Corporate Sustainability Due Diligence: Here We Come! – Corporate governance

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The European Commission has published the long-awaited proposal for a Directive on Corporate Sustainability Due Diligence.

As expected following the resolution approved by the European Parliament on March 10, 2021, the implications for companies are numerous and will have an impact on their organization and behavior. The directive also concerns companies and other organizations with which they have commercial relations.

Businesses will be required to identify and, where appropriate, prevent, eliminate or mitigate adverse human rights impacts of their activities, such as child labor and worker exploitation, and on the environment, for example pollution and loss of biodiversity.

Several Member States had already introduced national due diligence rules and some companies had also decided to act voluntarily. However, the European Commission considered that this patchwork of rules had created distortions between companies and that voluntary adoption was unlikely to have the necessary impact.

Companies covered

The new due diligence rules will apply to both EU-based companies and third-country companies operating in the EU, and this targeting of third countries is increasingly common in EU regulation.

In the case of EU companies, the rules will apply to:

  • companies of substantial size and economic power, i.e. companies with more than 500 employees and 150 million euros in net sales worldwide;

  • other companies operating in defined high-impact sectors such as agriculture, textiles and minerals, which (without meeting the above two thresholds) have more than 250 employees and a net turnover of 40 million euros or more in the world. For these companies, the rules will start to apply two years later.

The directive will also apply to companies from third countries operating in the EU and whose turnover generated in the EU exceeds the aforementioned thresholds. These companies will be required to appoint an EU-based representative for the purposes of the directive.

The proposal applies not only to the activities of the company itself and its subsidiaries, but also to their value chains (established direct and indirect business relationships).

SMEs are not directly covered by the scope of this proposal.

However, they will certainly be strongly affected when they become part of the value chain of large companies, and this will be particularly relevant for exporting companies.

The proposal applies not only to the activities of the company itself and its subsidiaries, but also to their value chains.

Financial sector

The Directive expressly refers several times to its application to the financial sector. This is the result of the debate that took place on the application of the UN Human Rights Council’s Guiding Principles on Business and Human Rights (UNGPs) to this sector.

Business activities that need to be included in the value chain of financial institutions as a result of providing financial services should only include activities directly funded by or subject to that service. SMEs cannot be included in this chain.

In addition, when extending credit or providing financial services, actual and potential adverse human rights impacts and adverse environmental impacts should only be identified before credit is granted. credit or the provision of the service.

In the context of the end or mitigation of the actual impact, financial institutions will not be required to terminate the credit, loan or other financial service contract if it can reasonably be expected that that this causes substantial damage to the debtor or to the entity to whom this service is provided. .

More immediate practical content of due diligence

In order to fulfill their duty of care, companies must:

  • have a plan to ensure that their business strategy is compatible with limiting global warming to 1.5°C in accordance with the Paris Agreement (applicable to large companies only);

  • integrate due diligence into their strategies;

  • identify actual and potential human rights and negative environmental impacts;

  • prevent or reduce potential impacts;

  • end or minimize actual impacts;

  • establish and maintain a complaints procedure;

  • monitor the effectiveness of the strategy and due diligence measures;

  • report on due diligence and its implementation.

Relevant negative impacts

Due diligence under the Directive must be exercised with respect to all adverse human rights and environmental impacts identified in the Annex to the Directive.

This means that companies must take appropriate measures to prevent, eliminate or mitigate impacts on the rights and prohibitions set out in international human rights agreements. These include the right to enjoy just and favorable conditions of work, such as a decent wage, a decent life, safe and healthy working conditions and reasonable limitation of working hours, prohibition of child labor and forced labor. Companies are also required to take measures to prevent, eliminate or mitigate negative environmental impacts that contravene the various multilateral conventions in the field of the environment. Among other things, there is the obligation to take the necessary measures regarding the use of biological resources to avoid or minimize negative impacts on diversity. Companies must also ensure that they do not violate the ban on handling, collecting, storing and disposing of waste in a way that is not environmentally friendly, etc.

Obligation to end or minimize actual impacts

The directive expressly provides for the obligation to minimize or stop any real impact that may occur.

This duty includes the obligation to:

  • neutralize the negative impact or minimize its magnitude, including by paying compensation to affected individuals or communities;

  • when the negative impact cannot be eliminated immediately, develop and implement a corrective action plan with clearly defined action deadlines and qualitative and quantitative indicators to measure the improvement;

  • obtain contractual commitments from a partner with whom it has established a business relationship that it will comply with the code of conduct and, where applicable, a corrective action plan, including obtaining contractual commitments from its partners in the extent to which they are part of the value chain (contract cascading);

  • make the necessary investments in management or production processes and infrastructure

  • provide targeted and proportionate support to an SME with which the company has an established business relationship, where compliance with the code of conduct or corrective action plan would compromise the viability of the SME;

  • work with other entities, including, where appropriate, to build the company’s ability to end the adverse impact, particularly where no other action is appropriate or effective.

The position of directors

The directors of the companies concerned are required to implement and monitor the application of internal due diligence processes and to integrate due diligence into the company’s strategy.

The directive expressly provides that, in making their decisions, directors must take into account the human rights, climate and environmental consequences that may result. They must also consider the likely long-term consequences of any decision. In our view, in Portugal directors wishing to apply the business judgment rule should already consider these consequences, and this express rule may have even broader impacts.

In addition, any variable remuneration linked to a director’s contribution to the company’s business strategy, as well as to long-term interests and sustainability, must take due account of compliance with the obligations of the business plan in matter of climate change.

Enforcement mechanisms

The proposal provides for the creation of independent national administrative authorities to be put in place by the Member States.

These authorities will be responsible for monitoring compliance with these new rules and will be able to impose fines in the event of non-compliance based on the companies’ turnover (as is the case in the GDPR). In addition, victims will have the option of taking legal action to recover losses that could have been avoided through due diligence measures.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

Helen D. Jessen