EU-Wide Supply Chain Law in Sight

last updated on 25 October 2023 | Reading time approx. 3 minutes

In Germany, binding corporate due diligence requirements for the protection of the environment and human rights in global supply chains have been in force since January 1, 2023. Other European countries have also introduced comparable statutory due diligence obligations or are planning to do so. Now a European law in the form of an EU directive is drawing ever closer. Companies should already prepare themselves for more comprehensive and stricter requirements.

Trilogue negotiations on a European supply chain law started

After the European Commission published its legislative proposal for a Directive on Corporate Sustainability Due Diligence (“CS3D”) on February 23, 2022, the Member States in the Council of Ministers (“the Council”) defined their negotiating position (General Approach) in the following december. After intensive debates between the political groups in the European Parliament, the negotiation position of the Parliament was finally adopted in plenary on June 1, 2023. Thus, the so-called trilogue, the negotiations between the EU Parliament and the Council, led by the European Commission, could start. Although the negotiations continue, we are now a significant step further towards binding corporate due diligence rules at European level.

Enhanced requirements for companies

Like the German Supply Chain Act (LkSG), the EU directive aims to ensure that globally active companies identify the impact of their activities on human rights and the environment and prevent, end, or mitigate corresponding risks. The exact requirements are still under discussion. Despite ongoing intensive negotiations, it can be assumed that the EU law will further tighten the German Supply Chain Act. The following regulations and negotiating points are to be expected:

Personal scope of application

Compared to LkSG, the personal scope of application of the European requirements is broader. Whereas LkSG bases its personal scope of application solely on the number of employees of the obligated company in Germany and sets a threshold of at least 3,000 employees as of January 1, 2023 (lowered to 1,000 employees as of January 1, 2024), the Commission proposal obligates EU companies as of a threshold of 500 employees and an annual net turnover of 150 million euros. The Council’s negotiating position gradually puts the threshold on large companies with more than 1,000 employees and global net sales of 300 million. The Parliament’s draft in turn lowers the threshold significantly to EU companies with 250 employees and a 40 million euros turnover and parent companies with more than 500 employees and a worldwide turnover of 15 million euros.
The directive will also apply to companies from non-EU member states if they generate a certain amount of turnover within the EU. Whether non-EU companies have a branch or a subsidiary in the EU is irrelevant for the scope of the EU Directive (in contrast to LkSG).
The due diligence requirements will most probably apply regardless of sector, possibly with lowered thresholds for certain risk sectors. However, the full integration of the financial sector is up for debate. In the European Parliament’s version, the financial sector remains included.

ENvironment and climate

Compared to LkSG, the EU Directive introduces more extensive due diligence requirements for the protection of the environment. In particular, the responsibility of companies in climate protection is subject of negotiations. The European Parliament’s text includes an obligation for companies to draw up climate transition plans to limit global warming to 1.5°.
In the case of large companies with more than 1,000 employees, meeting the climate transition plan targets will have an impact on the variable remuneration of company management members (e.g., bonuses).

Reach into the value chain

How deep the due diligence requirements will reach into the supply chain remains to be seen. The Commission proposal covers the entire “value chain”. Under the Council text, by contrast, the due diligence requirements of the directive apply only to a company's “chain of activities”, which focuses on upstream activities and excludes the use of a company's products and the provision of its services. The Parliament now provides that the requirements cover all activities related to the production, distribution, sale, waste management, transport, and storage of the product as well as the provision of services.

Civil liability and sanctions

Civil liability and improved access to justice for victims are also core issues in the negotiations. All three EU institutions provide in their draft concepts for a civil liability basis in different forms.
The reversal of the burden of proof – one of the main hurdles for victims of human rights violations on the way to compensation payments – has not been fully accepted by any of the EU institutions. However, the consolidated parliamentary draft provides that if there is evidence that makes a company's liability likely and the plaintiff indicates that additional evidence is within the company's control, national courts may order that such evidence be disclosed by the company in accordance with national procedural law.
The consolidated parliamentary draft also ensures that the limitation period for bringing actions for damages is at least ten years and it introduces the possibility of summary proceedings.
In addition, the EU directive provides for supervisory control and the possibility of sanctions by national authorities, including the possible imposition of fines of an amount comparable to the EU General Data Protection Regulation (GDPR).
In contrast to the Commission’s original proposal, the European Parliament’s consolidated version only includes the responsibility of company management for human rights due diligence obligations without any specification. This point will also be the subject of tough negotiations.

Simplified implementation

In addition to the tightening of the requirements compared to LkSG, the concrete implementation of the obligations by companies in the EU directive is to be simplified, however.

Coherence in reporting

Both the Council’s negotiating position and the European Parliament's draft stipulate that multiple reporting standards should be avoided to reduce the bureaucratic burden on companies. Companies required to report under Corporate Sustainability Reporting Directive (CSRD) or Sustainable Finance Disclosure Regulation (SFDR) will submit a joint annual report.
All information on a company's compliance with its due diligence obligations will be made available via the European Single Access Point (“ESAP”), which is expected to be available from mid-2027. Thus, in addition to CSRD and SFDR, public reporting on corporate due diligence is expected to support investment in the social-ecological transformation under the European Green Deal.

Increased risk-based approach

There is also agreement between Parliament and Council on the need to implement the requirements according to a risk-based approach, i.e., by insisting on the need to prioritize adverse impacts. The strengthening of the risk-based approach compared to the European Commission's draft directive is in line with the UN Guiding Principles on Business and Human Rights (UNGPs) and is intended to ensure that compliance with the due diligence requirements is feasible for companies.
The appropriateness criteria which are detailed in LkSG and in related BAFA Guidelines are only partially reflected in the EU Directive. The draft law pays particular attention to the severity of the impact and the probability of occurrence of a breach of the protective positions. Companies must address risks with the most severe impact and which are most probable to occur as a matter of priority.
In addition, the draft directive provides for the European Commission to issue concrete guidelines, to make templates available and set up further free support services before the directive enters into force.

Conclusion

When preparing or fulfilling due diligence obligations under the LkSG, it makes sense for companies to keep an eye on the stricter requirements of the upcoming EU directive. This also applies to indirectly affected customers of obligated companies. Define a strategy for prioritization and use synergies in the implementation of the various compliance obligations in the individual company context. This brings the fulfillment of human rights and environmental due diligence obligations in global supply chains well on track.