The comparison of the EU CS3D and the German LkSG directives

The EU Corporate Sustainability Due Diligence Directive ("CS3D")

The final text of the CS3D was adopted by the EU Parliament on 24 April 2024 after a lengthy legislative process introducing significant changes to the earlier text that co-legislators provisionally agreed in December 2023. The CS3D recently been published in the Official Journal of the European Union,

The CS3D requires in-scope companies to adopt a responsible and sustainable approach to global value chains. Companies must adopt a risk-based due diligence policy to identify and assess actual or potential adverse human rights and environmental impacts.

The German Due Diligence Supply Chain Act ("LkSG")

The LkSG is a pioneering piece of legislation that came into force in January 2023, aiming to strengthen human rights and environmental standards within global supply chains. The LkSG requires companies above a certain size operating in Germany to establish due diligence processes to prevent and mitigate human rights and environmental risks in their own operations and those of their direct suppliers, with an extension to indirect suppliers under certain requirements, e.g. when it comes to the complaints procedure and when the buyer has reliable information that there is a risk of violations.

Companies are mandated to conduct regular risk assessments, implement preventive measures, establish grievance mechanisms, and report annually on their due diligence efforts. Non-compliance can result in substantial fines and exclusion from public contracts, thereby incentivising companies to uphold responsible business practices throughout their supply chains.

The LkSG also has significant implications in Asian markets, in particular for Asian suppliers, necessitating changes in operations, increased compliance efforts, and potential shifts in market dynamics. While the Act presents challenges, it also offers opportunities for suppliers to distinguish themselves through responsible business practices. The long-term impact will depend on how both German companies and their Asian suppliers adapt to these new requirements and the effectiveness of their collaborative efforts to promote human rights and environmental sustainability within global supply chains.

The comparison of the CS3D and the LkSG

Comparison of Scope and Applicability

• Size of Companies: 

In contrast, the German LkSG initially applied to companies that have their central or administrative headquarters, central administration, principal place of business or a statutory seat in Germany with more than 3,000 employees, and from January 2024, it applies to such companies with more than 1,000 employees.

• Geographical Reach:

The EU CS3D has a broader geographical scope, affecting not only EU-based companies but also non-EU companies with significant operations in the EU. 

The LkSG is focused on companies based in Germany, although it also has extraterritorial implications as it covers activities along the entire supply chain, regardless of where they occur.

Due Diligence Obligations

• Risk Management: Both the EU CS3D and the LkSG require companies to establish and maintain a risk management system to identify, prevent, and mitigate risks related to human rights and the environment.
• Supply Chain Mapping: Companies must map their supply chains to identify risks. The EU CS3D emphasises the entire value chain, while the LkSG initially focuses on direct suppliers, with indirect suppliers being addressed when a substantiated knowledge of a violation exists.
• Reporting and Transparency: The EU CS3D and the LkSG both require companies to publicly report on their due diligence policies, processes, and findings.  

Enforcement and Liability

• Enforcement Mechanisms: 

The EU CS3D is expected to be enforced by designated national authorities in each member state, with the possibility of fines and sanctions for non-compliance.  The rules on penalties for breaching the requirements of national laws which implement the CS3D will be set out by member states. However, the maximum pecuniary penalty that can be imposed should not be less than 5% of the company or its parent's net worldwide turnover in the preceding financial year. 

The LkSG will be enforced by the German Federal Office for Economic Affairs and Export Control (BAFA). The BAFA has wide enforcement powers, including the ability to require companies to take specific actions to comply with their obligations, as well as impose penalties. The BAFA can also impose a range of administrative fines for breaching the provisions of the LkSG, including a fine of up to 2% of the annual turnover where a company averages a turnover of €400 million.

• Liability: 

Under the EU CS3D, companies can be held liable for damages caused by their failure to conduct proper due diligence. Affected persons may bring a claim for compensation or seek an injunction where they have suffered damage to their protected legal interests under national laws implementing the international and environmental obligations listed in the Annex to the CS3D where that damage is caused by a company's intentional or negligent failure to prevent, mitigate or end the adverse impacts identified by their due diligence.

The LkSG includes a provision which enables persons to authorise a trade union or NGO to bring proceedings to enforce his or her rights. However, this right is narrowly defined and requires claimants to demonstrate a breach of a protected position listed in the human rights conventions in the Annex to the LkSG.

Implications for Companies

Companies operating within the EU or in Germany will need to significantly enhance their due diligence processes. They will have to:

• Assess and Adapt: Companies must assess their current due diligence processes and adapt them to meet the requirements of both the EU CS3D and the LkSG, depending on their applicability.
• Invest in Compliance: Investment in compliance infrastructure, including training, systems, and personnel, will be necessary to meet the new requirements.
• Engage with Suppliers: Companies will need to engage more deeply with their suppliers to ensure compliance with the LkSG and the EU CS3D throughout the supply chain. 
• Prepare for Reporting: Companies should prepare for the reporting requirements by establishing mechanisms to collect and disclose the necessary information.
• Monitor Developments: As the EU CS3D is still a proposal, companies should monitor its progress and final requirements closely to ensure full compliance once it is enacted.

In conclusion, both the EU CS3D and the German LkSG represent significant steps towards ensuring that companies are accountable for their supply chains with respect to human rights and environmental standards. While there are similarities in their objectives and requirements, there are also differences in scope, applicability, and enforcement mechanisms. The LkSG serves as a notable practice to be prepared for the CS3D. Companies which already act in compliance with the LkSG' provisions are well on their way to tackle the CS3D's new requirements. It remains to be seen how the German legislation will be aligned with the EU Directive and how the two fundamental laws will continue to converge.

What does this mean for you?

Companies will need to carefully navigate these regulations to ensure compliance and to promote sustainable business practices. The complexity of implementing these regulations is substantial, and while this overview provides a general comparison, the specific legal and operational implications for any given company may require a detailed analysis that is beyond the scope of this summary. 

Please reach out to us here, if you need help in navigating the legal and operational landscape.