We are currently living in times where, next to rapid technological advancements, environmental and social requirements enter into every pore of society. This refers to businesses as well, where new methods of conduct are adopted, trying to reduce their carbon footprint on the environment, while simultaneously being inclusive of individuals with various social backgrounds and thinking.
The European Union (EU) is no short of attempts in that regard so it introduced the Corporate Sustainability Due Diligence Directive (CSDDD or CS3D) – a proposed legislative framework by the European Commission.
Purpose
The CSDDD is a part of a wider EU agenda - to encourage companies to integrate Environmental, Social and Governance (ESG) factors into their decision-making processes, ensuring that their activities do not have negative impacts on society or the environment. It aims to foster sustainable and responsible corporate behavior, requiring companies to demonstrate actions they are undertaking to protect the environment and human rights, thus contributing to EU’s and the world’s effort to mitigate climate change and achieve the goals of the Paris Agreement.
Because of its goal, the CSDDD is expected to increase trust in businesses, improve risk management and contribute to a healthier environment and increased, higher-quality protection of human rights.
Scope
The CSDDD applies to both EU and, to an extent, non-EU companies because the non-EU companies will have to apply measures from the Directive if they plan to operate in the EU area. Furthermore, whether operating or not in the EU, the non-EU companies will certainly feel a “peer pressure“ from their EU counterparts to adopt similar measures in their business.
To be more precise in terms of scope, not only does the CSDDD cover EU and non-EU companies (including those in the financial sector, among others as per some sources), but it largely covers companies with more than 500 employees and a net worldwide turnover of more than EUR 150 mil. Those are the so called Group 1 companies. The Group 2 ones are the companies with 250+ employees and net worldwide turnover of more than EUR 40 mil, operating in defined high impact sectors - textiles, agriculture, extraction of minerals, provided that at least 50% of the turnover is made within those sectors. There are also Group 3 and 4 (non-EU) companies – the non-EU companies that generated a net turnover of more than EUR 150 mil. in the EU in the last financial year (Group 3) and the ones that generate more than EUR 40 mil. net turnover in the EU, provided at least 50% of worldwide turnover was generated in a high-impact sector (Group 4).
Key Features
In general, as its name suggests, the Directive imposes a due diligence duty on companies to identify, prevent, mitigate, and account for negative human rights and environmental impacts in their operations, subsidiaries and value chains. Hence the pressure part on non-EU companies mentioned above, because the EU companies would have to reevaluate their business from top to bottom, encompassing their collaborative non-EU companies in the value chain, expecting such companies to demonstrate their due diligence initiatives and practices in order to maintain strong business ties. The material scope of the CSDDD encompasses the entire value chain, upstream and downstream (direct and indirect business relationships), where upstream value chain includes all company’s activities related to product manufacturing, and downstream value chain includes all activities conducted by business partners regarding distribution, transportation, storage and disposal.
Bearing in mind the above, the key features of the Directive are the steps that companies need to undertake in order to implement the purpose of the Directive, i.e. to perform the due diligence in the following manner (Articles 5-11 of the CSDDD):
• Integration of due diligence into companies’ policies and risk management systems – the companies would be required to implement a due diligence policy outlining their approach to due diligence, as well as code of conduct that all the employees and subsidiaries must adhere to, while providing a description of the processes put in place to implement due diligence, including the measures taken to verify compliance with the code of conduct and to extend its application to established business relationships. This policy should be updated annually (Article 5 of the Directive);
• Identification – by way of Article 6 of the proposed Directive, the companies would need to take appropriate measures to identify actual and potential adverse human rights and environmental impacts arising from their own operations or those of their subsidiaries and, where related to their value chains, from their established business relationships (direct and indirect);
• Prevention and mitigation of potential adverse impacts, and bringing actual adverse impacts to an end and minimizing their extent – this step is pretty much self-explanatory so to concretize it the actual examples of this point are by developing action prevention plan, seeking contractual assurances from business partners with whom the company has a direct business relationship, make necessary investments in business infrastructure, support SMEs (Small and Medium-Sized Enterprises) etc. If necessary, bringing contractual relations to an end with relevant business partners, or to turn to partners with whom the company has indirect relationships. That is a prevention part. As for putting-an-end and/or minimizing the extent of those impacts, the specific actions would include the neutralization of arisen effects t or minimize its extent, including by the payment of damages to the affected persons and of financial compensation to the affected communities, in proportion to the significance and scale of the adverse impact. Other methods are the development of a corrective action plan, again seeking contractual assurances from business partners, making necessary investments and the like (Articles 7 and 8);
• Establishing and maintaining of complaints procedure – the said procedure should enable the affected persons and organizations, or the ones reasonably believing to be affected, to submit complaints in relation to real or potential adverse impacts (Article 9);
• Monitoring – companies should carry out periodic assessments of their own operations and measures, those of their subsidiaries and, where related to the value chains of the company, those of their established business relationships, to monitor the effectiveness of the identification, prevention, mitigation, bringing to an end and minimization of the extent of human rights and environmental adverse impacts. The monitoring should be conducted at least every 12 months or after a significant change occurs (Article 10);
• Public communication on due diligence – companies in scope of Corporate Sustainability Reporting Directive (CSRD) must communicate relevant due diligence information via their annual reports in accordance with CSRD requirements. Companies not subject to CSRD must publish annual statement on their websites, on language in a language customary in the sphere of international business. The statement shall be published by 30 April each year, covering the previous calendar year (Article 11).
Climate transition plan – not a necessary step per se, but a specific obligation to ensure that a company’s business model complies with limiting global warming to 1.5°C. This obligation will add to the disclosures under the CSRD, which does not by itself require companies to have climate change transition plans. For companies in scope of both the CSDDD requirement and the CSRD reporting requirements, this likely means that they will have to report on their transition plan as part of their annual CSRD disclosure.
Non-compliance with CSDDD requirements may result in a pecuniary fine by national supervising bodies which are to be established by Member States (administrative liability, amounting up to 5% of the company’s total net turnover), i.e. damages compensation to affected persons and/or organizations (civil liability – the procedure could be instilled within five years from the damage occurrence).
Hitting the Brick Wall
The CSDDD, however, was not adopted. Namely, the Directive did not receive a “green light” in the European Council – there was no (qualified) majority to approve the final text of the Directive. This was mainly due to Germany’s decision to abstain from voting, which other countries quickly followed thus eroding the support swiftly. As a result, the CSDDD is off the table (for now) and the EU institutions have to go back to the drawing board.
The reasons for such an unprecedented outcome were mainly political. Apart from Germany’s actions, France went in with a suggestion to water down its effects, followed by Italy soon after. The criticisms revolved mainly around stiffing the businesses with bureaucracy, as well as indirectly affecting smaller and medium-sized businesses due to focus on supply chains, overreaching its extraterritoriality to the unreasonable extent.
With its life “hanging at the balance”, necessary amendments and compromises had to be reached.
Amendments That Led to Council Acceptance
The Directive has recently been accepted on the Council level and it now remains to be seen whether EU Parliament will endorse it. The key to its acceptance was in making adjustments, which vary significantly from the original text.
Some of these amendments include:
• Lifting the threshold – the threshold for application of the Directive is now changed to companies with 1000+ employees and EUR 450 mil. net annual turnover. Similarly, the threshold for non-EU companies was increased to EUR 450 mil. in the EU;
• Deletion of high-risk sectors – as opposed to the original text the high-risk industries provision is now deleted, but leaving the space for later implementation, if necessary;
• Chain of activities – the downstream part of the definition has been limited by deleting the references to the disposal of the product, and by limiting it to business partners who carry out activities in the name and on behalf of the company. Therefore, the indirect business relationships are now deleted;
• Civil liability – the Member States are now given greater flexibility, by having them provide for “reasonable conditions” under which injured parties may authorize the organizations to bring actions to enforce their rights.
These are only some of the amendments introduced (we did not touch the transition periods, climate transition plans and the like).
What Does the Future Hold?
In light of the recent events, the future of the CSDDD is not yet certain. Namely, the EU parliament must now accept the current text in its finally plenary sitting in April, before the upcoming elections in June. After that, the Council must formally adopt it in order for it to be finally considered as “done deal”.
However, once in force, the ramifications would be massive because the businesses would need to make a U-turn in their policies, adapting to new circumstances in order to maintain their reputation, good brand and customer trust.
Authors:
Aleksandar Čermelj, Senior Associate, IVVK in cooperation with LexQuire, aleksandar.cermelj@lexquire-ivvk.rs
Katarina Marković, Junior Associate, IVVK in cooperation with LexQuire, katarina.markovic@ivvk.rs
*The information in this document does not represent legal advice and is provided for general informational purposes only.
**Partner, Senior Associate, Associate and/or Junior Associate refers to Independent Attorney at Law in cooperation with IVVK Lawyers in Cooperation with LexQuire.
22/03/2024
