The new Supply Chain Act - challenges and opportunities for the German economy

published on 15 September 2022 | reading time approx. 3 minutes

Since 2021, also Germany has its own supply chain law, following the international trend toward greater transparency and responsibility in its international supply chains. However, the requirements of the new law will present German industry with quite significant challenges in the coming years.

Under the German Supply Chain Due Diligence Law (Lieferkettensorgfaltspflichtengesetz, LkSG), companies based in Germany will in future be legally obligated to meet their responsibility to respect human rights and basic environmental standards in their direct supply chains and thus, for the first time, also outside their own business operations, once a certain number of employees are reached (2023: from 3,000 employees; 2024: from 1,000 employees).

To this end, the German legislator wants them to address the following five core elements of due diligence in the supply chain:

1. Assume responsibility – by including respect for human rights in the corporate philosophy;
2. Analyse risks – by being aware of where potential or actual human rights violations threaten in the individual business model;
3. Minimise risks – by taking measures to prevent human rights violations or to stop them if violations have already occurred, and by monitoring their effectiveness on an ongoing basis;
4. Inform and communicate – to all relevant stakeholders; and
5. Enable complaints – by establishing a transparent process that enables all stakeholders to claim their rights.

The requirements of the LkSG are internationally compatible as they are based on the due diligence standard of the United Nations Guiding Principles on Human Rights, on which already the German National Action Plan for Business and Human Rights was based in 2016.

Although the law in its current version only establishes an obligation to make efforts and does not provide for a ‘duty of success’ or a guarantee by the obligated companies to comply with human rights in the supply chain, the requirements of the LkSG still pose major challenges for German companies. In particular, the German SMEs will be affected due to their traditionally high share of value creation in the supply chain and their highly globalised business models – if not directly, then at least indirectly.

In many German companies, a solid preparation for compliance with the new due diligence obligations outside their own business operations will initially comprise a systematical processing of all available supplier data for the purpose of analysing and assessing individual supply chain risks. Accordingly, the German Federal Office of Economics and Export Control (BAFA), which is entrusted with the legal mandate to monitor compliance with the LkSG, has identified in its first handout on the implementation of a risk analysis in accordance with the requirements of the LkSG, that the creation of transparency regarding the nature and scope of its own business operations and business relationships in the supply chain is a fundamental prerequisite for a company’s imple­mentation of an appropriate risk analysis as defined by the law. However, due to the sheer mass of data to be processed in this respect, such transparency will hardly be possible without the timely implementation of suitable software solutions. Setting up software-supported processes should also help obligated companies with the ongoing documentation, but also with the compliance with the auditing and reporting obligations under the new law, which in future will have to be fulfilled at least once a year, but also on an ad hoc basis if necessary (e.g., after notification of the complaints system).

In dealing with any supply chain risks, the LkSG basically provides for a graduated level of responsibility. While an unrestricted duty of care applies on the company's own business operations and now also in its business relations with direct suppliers, a limited duty of care applies to indirect suppliers in cases where the obligated company is already aware of relevant human rights violations by this supplier. In its aforementioned handout, BAFA thus clarified that an appropriate risk analysis of obligated companies always requires the introduction of systematic and comprehensible processes for the identification, weighting and prioritisation of supply chain risks. However, companies are granted a certain degree of discretion in the design and choice of their methods in this regard, always subject to the principle of adequacy. In practice, the decisive factor in the future will likely be whether the obligated company has verifiably done everything necessary and adequate to avoid en­dan­gering and violating protected legal assets in the supply chain. Resource-intensive companies with a large value added in developing countries will therefore be subject to a stricter standard than a service company with purely European suppliers.

The situation of obligated German companies is made even more complex by the fact that a European supply chain directive has also been under discussion at European level for quite some time. The formal legislative proposal of the EU Commission in this regard is now available and, as expected, indicates already a signi­fi­cant­ly expanded scope of application and liability for European companies, which is likely to result into a tightening of the German legal framework in the future.

However, even though the requirements of the LkSG are currently confusing to many companies, the new legal framework for a responsible business conduct in supply chains, holds great potential for German and poten­tially also European companies. Firstly, a uniform due diligence standard will bring together the laws that already exist in the EU in numerous member states and on various aspects of supply chains into a single legal framework, thus promote a fair and legally secure competition within the European market. Furthermore, the German supply chain legislation and, in the future, also the European supply chain legislation reflected the two mega-trends of our time: digitisation and sustainability. German companies now have the opportunity to actively participate in the creation of what may be a cross-sector standard for sustainable global trade. Against the backdrop of increasing geopolitical risks for international business conduct, from which especially the German economy benefits greatly, German companies are well advised to establish effective global risk manage­ment systems at their earliest convenience – also, but not only, with regard to the new due diligence requirements of the LkSG.