for external harm resulting from adverse human rights and environmental impacts in a company’s operations, subsidiaries and value chain.

Corporate sustainability due diligence duty: gathering momentum

Practical Law UK Articles w-034-8795 (Approx. 6 pages)

Corporate sustainability due diligence duty: gathering momentum

by Claire O'Donnell and Stuart Neely, Norton Rose Fulbright LLP
Published on 24 Mar 2022European Union, United Kingdom
According to the European Commission, its draft directive on corporate sustainability due diligence will apply to around 17,000 EU and non-EU companies. It will create a substantive corporate duty to identify, prevent, mitigate and account for external harm resulting from adverse human rights and environmental impacts in a company’s operations, subsidiaries and value chain.
According to the European Commission, its draft directive on corporate sustainability due diligence, which it adopted on 23 February 2022, will apply to around 17,000 EU and non-EU companies. The draft directive aims to build on the patchwork of national rules on due diligence that a number of EU member states have introduced in recent years. It will create a substantive corporate duty to identify, prevent, mitigate and account for external harm resulting from adverse human rights and environmental impacts in a company’s operations, subsidiaries and value chain.

Companies in scope

Whether a company comes within the scope of the draft directive will depend on its turnover, number of employees and the industry sector in which it operates. Crucially, the draft directive’s reach is global; non-EU companies may, in certain situations, be subject to the same obligations as EU companies.
In summary, the draft directive will apply to:
  • Large companies incorporated in the EU that have more than 500 employees and a global net annual turnover of over €150 million.
  • Middle-sized companies incorporated in the EU that have more than 250 employees and a global net annual turnover of €40 million where at least half of that turnover is generated from specified high- impact sectors, including textiles, food manufacturing, agriculture and mineral extraction. These midcap companies will have a longer transition period to comply with the draft directive’s obligations.
  • Companies incorporated outside of the EU if they generate either more than €150 million per annum in the EU or more than €40 million per annum in the EU where at least half of the company’s worldwide turnover is derived from a high-impact sector.
Although the draft directive does not directly apply to SMEs, they will inevitably be affected if they are doing business with in-scope companies and want those working relationships to continue.

Actions for companies

The draft directive requires companies to guard against actual and potential human rights and environmental adverse impacts. These impacts are defined with reference to a list of specified conventions and international agreements, including the Universal Declaration of Human Rights and the Montreal Protocol (www.un.org/sites/un2.un.org/files/udhr.pdf; https://ozone.unep.org/sites/default/files/Handbooks/MP-Handbook-2020-English.pdf).
Companies will need to demonstrate that they are conducting due diligence that meets the requirements set out in the draft directive (see box “Directors’ duties). These requirements include:
  • Integrating due diligence policies and processes into their business as well as carrying out periodic assessments of their effectiveness on at least an annual basis.
  • Taking appropriate steps to identify the potential and actual impacts of their business from a human rights and environmental perspective. Importantly, these steps should extend beyond the company to both its subsidiaries and the operations comprising its value chain.
  • Preventing or appropriately mitigating potential adverse impacts; for example, by creating and implementing a prevention action plan that contains reasonable and defined timelines and indicators for assessing improvement.
  • Ending actual adverse impacts or, if that is not possible, minimising the extent of these impacts; for example, through paying compensation and implementing a corrective action plan.
  • Establishing a complaints process and, more importantly, maintaining that process so as to enable anyone to bring a complaint if they have a legitimate concern that the company, or its subsidiaries or business partners, is conducting activities that have a potential or actual adverse impact on human rights or the environment.
The draft directive also spells out what companies must do in terms of their contractual dealings if they are unable to mitigate or end potential or actual impacts that are associated with any relevant business partners. Companies must not enter into new commercial relations with those business partners and must either suspend or terminate existing commercial relationships. It will be interesting to see how this plays out in practice in the context of a commercial, and contractual, relationship.

General ESG due diligence

Aspects of environmental, social and governance (ESG) due diligence, such as human rights, anti-bribery and corruption, have been high on the agenda of many companies and their legal advisers for some time (see feature articles “Managing ESG compliance: challenges for UK listed companies” and “Bribery Act 2010: ten years on”; Briefing “ESG liability: risks increasing for multinational companies”; and Focus “ESG targets and remuneration: making a connection).
The draft directive looks to formalise some aspects of this trend and, in addition, heightens the need for companies to:
  • Embed a culture of due diligence as a key component of their day-to-day business strategy rather than simply when making acquisitions.
  • Embrace new methodologies in conducting due diligence. Legal due diligence traditionally focuses on assessing historic legal and regulatory compliance, and identifying hidden liabilities in a target company’s business. The type of diligence envisaged by the draft directive will instead necessitate a focus on testing the pervading culture, whether of a target company or the company itself.
  • Engage appropriate professional advisers with varied skillsets, based on an assessment of the most salient ESG issues, and ensure the proper co-operation of those advisers. An example of this would be the company’s lawyers working closely with specialist consultants to review the achievement of emissions targets.

Compliance and sanctions

The draft directive expects member states to identify supervisory authorities that will monitor compliance and impose sanctions. Those sanctions will include monetary penalties calculated by reference to the company’s turnover. Separately, the draft directive allows persons who have suffered harm to seek damages.
If a company can demonstrate that it has conducted appropriate due diligence, this may be a defence to claims, but only if it would be reasonable to expect that these measures would adequately prevent or mitigate an adverse impact. In any event, any liability under the draft directive is intended to be in addition to, rather than instead of, any stricter liability rules that may otherwise apply under EU or domestic legislation.

Next steps

The draft directive is attracting much attention, but will enter into force only once it has been approved by the European Parliament and the European Council, and implemented through national law by member states. This process is likely to take a number of years and there is no certainty that the provisions, as envisaged, will be adopted without substantial debate and amendment.
That said, it would be prudent for companies to review their existing due diligence processes sooner rather than later to ensure that they are fit for purpose. What seems to be a long lead may start to feel quite short very soon. Indeed, many businesses are already responding to the patchwork of similar national due diligence legislation that has emerged in jurisdictions such as France, Norway and Germany. The momentum towards mandatory sustainability due diligence across Europe is gathering pace.
Claire O’Donnell is a partner, and Stuart Neely is counsel, at Norton Rose Fulbright LLP.

Directors’ duties

In addition to the general obligations under the draft directive on corporate sustainability due diligence, each director of an in-scope company will need to consider its impact on their duty to act in the best interests of that company. In a nutshell, the draft directive will require directors to take into account human rights, climate change and the environment when discharging that duty. This requirement will apply only to EU-incorporated companies, although the UK already has an equivalent legislative requirement in section 172 of the Companies Act 2006.
Directors will also be responsible for putting in place, and overseeing, the company’s due diligence policy.