What you need to know about the EU commission's proposal

By Thomas Trier Hansen

On Wednesday 23 February, The EU Commission published its long-awaited proposal for an EU directive on human rights and environment due diligence called the Directive on Corporate Sustainability Due Diligence. It is still a proposal, and the next step will be for the EU Parliament and members states to discuss the proposal and most likely to suggest adjustments.

The discussion may take up to several years, but it is likely that the European Parliament will attempt to have the process finalized before its current terms ends in 2024. Nevertheless, the proposal is a landmark piece of legislation because it is the first ever initiative of its kind, however it may also disappoint many for being too unambitious and full of exemptions.

What are the main features of the directive?

The proposal will only be applicable to certain EU and non-EU companies and operates with two categories of EU companies:

Group 1: All EU limited liability companies of substantial size and economic power (with 500+ employees and EUR 150 million+ in net turnover worldwide).

Group 2: Other limited liability companies operating in defined high impact sectors, which do not meet both Group 1 thresholds, but have more than 250 employees and a net turnover of EUR 40 million worldwide and more. This covers companies active in particularly high-impact sectors that are at the same time covered by existing sectoral OECD guidance sectors.

According to the proposal at least 50% of this net turnover should be generated in one or more of the following sectors: (i) the manufacture of textiles, leather and related products (including footwear), and the wholesale trade of textiles, clothing and footwear; (ii) agriculture, forestry, fisheries (including aquaculture), the manufacture of food products, and the wholesale trade of agricultural raw materials, live animals, wood, food, and beverages; and (iii) the extraction of mineral resources.

The proposal also covers non-EU companies active in the EU with turnover threshold aligned with Group 1 and 2, generated in the EU.

Consequently, small and medium sized enterprises (SMEs) that include micro companies and accounting for around 99 % of all companies in the Union, are excluded from the proposal’s due diligence duty. The EU Commission argues that the financial and administrative burden of setting up and implementing a due diligence process would be relatively high for SMEs.

They will, however, be exposed to some of the costs and burden through business relationships with companies in scope as large companies are expected to pass on demands to their suppliers. This exclusion is not aligned with the UNGPs and the OECD Guidelines, but the proposal does not change the fact that the SMEs are still expected to be compliant with these non-EU international minimum standards.

The proposal further emphasizes that it is not just about impacts in the supply chain. The proposal actually applies to the companies' own operations, their subsidiaries and their value chains (direct and indirect established business relationships)

Why care if it is just a proposal?

There is no indication that the proposal should not become a directive as the trend in many of the EU member states is to adopt legislation requiring human rights and environment due diligence, civile society supports it and large companies in the EU are not opposing the principles of due diligence.

Further, the EU Taxonomy already refers to such due diligence based on UN Guiding Principles for Human Rights and Business (UNGPs) and OECD Guidelines for Multinational Enterprises (OECD Guidelines) as minimum safeguards. So, our estimate is that the proposal will result in a directive sooner or later requiring the member states to ensure that the directive becomes national legislation.

Due diligence and complaint mechanism

The due diligence duty of the companies is to integrate due diligence into policies and have in place a due diligence policy that is updated annually; to identify actual or potential adverse human rights and environmental impacts; to prevent or mitigate potential impacts; to bring to an end or minimise actual impacts; to monitor the effectiveness of the due diligence policy and measures; and to publicly communicate on due diligence.

Stakeholder consultation is envisaged where relevant throughout the process. Furthermore, the companies must establish and maintain a complaints procedure. The complaints procedure should be applicable to legitimate concerns regarding those potential or actual adverse impacts, including in the company’s value chain and accessible to persons who are affected or have reasonable grounds to believe that they might be affected by an adverse impact, to trade unions and other workers’ representatives representing individuals working in the value chain concerned, and to civil society organisations active in the area concerned.

Clear link to international conventions

The material scope of the proposal is focused and structured mainly upon the corporate due diligence obligation and covers human rights and those environmental adverse impacts that can be clearly defined in selected international conventions. The lists contained in the Annex to the proposal specify the adverse environmental impacts and

adverse human rights impacts relevant for the directive, to cover the violation of rights and prohibitions including the international human rights agreements (Part I Section 1), human rights and fundamental freedoms conventions (Part I Section 2), and the violation of internationally recognised objectives and prohibitions included in the environmental conventions (Part II).

Interestingly, the annex is not just referring to the most common human international standards such as the International Bill of Rights, the ILO core conventions etc. but also the fundamental UN Declaration on the Rights of Indigenous Peoples. Another interesting feature is the reference to the prohibition of withholding an adequate living wage in accordance with Article 7 of the International Covenant on Economic, Social and Cultural Rights.

The role of company directors

Now, let’s look at the role of the directors as defined article 25 and 26 of the proposal. According to article 25, the company’s directors have a duty to care. This includes taking into account the consequences of their decisions for sustainability matters, including - where applicable - human rights, climate change and environmental consequences, including in the short, medium and long term.

Article 26 lays down a duty for directors of EU companies to set up and oversee the implementation of corporate sustainability due diligence processes and measures and to adapt the corporate strategy to due diligence. The proposal envisages that Member States must ensure that their laws, regulations and administrative provisions providing for a breach of directors’ duties also apply to the provisions of article 25.

Monitoring and enforcing

The proposal also introduces a system for monitoring, supervising and enforcing the proposal. Each member state is required to have an authority responsible for supervising these new rules and being mandated to impose fines in case of non-compliance. The supervisory authority may initiate an investigation on its own motion.

However, natural and legal persons are also entitled to submit substantiated concerns to any supervisory authority when they have reasons to believe, on the basis of objective circumstances, that a company is failing to comply with the national provisions adopted pursuant to the Directive. The sanctions provided for shall be effective, proportionate, and dissuasive. When pecuniary sanctions are imposed, they shall be based on the company’s turnover.

In addition, companies may also become liable for damages if: (a) they failed to comply with the obligations to preventing potential adverse impacts and bringing actual adverse impacts to an end and; (b) as a result of this failure an adverse impact led to damage.

Be prepared and be credible

The scope of the Directive is not very likely going to be changed much and it still depends to some extent on the national implementation. However, the Directive will complement the current Non-Financial Reporting Directive (NFRD) and its proposed amendments (proposal for CSRD) by adding a substantive corporate duty for some companies to perform due diligence. It also complements the EU Taxonomy regulation and other current or future EU legislation requiring due diligence.

The existing international minimum standards such as the UNGPs and the OECD guidelines will continue to be the expectations to all companies.

So, rather than a ‘wait and see’ approach, we believe that the principles of due diligence should remain the centrepiece for the management of human rights and environmental impacts. We advise companies to still keep improving and strengthening their alignment

with the international minimum standards; not just to prepare for legislative developments but also to make their sustainability activities effective as well as credible and to address the expectations of their stakeholders.

About the author

Thomas Trier Hansen is a chief advisor on responsible business conduct in Ramboll Management Consulting having worked in more than 50 countries on various aspects of human rights over the last two decades.