European Directive on mandatory due diligence on human rights and the environment

On 24 May 2024, the Council of the European Union formally adopted Directive 2022/0051, referred to as the Corporate Sustainability Due Diligence Directive (the CS3D).

CS3D introduces due diligence requirements for large EU and non-EU companies to account for the negative impacts of their activities on human rights and the environment.

The new regulation affects not only large enterprises but also the activities of their subsidiaries and business partners along the value chain.

 

FOREWORD

CS3D builds on a Commission proposal dating back to 23 February 2022, as part of the European Green Deal and the UN Sustainable Development Goals. The legislative path was marked by a long trialogue, which lasted throughout 2023, leading to the 14 December 2023 draft version. But the text of the draft was rejected by the Council on 28 February 2024 (as some Member States had "second thoughts," including Italy, France, and Germany).

The new version of the Directive, which was revised to ensure a narrowing of the scope of application in acceptance of the concerns raised in the first rejection of the text, was approved by the Council on 15 March 2024, and by the Parliament in plenary session on 24 April 2024, and then formally adopted by the Council a month later on 24 May 2024.

The Directive will have to be implemented by Member States within two years of its entry into force (ie 20 days after its publication in the EU Official Journal, which is already expected in the coming days).

 

THE SCOPE OF APPLICATION

The final version of CS3D saw a significant narrowing (almost 70%) of its scope compared to the draft version. The regulation only covers EU companies with at least 1,000 employees and a worldwide turnover of more than EUR450 million and non-EU companies with a net turnover of more than EUR450 million generated in the EU. Parent companies of groups reaching this size are also included. This contradicts what was envisaged in the proposed Directive, where companies with more than 500 employees and a worldwide net turnover of over EUR150 million were included.

The size thresholds are also relevant for the purpose of the time frame of applicability of the new Directive, which will be mandatory within:

• Three years after entry into force for EU companies with more than 5,000 employees and EUR1,500 million in worldwide net sales and non-EU companies with more than EUR1,500 million in net sales in the EU.
• Four years for EU companies with more than 3,000 employees and EUR900 million net worldwide turnover and for non-EU companies with more than EUR900 million net turnover in the EU.
• Five years for EU companies with more than 1,000 employees and EUR450 million net worldwide turnover and for non-EU companies with more than EUR450 million euros net turnover in the EU.

Compared to the late December 2023 version, the exceptions with reference to so-called high-risk operating sectors (eg oil, mining, agriculture, textiles and fishing) have also not been reintroduced. These sectors were covered in previous versions of the Directive so the latter could also apply to companies that, although below the size requirements, operated in sectors particularly at risk of social and environmental impacts.

As a result of these changes, the scope of the Directive includes only very large companies (representing about 0.5% of companies operating in the EU). However, CS3D will apply not only to large European companies but also to their subsidiaries and, in general, to the value chain, thus potentially also involving non-EU companies.

 

OBLIGATIONS

CS3D consists of multiple human rights due diligence obligations, including:

• identifying and assessing potential adverse impacts on human rights and the environment (including mapping of its own operations, those of subsidiaries and business partners);
• preventing and mitigating negative externalities and minimising their effects (including by refraining from entering into business relationships with companies that have caused negative impacts as well as suspending and/or terminating existing business relationships);
• integrating due diligence into company policies and risk management systems (including providing a code of conduct describing the principles to be followed by the company and its subsidiaries);
• stopping any negative impact generated and the resulting remedial activity (restorative and/or compensatory) to be implemented;
• monitoring the effectiveness of implemented activities, including those implemented by subsidiaries and business partners;
• providing intra-company complaint mechanisms for aggrieved individuals;
• external communication of identified impacts and implemented measures (including through the sustainability report); and
• aligning corporate policies with the Paris Agreement goals of limiting global warming to 1.5°C by adopting annual transition plans for climate change mitigation, possibly to be included in the sustainability report.

To facilitate the implementation of complex due diligence activities, it is planned in the near future for the European Commission to implement: guidelines on best practices for conducting due diligence; helpdesks, through which companies can request information and support on how to fulfil due diligence obligations; and model contractual clauses to be included on a voluntary basis in business partners' contracts to adhere to parent company codes of conduct.

 

SANCTIONS AND SUPERVISORY AUTHORITIES

The Directive requires Member States to provide for appropriate administrative sanctions with reference to the violation of due diligence obligations. Specifically, there must be financial penalties of not less in the maximum edictal amount than 5% of the company's worldwide net turnover. The penalty should be applied taking into account:

• the severity of the violation and the impact
• any remedial and repentance activities;
• any investments undertaken ex ante; and
• any benefits gained or economic losses avoided as a result of the violation.

As an ancillary sanction, there’s also the possibility of ordering the publication of the measure imposing the sanction with both the name of the responsible company and the nature of the violation made explicit.

To this end, the Directive requires states to establish supervisory authorities (to be included in a European network coordinated by the Commission) and suggests that national authorities already in charge of supervising financial intermediaries be designated for this purpose. The authorities are endowed with powers of investigation, reporting, documentary acquisition, inspection, and injunction as well as the ability to impose remedial obligations and impose sanctions.

 

CIVIL LIABILITY

Compensatory liability is provided for the case of a violation, whether intentional or negligent, of the due diligence obligations under CS3D, if actual damage to a natural or legal person results from the violation. If the the violation was caused jointly by a company and its subsidiaries or business partners, liability is joint and several. In contrast, the liability of the target company is excluded if the damage was caused solely by business partners.

In this sense, having due diligence measures in place (even if they’ve been certified by independent third parties and/or are supported by contractual clauses) does not automatically exempt the company from liability.

In addition, states must provide statutes of limitations that don’t prevent injured parties from bringing legal actions and in any case not less than five years.

 

EFFECTS WITHIN THE EUROPEAN ESG REGULATION

The new CS3D aims to significantly increase awareness of the social and environmental impacts of the (few) regulated companies. To this end, this legislation represents the completion of a series of European regulations on social corporate responsibility.

Specifically, CS3D establishes the substantive obligations that must be disclosed through sustainability reporting under Directive (EU) 2022/2464, referred to as the Corporate Sustainability Reporting Directive (which prescribes sustainability disclosure requirements to be included in the notes to the financial statements). It also allows companies to accurately account for their commitment to sustainability, curbing unfair competition phenomena based on greenwashing practices (in light of the Green Transition Directive and the proposed Green Claims Directive).

This all comes in the context of improving competition in the market in terms of comparability of non-financial information. CS3D establishes a clear reference on human rights due diligence requirements in the EU market, counteracting the proliferation of state regulations that could distort competition and so-called forum shopping phenomena.