On December 14, 2023, the European Union achieved a historic agreement on corporate sustainability regulation, known as the Corporate Sustainability Due Diligence Directive (CSDDD). The directive, proposed by the EU Commission on February 23, 2022, has undergone extensive negotiations, concluding the legislative process. On April 24, 2024, the European Parliament voted in favor of the CSDDD giving green light to new rules obliging companies to mitigate their negative impact on human rights and the environment. The CSDDD signifies the EU's commitment to becoming a pioneer in responsible and sustainable business practices. This legislative initiative marks a significant reform in corporate diligence and responsible business practices within the EU.
One of the driving factors behind this directive was the tragic collapse of the Rana Plaza factory in Savar, Bangladesh, in April 2013. The eight-story building housed several clothing companies producing garments for international brands. The disaster resulted in over 1100 fatalities and 2500 injuries, exposing unsafe working conditions and the exploitation of workers. The CSDDD aims to prevent such incidents, ensuring that large companies have both the opportunity and obligation to protect human rights and the environment throughout their business relationships.
Key Provisions and Innovations
The CSDDD introduces substantial obligations for large companies within its scope. Simultaneously, the directive provides relief by preventing regulatory fragmentation, eliminating the need for internationally operating companies to adjust their operations due to varying national laws. Key negotiation points included the scope of the directive, obligations imposed on companies, and whether the financial sector falls under its purview.
Key provisions of the directive include:
- Applicability to Large Companies: The directive applies directly to large EU companies and parent companies with a global turnover exceeding €450 million and more than 1000 employees. In addition, the directive applies to companies with franchising or licensing agreements in the EU with a global turnover exceeding €80 million if at least €22.5 million was generated by royalties. Non-EU companies reaching the same turnover thresholds will also be covered.
- Transition period: The new rules will start to apply first on 'First movers' by 2027: companies with over 5 000 employees and 1,5 billion € turnover, moving on to 'Second round' by 2028: companies with over 3 000 employees and 900 million € turnover, and into 'Third round' by 2029: companies with over 1 000 employees and 450 million € turnover. Francise and licensing and entities with EU royalties above 22,5 million € and turnover above 80 million € will be included in the scope by 2029.
- Due Diligence Processes: Companies must integrate risk-based "due diligence" into their policies, processes and risk management systems to prevent, end or mitigate adverse impact on human rights and the environment. In addition, companies also have to adapt a transition plan to align their business model with global warming limitations set out in the Paris Agreement.
- Inclusion of Supply Chain Partners: The due diligence obligations extend to a company's entire value chain, including upstream suppliers and downstream distribution and retail partners.
- Engaging Stakeholders: Companies must take appropriate measures to effectively engage with their stakeholders during different stages of the risk-based due diligence process.
- Climate Transition Plan: The directive requires companies in scope to prepare a climate transition plan in line with the Paris Agreement, and which is to be reported under the CSRD (Corporate Sustainability Reporting Directive). The plan shall be implemented and reviewed annually, but there is no separate reporting of this under the CSDDD. Preparations for climate plans should be underway, if not done yet.
- Civil Liability for Damages: The directive establishes civil liability for companies for damages resulting from the breach of their due diligence obligations. The victims will be entitled to full compensation.
- 5% Administrative Sanction: Companies failing to fulfill their obligations may face administrative sanctions amounting to a maximum of 5% of their global annual revenue.
- Impact on Public Procurements: Compliance with the CSDDD may become a criterion in public procurement tender evaluations.
- Indirect Impact on SMEs: Although SMEs are not directly obligated, the ripple effects through business chains make compliance indirectly significant.
What is the Broader Context behind the new Corporate Sustainability Rules
The CSDDD aims to align power and responsibility, compelling large companies to protect human rights and the environment in their business dealings. The legislation seeks to harmonize with existing sustainability regulations, such as the Corporate Sustainability Reporting Directive (CSRD).
Most of the regulatory focus revolves around how obligated companies should fulfill due diligence obligations. On the flip side, sanctions come into play when these regulations are not adhered to. National legislators are tasked with appointing authorities responsible for monitoring compliance, with a potential maximum sanction of 5% of a company's global revenue.
What Now and What's Next
The CSDDD now also needs to be formally endorsed by the Council, signed and published in the EU Official Journal. It will enter into force twenty days later. The EU member states will have two years until mid-2026 to implement the rules of the directive into their national laws. Transition provisions will play a crucial role during this period.
Enforcement and Consequences
Enforcement of the directive will involve monitoring compliance by national authorities. Sanctions may include administrative fines and public disclosure of non-compliant entities and their infringements. Notably, the directive introduces a five-year limitation for filing damage claims related to breaches of its obligations.
The directive's broader implications involve facilitating damage claims against companies failing to meet due diligence obligations. Unlike administrative sanctions, there is no cap on compensable damages as those must be compensated in full, which exposes companies to significant legal and financial risks.
Practical Considerations
Companies are advised to review their processes, organizational responsibilities, and supply chain mechanisms to ensure compliance with due diligence obligations. Essential considerations include risk management, human rights and environmental impact assessments, environmental protection measures, and the evaluation of contractual risks.
Due Diligence process is not a novelty in corporate sustainability, but CSDDD makes it legally binding and introduces stringent documentation obligations. The process itself consists of six-steps, but the legal provisions of the CSDDD do not include much detail on the contents of the process itself. There are international soft-law guidance and resources that provides helpful, and the European Commission will publish guidance on the best practices and published guidance on model contractual clauses. Nevertheless, the companies must take time and effort to prepare, modify or fine-tune these processes to comply with the new rules.
It is important to note that there is often a direct link between the new Corporate Due Diligence rules and other sustainability themed initiatives and new regulations. It is important to consider the joint implications of all the new and amended rules.
Conclusion
The Corporate Sustainability Due Diligence Directive represents a groundbreaking development in EU regulation, aiming to position the bloc as a leader in responsible and sustainable business practices. As the directive's details and national implementations unfold, now is the time to continue, or start planning for the implications.
Originally published 02 May 2024
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