Human Rights And The Environment – EU Institutions Reach Political Agreement On Corporate Sustainability Due Diligence Directive - Human Rights

On 14 December 2023, following several rounds of inter-institutional negotiations, the European Council of the European Union (Council) and the European Parliament (Parliament) announced that a political agreement had been reached on a Directive on Corporate Sustainability Due Diligence (CS3D). The European Commission (Commission) had initially published its proposal for CS3D on 23 February 2022, with the Council and the Parliament issuing their own positions on the text on 30 November 2022 and 1 June 2023, respectively (see our previous blogs, here, here and here).

Inspired by the 2017 French law on Corporate Duty of Vigilance and the 2021 German Supply Chain Law (see our previous blog post), and in response to growing stakeholder expectations and demands in the EU and globally, CS3D sets out EU standards for human rights and environmental due diligence (HREDD), requiring in-scope companies to mitigate their negative impact on human rights and the environment with respect to their own operations, those of their subsidiaries and those carried out by their business partners. In so doing, CS3D seeks to provide legal certainty and a level playing field as regards corporate supply chain obligations.

What is CS3D?

CS3D will require certain large EU and non-EU companies to implement mandatory, risk-based HREDD measures, reflecting a meaningful engagement including dialogues and consultations with affected stakeholders.

CS3D will also require in-scope companies to adopt and implement a climate transitions plan, ensuring that their business model and strategy are compatible with the Paris Agreement (i.e., to limit global warming to 1,5° C).

CS3D finally establishes a dual enforcement mechanism through (i) administrative supervision and sanctions and (ii) a dedicated civil liability regime for damages resulting from a failure to comply with mandated HREDD requirements.

CS3D complements parallel sustainability-related initiatives and, in particular, the EU Corporate Sustainability Reporting Directive (CSRD, see our previous blog post). While both directives seeks to promote sustainable corporate behaviours and will significantly expand the number and obligations of in-scope companies, CSRD sets forth how companies should report on their sustainability efforts and practices, whereas CS3D mandates how companies should orient such efforts and practices.

Which were the divergences between the Council and the Parliament?

As explained in our earlier blog post, the Council and Parliament had diverging approaches with regard to the following issues:

Scope of CS3D, in particular in respect of the relevant threshold values and the inclusion of the financial services sector;
Whether HREDD measures should cover the company's "value chain", i.e., up to the use of companies' products or the provision of companies' services, or only its more restrictive "chain of activities", as advocated by the Council;
Scope of directors' duties, including duty of care and responsibility for directors to oversee their company's due diligence actions, with the Council proposing to exclude the relevant provisions from the CS3D;
Climate transitions plans requirements;
Level and nature of penalties for non-compliance with CS3D;
Scope and conditions to trigger civil liability, with the Council limiting the civil liability regime in respect of violations of CS3D.

What has been agreed as part of the political agreement?

With the Spanish presidency of the Council nearing its end and the upcoming term of the Parliament's legislature, it was unclear whether an agreement could be reached between the Council and the Parliament until the last minute, with strong lobbying from a range of stakeholders, particularly as to whether financial services should be covered by CS3D. Following intense negotiations, a deal was finally reached in the early hours of 14 December 2023.

Although legal texts have not been published, press releases referring to the compromise agreement (here, here and here) indicate that:

Scope of application – CS3D will apply to:
- large EU limited liability companies with more than 500 employees and a net worldwide turnover above EUR 150 million (Large EU Companies);
- EU limited liability companies that operate in high-impact sectors, namely textile, clothing and footwear, agriculture, food, raw agricultural materials, mineral resources and construction, based on lower thresholds of 250 employees and EUR 40 million net turnover;
- three years after entry into force, non-EU companies meeting the above thresholds, which generate a net turnover of EUR 300 million in the EU, with a list of such companies to be published by the Commission.
  Small and Medium Enterprises (SMEs) are excluded from the scope of CS3D (but may indirectly be affected, e.g., as suppliers to companies subject to the CS3D).
Financial sector – The financial sector will be mostly "temporarily excluded" from the scope of CS3D, subject to a review based on an impact assessment to be carried out by the Commission. Climate transition plans requirements will however apply to the financial sector.
Coverage of HREDD requirements – HREDD requirements will cover a limited "value chain" approach. In-scope companies will have to implement HREDD measures to identify and prevent or mitigate actual and potential adverse impacts on human rights and the environment (including, e.g., child labour or exploitation of workers, but also environmental adverse impact such as pollution and biodiversity loss),¹ with respect to:
- their own operations;
- those of their subsidiaries; and
- those carried out by business partners including upstream business, whereas downstream partners would only partially be covered, such as distribution or recycling. Hereby, the CS3D has a much broader definition of the value chain than other existing legislation such as, e.g., in Germany.
Nature of HREDD requirements – To comply with these HREDD requirements, in-scope companies will have to:
- integrate due diligence into their policies and risk-management systems;
- take appropriate measures to:
  - identify, assess and prioritize actual or potential adverse impacts on human rights and the environment; and
  - prevent or mitigate potential adverse impacts and bring to an end, minimize or remedy actual adverse impacts, it being understood that ending a business relationship should be a last resort measure, when adverse environmental or human rights impacts cannot be prevented or ended.
- these measures may include investments, contractual assurances from partners, improving business plan or providing support to partners, in particular to SMEs.
- establish and maintain notification mechanisms and complaints procedures;
- monitor the effectiveness of their policies and measures;
- publicly communicate on due diligence.
Directors' duties – specific rules on directors' duties have been omitted, although directors' remuneration will be covered by climate transition plans requirements.
Climate transition plans – In addition to HREDD requirements, and as advocated by the Parliament, Large EU Companies will have to adopt and effectively implement a climate transition plan, which will reflect an obligation of means, and not of results.
Administrative penalties – National administrative authorities will be responsible to supervise and enforce CS3D and may impose penalties, including "naming and shaming" and fines of a minima maximum 5% of the company's net turnover, subject to injunction measures in case of non-payments. In addition, in-scope companies that do not comply with CS3D may be disqualified from public contracts or concessions.
Civil liability regime – Persons affected will have access to justice to seek legal redress from damages that they suffer as a result of an in-scope company's failure to conduct appropriate due diligence. Such actions will be subject to a five year time-limit and procedural safeguards will govern the disclosure of evidence, injunctive measures and cost of the proceedings for claimants.
Accompanying measures –To assist with its implementation, CS3D foresees (i) dedicated websites, platforms or portals, (ii) potential financial support for SMEs, (iii) specific guidance by the Commission, including on model contract clauses and (iv) additional support measures, including to help non-EU companies.

What are the next steps?

The political agreement reached by the Council and the Parliament must now be formally endorsed by both institutions. This step is expected to take place in early 2024. CS3D will subsequently be published in the Official Journal and enter into force 20 days from such publication. Member States will thereafter have two years to transpose CS3D into national law.

How can companies anticipate the implementation of CS3D?

The political agreement and upcoming adoption of CS3D represents a substantial step away from a voluntary towards a mandatory approach to HREDD and responsible business conduct in and outside the EU. CS3D will have important ramifications not only in Member States that do not have HREDD requirements under national law, but also on existing national laws, such as those in France, Germany or Norway, which will have to be adapted in line with CS3D.

In-scope companies, both inside and outside the EU, will be required to take appropriate steps to identify, prevent and mitigate adverse human rights and environmental impacts arising from their operations worldwide and throughout most of their value chains.

For many large companies that will be in-scope of CS3D, designing and implementing appropriate systems and controls and embedding them into "business as usual" could be, in many cases, a multi-year multi-stakeholder exercise, and so it is imperative for companies to prepare for these new obligations in haste. Companies should already map, align and leverage their existing policies and procedures to the requirements in CS3D to identify gaps and areas for enhancement and improvement ahead of the effective implementation of CS3D.

To that end, companies can look to lessons learned from prior experience under existing Member States legislation (for further information on the relevant German, Dutch, French and Norwegian legislation, please read our earlier blog posts here, here and here). Companies may also look to their implementation of policies, procedures and practices that are aligned with international standards, such as the United Nations Guiding Principles on Business and Human Rights (UNGPs) (for further information on the UNGPs, please read our earlier blog posts here and here) or the OECD Guidelines for multinational enterprises.

More generally, businesses can position themselves for CS3D by:

Integrating HREDD into group policies and strategic planning processes;
Defining HREDD responsibilities;
Training employees and suppliers with a view to HREDD requirements
Disclosing how HREDD considerations are integrated into strategies, policies and procedures;
Carrying out a HREDD impact assessment and taking proportionate counter-measures, as well as communicating internally and externally on what measures have been taken;
Reviewing and reinforcing complaints mechanisms and speak-up programmes;
Ensuring the business is well equipped to deal with 'crises';
Reviewing the extent to which their board is equipped to address supply chain risks; and
Reviewing the role, resources and expertise of the legal and compliance functions, who should play a key part in addressing these new challenges.

Read more of our Business and Human Rights perspectives.

Footnote

1. The assessment of adverse human rights and environmental impacts will be based on a list of specific rights and prohibitions, reflecting international instruments that set sufficiently clear standards, which will be annexed to CS3D. The compromise agreement clarifies and expands this list.

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