Effective collaboration in supply chains through contractual agreements

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​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​published on 5 December 2024 | reading time ​​approx. 5 minutes​

Constructive cooperation between companies along the supply chain plays a key role on the road to enhanced sustainability. Contracts define the legal framework for such cooperation. They reflect whether companies in supply chains meet on an equal footing or whether there is a pronounced power imbalance. With regard to the effective protection of human and environmental rights, the drafting of con­tracts therefore represents both an opportunity and a risk. On the one hand, there is the opportunity to legally anchor expectations of suppliers and initiate positive changes in the supply chain. On the other hand, there is the risk of contractually passing on responsibilities without increasing the actual environ­mental and social responsi­bility of companies in the supply chain. Contractually passing on of risks and obligations also entails the danger that all risks and obligations ultimately accumu­late at the beginning of global supply chains – and thus with those whose (human) rights should actually be protec­ted and strengthened. Overburdening business partners, especially smaller SMEs, with contractual obligations can also lead to clauses being signed blindly to avoid losing the customer. An effective protection of fundamental human and environmental rights in the supply chain cannot be achieved in this way. ​

 
The new supply chain regulations now also focus on this protection. The German Supply Chain Due Diligence Act (LkSG) has been in force since January 1, 2023 and the EU Supply Chain Directive (CSDDD) came into force on July 25, 2024, which still needs to be transposed into national law in Germany over the next two years (both hereinafter referred to as the Supply Chain Laws). Accordingly, companies above a certain size1 are legally obliged to prevent, mitigate or eliminate defined human rights and environmental risks by complying with certain due diligence obligations. The Supply Chain Laws specify the steps in which companies must implement these due diligence obligations. The initial step is to carry out a risk analysis to identify relevant risks, such as forced labor, child labor or discrimination in the workplace, in their own business area and with their business partners. If risks become apparent, the obligated companies must address them with adequate, yet effective preventative and remedial measures. Both the LkSG and the CSDDD specify certain preventive and remedial measures in this regard. Obtaining contractual assurances from business partners is also mentioned as a preventive measure. 

According to the LkSG, companies should work towards ensuring that high-risk direct suppliers give assurances that it will comply with the human rights and environmental expectations of their customers and address them appropriately along their supply chain. In this way, the LkSG has an impact on the supply chains of the obliga­ted, mostly larger German companies and provides impetus for sustainable activities in medium-sized and smaller companies as well. The LkSG thus aims to use contractual assurances as an opportunity for effective protection of human and environmental rights, by addressing businesses and suppliers beyond the initially obligated companies' own sphere of influence.  Large companies should therefore use their market power in contract negotiations to address the issue of sustainability and, if necessary, exert pressure on other companies. 

However, this does not apply without limits. Even if the LkSG is intended to have an indirect effect beyond the personal scope of application via the contractual assurance of suppliers, the legislator does not want to give companies directly obliged under the law the opportunity to undermine the protective purpose of the LkSG by contractually delegating their due diligence obligations to the supply chain. However, this would be the case if a company could pass on all due diligence obligations to its suppliers in a blanket way. The authority responsible for monitoring the implementation of the LkSG in Germany, the Federal Office of Economics and Export Control (BAFA), has thus clarified in its guidelines that the LkSG does not permit the mere contractual transfer of due diligence obligations and that such an approach may result in official control measures. The BAFA emphasizes that obligated companies are required to take a risk-based and appropriate approach in the context of their individual supply chain risks. In this context, it should also be noted that a contractual agreement whose legal effectiveness is already questionable, e.g. under aspects of general civil law terms and conditions, can never constitute an adequate preventive measure as requested by LkSG. In the CSDDD, these limits of contractual assurances are even more precisely described. For example, the directive explicitly stipulates that contractual terms with small and medium-sized enterprises (SMEs) must be fair, reasonable and non-discriminatory. In doing so, it explicitly addresses the problem that suppliers may not have the necessary knowledge, resources or other means to actually be able to fulfill obligations passed on contractually on a large scale. The EU Commis­sion intends to publish model contract clauses by the end of 2026 to provide guidance on how to draft appro­priate contractual assurances in the context of supply chain regulation. 

When it comes to the specific form of contractual assurances, obligated companies are therefore always caught between effective implementation of their due diligence obligations on the one hand and the requirement of appropriateness, fairness and therefore often also the (legal) effectiveness of contractual agreements with their business partners on the other. For responsible contract management, it is therefore advisable to consider the following aspects in particular: ​

Effective communication 

An implementation of the due diligence obligations of the Supply Chain Laws must be achievable to be effective. When negotiating contracts, it is therefore important to clearly communicate the human rights and environmental expectations of the requesting company. It should be clear to the business partner what the specific expectations are, to whom queries, or additional information requirements can be addressed and how the contractually agreed (sustainability) obligations could be monitored and, if necessary, sanctioned.  ​

Adapted to the specific risk situation 

Contractual assurances must be risk-based, i.e. they link preventive measures to specific risks or hazardous situations. These must first be determined in the risk analysis of the company obligated by the Supply Chain Laws. The BAFA has clarified that the performance of a risk analysis in this regard may not be replaced by comprehensive, blanket assurances requests towards suppliers. The contractual assurances should also allow for adjustment after a conclusion of the contract if the risk indication changes during future risk analyses. In addition, it must be realistic for the business partner to fulfill the requirements in its individual business / indus­try context. If the business partner is obviously overburdened, it anticipates that expectations will not be met and, in the worst case, human rights risks or abuses will be concealed. Overall, the requirements should be tailored to the specific risks and the individual human and financial resources of the business partner. If an individual assessment of business partners is too time-consuming in practice and therefore unreasonable for the obligated company, it is advisable to combine several business partners into risk groups and to specify the respective requirements for each group.  

Mutuality instead of excessive demands 

Furthermore, contractual agreements should be based on reciprocity. A one-sided dictation of obligations and requirements would not do justice to the obligated company's own responsibility under the Supply Chain Laws. Assurances given by the business partner can, for example, be offset by contractually anchored support measures. In this respect, the CSDDD mentions measures such as training offerings, a provision of modernized management systems or financial support. The motivation to achieve a good sustainability performance can also be promoted through incentives such as bonus payments or cost sharing. As part of reciprocity, obligated companies are also required to reflect their own contributions to existing risks in their contractual agreements with business partners. The principle of sustainability is never an isolated concept. Rather, the Supply Chain Laws require companies to integrate human rights and environmental due diligence obligations into their entire business activities. Responsible pricing can also help to minimize risks. 

Consequences of violations  

Effective cooperation is based on trust and stability. If a business partner does not comply with contractual assurances and expectations, it should first be given the opportunity to take independent remedial action. Also, the obligated company can help to develop a reasonable plan to jointly mitigate or eliminate human rights and environmental risks. The Supply Chain Laws only provide for termination or suspension of the business relationship as a last resort or in the event of particularly serious violations. This principle should also be reflected in the relevant contractual terms and conditions. If the conditions for a termination of the business relationship are nevertheless met, the CSDDD requires a responsible exit. Accordingly, companies should cushion the negative consequences of the exit, for example by offering financial support for a transitional period. 


Conclusion ​

The Supply Chain Laws require a new approach to contract design: away from the traditional passing on of risks (“risk shifting”) and towards shared responsibility and constructive cooperation between obligated companies and their business partners for greater sustainability. Companies can use this opportunity to strengthen cooperation in their supply chains and thus also their supply chains themselves. This is particularly successful if companies attach sufficient importance to this topic in the context of their business activities and keep an eye on both the effective protection of human and environmental rights as well as potential personnel and/or financial limitations of their business partners. A blanket passing on of due diligence obligations or the rigorous insistence on signing contractual conditions that are not achievable should be avoided. In cases where suppliers are overburdened, amicable solutions should be sought. Model contract clauses can also be used as a basis and support, but individual cooperation on an equal footing should always be given priority.  
 
 
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1) The LkSG will apply from January 1, 2023 for companies with more than 3,000 employees and from January 1, 2024 for companies with more than 1,000 employees. THe CSDDD also takes a company's turnover into account.

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