The Corporate Sustainability Due Diligence Directive proposal

What you need to know

As discussed in our previous Ashurst Corporate Update, under the Commission's proposal for the Corporate Sustainability Due Diligence Directive ("CSDDD"), in-scope companies would be required to conduct human rights and environmental due diligence across the whole of their business (including any subsidiaries) and any value chains which are, or are expected to be "lasting". 

On 1 December 2022, the European Council adopted its 'Negotiating Position' on the CSDDD. This is an informal agreement within the Council which helps the European Parliament understand the Council's position on the Commission's proposal. This is meant to make it easier for the Council and the Parliament to reach a formal agreement on the final text of the CSDDD.

The Council's Negotiating Position has made a number of substantive changes to the Commission's proposal which we consider in detail below. Broadly these changes have:

• reduced the scope of the CSDDD, by replacing the concept of 'value chains' with the narrower concept of 'chain of activities' and leaving it up to individual Member States as to whether the CSDDD applies to regulated financial undertakings;
• aligned the CSDDD with the recently adopted Corporate Sustainability Reporting Directive to mitigate inconsistencies in legal interpretation between the two directives and avoid broadening the obligations of companies; and
• amended the provisions on civil liability and directors' duties and remuneration to provide more clarity and avoid interference with Member States' domestic legislation.

Certain Member States are already implementing legislation on supply chain due diligence:

• In 2017, France adopted the Corporate Duty of Vigilance Law which requires the largest French companies to effectively manage their human rights and environmental risks – both within the company itself, but also its subsidiaries, subcontractors and suppliers.
• On 1 January 2023, the German Supply Chain Due Diligence Act (Lieferkettensorgfaltspflichtengesetz, "LkSG") came into force and applies to companies with more than 3000 employees. It requires companies to engage in diligence through their value chain and report publicly on their policies and procedures in regards to such diligence. In 2024, the applicability threshold for the Act will decrease to 1000 employees.

Compared to the French and German laws, the CSDDD has lower employee thresholds for EU companies thereby bringing more companies into scope. Ultimately, the CSDDD is intended to harmonise supply chain due diligence requirements across the EU and create a level playing field throughout the EU internal market.

This article provides an overview of:

• the European Commission's proposal for a Corporate Sustainability Due Diligence Directive ("CSDDD");
• other Member States supply chain due diligence legislation;
• the key differences in the Council of the European Union's proposal; 
• next steps in the legislative process; and
• key takeaways for businesses that potentially come under the CSDDD's scope.

Which companies are likely to be in-scope and when will reporting be required?

The Council's Negotiating Position made changes that reduce the number of companies brought into scope, including:

• amending the criteria for Group 2 companies⁴ to require that at least €20 million was generated in one or more of the "high-impact sectors"⁵;
• leaving it to each Member State to decide whether or not to apply the CSDDD to the provision of financial services by regulated financial undertakings; and
• introducing a higher threshold for "very large companies" and a phased-in approach so that the CSDDD will first apply to "very large companies". "Very large companies" are defined as EU incorporated companies with more than 1000 employees and more than €300m net worldwide turnover in the preceding financial year, and companies not incorporated in the EU with a net turnover of more than €300m in the EU in the preceding financial year⁶. "Very large companies" are required to report three years from the entry into force of the CSDDD, Group 1 companies four years from the entry into force of the CSDDD and Group 2 companies five years from the entry into force of the CSDDD.

Principle of 'value chain' and 'chain of activities'

Under the Commission's proposal, in-scope companies would be required to conduct due diligence on the impact of their operations on human rights and the environmental risks of their 'value chain', and to adopt measures to prevent or mitigate identified adverse impacts. The Annex to the Commission's proposal lists the relevant adverse environmental impacts and adverse human rights impacts. These are broad and refer to international agreements and conventions on human rights, freedoms and the environment.

A 'value chain' is widely defined to mean activities related to the production of goods or the provision of services by a company. Activities include the development of a product or a service and the use and disposal of such a  product as well as the related activities undertaken in the course of upstream and downstream established business relationships.

The Council's Negotiating Position replaces the term 'value chain' with 'chain of activities'.

The concept of 'chain of activities' is narrower than 'value chain'. In particular, the Council has sought to restrict the  scope of downstream business partners by excluding the activities of downstream business partners related to the production of goods or the provision of services from the definition of 'chain of activities'. In turn this narrows the extent of an in-scope company's due diligence obligations. 

'Chain of activities' includes activities of a company's:

• upstream business partners related to the production of goods or the provision of services; and
• downstream business partners related to the distribution, transport, storage and disposal of the product.

The Council's Negotiating Position has also made changes to the Annex to make clearer the relevant adverse environmental impacts and adverse human rights impacts.

The obligation to adopt a climate transition plan

Under the Commission's proposal, in-scope companies have an obligation to adopt a transition plan to show that their business model and strategy are compatible with limiting global warming to 1.5C in line with the Paris Agreement. This transition plan must identify, on the basis of information reasonably available to the company, the extent to which climate change is a risk for, or an impact of, the company’s operations.

The Council's Negotiating Position maintains this obligation, however it amends the relevant provisions to more closely align them with the Corporate Sustainability Reporting Directive (CSRD). This is intended to mitigate inconsistencies in legal interpretation between the two directives and avoid broadening the obligations of companies.

For an overview of the impact of the CSRD, including on UK incorporated companies doing business in the EU, please see the  Ashurst Governance & Compliance Update – Issue 26.

Directors' duties and remuneration

Under the Commission's proposal, a director's duty of care to act in the best interests of the company would be expanded to take into account, where applicable, human rights, climate change and environmental consequences, including in the short, medium and long term. 

Additionally, where variable remuneration is linked to a director’s contribution to the company’s business strategy, long-term interests and sustainability, then this must take account of the company’s climate transition plan (including any emission reduction objectives).

The Council's Negotiating Position removes these provisions. 

Civil liability

Under the Commission's proposal, in-scope companies face civil liability for failure to conduct due diligence on the impact of their operations on human rights and environmental risks of their value chains and take adequate action to prevent or mitigate identified adverse impacts.

The Council's Negotiating Position amends the Commission's proposal by clarifying the four conditions for a company to be held liable, including by introducing the requirement for fault (intentional or negligent). The four conditions are:

• damage caused to a natural or legal person;
• a breach of duty;
• causal link between the damage and the breach of duty; and
• a fault (intentional or negligent).

Joint and Several Liability – Where damage is caused jointly by the company and its subsidiary, direct or indirect business partner, the CSDDD intends for the relevant entities to be jointly and severally liable, without prejudice to the provisions of national law concerning the conditions of joint and several liability and any 'rights of recourse'.

However, a company cannot be held liable for damage caused solely by its business partners in its chain of activities.

Human rights and Environmental Impacts – The Council's Negotiating Position entitles victims of human rights or environmental adverse impacts to "full compensation" for the damage suffered. This excludes "overcompensation", such as punitive damages.

Consequences of non-compliance

Non-compliance under both the Commission's proposal and the Council's Negotiating Position could result in:

• a requirement from a supervising authority, designated by each Member State, to cease or not to repeat the infringement and, where appropriate, take remedial action required to bring the infringement to an end;
• a requirement to undertake interim measures to avoid the risk of severe and irreparable harm;
• sanctions, which would take into account factors such as a company's efforts to comply with any remedial action required of them by a supervising authority. Sanctions will be based on a company's turnover and will be publicly published; and
• damages, where a failure to comply with the obligations to prevent potential adverse effects and end actual adverse effects lead to damage caused by the adverse effect.

Next steps

The Opinion Committee of the European Parliament Committee on Internal Market Consumer Protection is expected to adopt its draft opinion on the CSDDD at its 1-2 March 2023 meeting. It is then expected that the Lead Committee of the European Parliament Committee on Legal Affairs will consider the adopted opinion before adopting its draft report on 13 March 2023. Following the adoption of the report, the European Parliament will adopt its Negotiating Position on the CSDDD.

Tripartite negotiations between the European Parliament, Council and Commission will then take place to agree the CSDDD proposal. Once agreed, the Council and Parliament will formally adopt the agreed CSDDD proposal. This is not expected before early 2024.

Once formally adopted, Member States will have two years to transpose the CSDDD into domestic law.

Key takeaways

The text of the CSDDD is likely to receive further changes as the European Parliament adopts its Negotiating Position and tripartite negotiations take place. However, while the specifics of the CSDDD are not yet certain, when the CSDDD comes into force, in-scope companies will need to identify actual and potential adverse human rights and environmental impacts from their own operations and across their supply chains and take appropriate measures to mitigate or prevent these adverse impacts.

Companies which are likely to meet the CSDDD's qualifying criteria should follow the CSDDD's developments closely and take the time to identify whether they are likely to fall within the CSDDD's scope and what steps they would need to undertake to ensure compliance. 

Steps that companies might take now to prepare for the implementation of the CSDDD include:

• conducting a risk analysis of existing operations and their supply chains to identify potential adverse human rights and/or environmental impacts likely to contravene the CSDDD. Businesses should consider the potential impact of any sanction imposed, and details of penalties imposed may be made publicly available by the supervisory authorities;
• reviewing and updating systems, policies and procedures;
• reviewing how due diligence information is gathered on operations and their supply chain, what information suppliers already disclose to them and whether it is sufficient against the current CSDDD proposals; and
• considering what contractual provisions may be appropriate to facilitate CSDDD compliance when entering into new, or renewing existing, contracts. These could include the right of the business to request information from their supply chain to satisfy future CSDDD disclosures, and appropriate remedies where those members will not provide the information, or the information disclosed indicates that they are in contravention of the CSDDD's requirements. Businesses could also consider adopting climate conscious drafting such as The Chancery Lane Project's provisions into their contracts.

If you have any questions or if you would like to discuss the CSDDD and its prospective implications for your business, please reach out to a member of the team.

We would like to thank Christopher Phillips for his assistance with this article.

1. The text of the Commission's proposal defines a long list of regulated financial undertakings under Article 3(a)(iv). This includes, among others, insurers and reinsurers, alternative investment fund managers, securitisation special purpose entities and crypto-asset service providers.
2. Companies in "high-impact sectors" are those in one or more of the following sectors:
3. See footnote 3 above for definition of "high-impact sectors"
   

   
   i. the manufacture of textiles; leather and related products (including footwear) and those involved in the wholesale trade of textiles, clothing and footwear;
   

   ii. agriculture; forestry; fisheries (including aquaculture); the manufacture of food products, and the wholesale trade of agricultural raw materials, live animals, wood, food, and beverages;

   iii. the extraction of mineral resources regardless of where they are extracted from (including crude petroleum, natural gas, coal, lignite, metals and metal ores, as well as all other, non-metallic minerals and quarry products); the manufacture of basic metal products, other non-metallic mineral products and fabricated metal products (except machinery and equipment), and the wholesale trade of mineral resources, basic and intermediate mineral products (including metals and metal ores, construction materials, fuels, chemicals and other intermediate products).

   As the definition of "high-impact sectors" does not include financial services, regulated financial undertakings will only be subject to the requirements of the Commission's proposal if they meet the Group 1 thresholds.
   
4. Unlike the text of the Commission's proposal, the text of the Council's Negotiating Position does not use the terminology of Group 1 or 2 companies. However, as the Council's Negotiating Position uses the same turnover and employee thresholds we have kept this terminology for ease of reference and comparison.
5. See footnote 3 – the Council's Negotiating Position uses the same definition of "high-impact sectors" as the Commission's proposal.
6. There is no employee threshold for companies not incorporated in the EU.