Supply chain compliance, human rights and environmental protection: further tightening for companies looming!
Well-intentioned and badly done? The planned EU Supply Chain Directive has made headlines across Europe in recent weeks. The background is that the EU Parliament has now given its opinion on the EU Commission’s controversial proposal for an EU Supply Chain Directive.
What can be taken from the statement and what do companies have to prepare for in the future?
After the EU Commission presented a draft for a so-called EU Supply Chain Directive in February 2022 (COM (2022) 71 final, 23 February 2022), the EU Council of Ministers adopted its position on the Commission draft in November 2022 (15024/1/22 REV 1). In order for the Council of Ministers and the EU Parliament to enter into negotiations, the opinion of the EU Parliament was now required, which took place on 1 June 2023.
The EU Commission’s draft directive from 2022 aims to establish comprehensive due diligence obligations for European companies along the entire value chain. In addition to the obligation to prevent negative impacts on human rights, which is already anchored in the German Supply Chain Act (LkSG) – which will come into force at the beginning of 2023 – companies are also to avert negative environmental impacts in the future.
The draft fits into a series of EU legislative projects that serve to achieve the ambitious climate goals and the realisation of human rights standards by European companies. According to the EU Commission, the goal of transforming Europe into a climate-neutral continent with a greenhouse gas-neutral economy by 2050 can only be achieved through a comprehensive programme of obligations for European companies.
The draft of the so-called “EU Supply Chain Act” is therefore to be significantly tightened again according to the EU Parliament’s idea.
The EU Parliament’s proposed amendments are briefly presented below:
What thresholds should now apply to the size of companies?
The threshold of the required size of a company to be covered by the EU Directive is to be lowered significantly: European companies with more than 250 employees and an annual net turnover of 40 million euros are to be covered per se by the scope of application of the national transposition laws based on the Supply Chain Directive. In contrast to the Commission’s draft from 2022, the sector in which the company based in Europe operates is not to play a role. Parent companies with more than 500 employees and a worldwide turnover of more than 150 million euros are also to be covered.
It is interesting to note that the Directive also affects non-European companies operating in Europe. Non-European companies are those established under the laws of a third country. They are covered as long as they have a worldwide annual net turnover of at least more than 150 million euros and achieve at least 40 million euros in the European internal market.
The calculation of the number of employees includes employees in the classical sense as well as employees in atypical forms of employment such as temporary work, part-time work or self-employment dependent on the enterprise. Employees of branches and subsidiaries are also to be included if the parent company exercises control over them.
If a company does not fall under the aforementioned minimum thresholds, it may nevertheless be indirectly bound by supply chain due diligence obligations if it is part of a value chain of an obligated company and is contractually obligated to comply with the supply chain standards (so-called contractual cascade). In this respect, it is foreseeable that small and medium-sized enterprises (SMEs) will also have to comply with supply chain obligations. In practice, this is already evident in the special supply chain agreements of large companies with their direct and/or indirect suppliers within the meaning of the LkSG.
What do companies have to consider?
Companies shall undertake due diligence in their own operations, in the operations of subsidiaries they control, and in their direct and indirect business relationships. Human rights and environmental concerns in the value chain shall be identified. Furthermore, preventive and remedial measures must be taken. There is also an obligation to document the measures taken.
The draft directive obliges companies to comprehensively monitor actual and potential impacts on the climate, the environment and human rights (risk-based approach). If risks are identified, they are to be avoided as far as possible. In addition, the measures taken are to be monitored and documented in an annual report. It is therefore essential to establish a suitable compliance management system (CMS), which also includes monitoring mechanisms. The establishment of supply chain compliance measures does not only concern large, but also medium-sized and small companies, provided they are part of a supply chain/value chain.
The amendment proposed by the EU Parliament is particularly explosive in that the due diligence obligations no longer extend only to established business relationships. Established business relationships are those that are long-lasting and of sufficient importance for the value chain of the obligated company. By moving away from this requirement, which was still envisaged in the Commission proposal, every direct and indirect business relationship is to be included in supply chain compliance. This will entail a significant expansion of supply chain obligations for companies.
According to both the Commission’s and the EU Parliament’s ideas, the value chain covers not only suppliers (“upstream activities“), but also distribution, sales and disposal (“downstream activities“). In the EU Parliament’s proposed amendments, it is now made clear that waste disposal by the end consumer is to be excluded, however. This seems to be only a logical consequence if one does not want to confront the operating companies with completely unsolvable tasks.
What sanctions do we now face?
The EU Parliament concretises the requirements for possible sanctions against companies that violate the provisions of the “EU Supply Chain Act”. The public naming of “supply chain offenders” can have a deterrent effect according to the principle of “naming and shaming“, which has proven itself in practice. This mechanism is known, among other things, for violations of transparency register reports. In addition, there is the threat of a company’s goods being withdrawn from the market in future. Insofar as fines are imposed by the national supervisory authorities, they are to amount to at least five percent of the annual net turnover.
The obligation of the member states to establish civil liability for companies should be retained if concrete damage occurs in the course of disregarding due diligence obligations. The same applies to the establishment of a complaints procedure for affected persons and NGOs.
In order to avoid sanctions, companies are recommended to extensively document the measures taken – such as controlling, remedial action, etc. This can avoid or at least limit liability for damages caused by business partners.
Outlook and conclusion – should companies take action now?
With regard to the EU Parliament’s proposed amendments to the Commission’s draft directive on an “EU Supply Chain Act”, the negotiations in the EU’s power triangle – between the Council of Ministers, the Commission and the Parliament – remain to be seen. However, it can be seen that it is the will of the Parliament to tighten up the EU Commission’s draft. Against this backdrop of understanding, it cannot be ruled out that there will be further tightening of the “EU Supply Chain Act” in the course of the legislative process.
Due to the extensive catalogue of obligations under the planned “EU Supply Chain Act”, companies are threatened with a high level of additional bureaucracy. For large corporations, compliance with the proposed due diligence obligations in the EU directive proposal would certainly be a programme of obligations to be managed. It should be noted, however, that according to the proposals of the EU Parliament, companies with as few as 250 employees are already covered, whereby the concept of employee is to be based on a very broad understanding. Especially family businesses as well as small and medium-sized enterprises could shy away from the additional administrative burden and feel compelled to shorten supply chains by withdrawing from certain third countries.
Furthermore, it is foreseeable that large companies falling within the scope of the Supply Chain Directive will demand compliance with human rights and environmental standards from their contractual partners along the entire value chain (so-called trickle-down effect) – not least because large companies are obliged to do so by the “EU Supply Chain Act”. In this respect, the supply chain obligations from the EU Directive will indirectly also affect companies of smaller or indirect size that are below the application thresholds (e.g. 250 employees and 40 million euros annual net turnover).
It should also be noted that the draft directive’s desirable goals seem to be based on an erroneous assessment of the current situation: both the European Commission and the European Parliament fail to provide a comprehensible explanation of the fact that European companies and their subsidiaries themselves or in their business relationships structurally disregard human rights impacts. Medium-sized companies in particular could refrain from engaging in business activities in certain third countries. Whether the withdrawal of European companies, which in a regional comparison of the host state usually represent attractive employers for the local population in terms of their labour and human rights standards, serves to improve the human rights situation on the ground is in any case questionable.
In the negotiations in the EU Parliament, some parliamentary groups have been surprisingly vocal in their opposition. Why the significance of the directive in question for the competitiveness of European companies in a global context is only now attracting the attention of EU parliamentarians is very surprising, given the far-reaching and possibly daunting catalogue of obligations.
Nevertheless, companies are advised to prepare for a comprehensive and far-reaching “EU supply chain law” at an early stage in order to be able to comply with the supply chain standards if necessary. Only in this way should the company be able to counteract the threat of sanctions and negative effects on the company’s financial situation.
