The German Supply Chain Due Diligence Act and the Chemical Industry
As of 1 January 2023, the German Supply Chain Due Diligence Act ( the “Act”) has entered into force. As a result, approximately 700 companies with a presence and more than 3,000 employees in Germany are required to comply with several supply chain due diligence obligations set out in the Act. In 2024, the scope will be broadened and will cover approximately 2,900 companies with a presence and more than 1,000 employees in Germany. The Act foreshadows its equivalent at EU-level, the Corporate Sustainability Due Diligence Directive (the “Directive”), which provides for largely the same obligations but goes even further. It is currently only a draft but expected to become law in a couple of years’ time (once entered into force and implemented by member states into national laws). Companies complying with the Act will in all likelihood be able to meet the requirements of the Directive when supply chain due diligence becomes mandatory across the entire European Union.
What has happened so far?
The core of the Act’s due diligence obligations provides that companies that fall under the law must undertake a risk analysis. The goal is to understand any potential and actual human rights and environmental risks in their supply chain—in their own business operations as well as those of their direct suppliers. The companies are required to weigh and prioritize the identified risks and to implement measures to prevent or remedy any prioritized risks or violations. Other requirements of the Act include designating responsibility for human rights compliance within the company (e.g., designating a human rights officer) and introducing a complaint program. The latter must allow employees, suppliers’ workers and other third parties to blow the whistle on any human rights or environmental risks or violations in the company’s supply chain. (We provide a more detailed overview of the risk analysis here.)
The Federal Office for Economic Affairs and Export Control (Bundesamt für Wirtschaft und Ausfuhrkontrolle, “BAFA”) has already kicked off enforcement initiatives by questioning several companies from a risk-based approach (i.e., questioning companies that are particularly prone to human rights or environmental risks in their supply chain). In addition to facing potential spot checking from BAFA on their compliance with the law, companies subject to the Act are themselves obliged to report on their compliance with the applicable due diligence obligations. The first compliance reports are technically due no later than four months after the end of the financial year of the reporting entity that ends during the calendar year 2023 (for enterprises with 3,000 or more employees) or 2024 (for enterprises with 1,000 or more employees). However, BAFA has indicated that it may show some leniency by pushing the deadline into the summer of 2024. The compliance questionnaire—the text of which has already been published—will launch as an online tool during 2023. It must be answered in German. (We provide more details on the structure of the questionnaire here.)
Why is the Act particularly relevant for the chemicals sector?
A significant number of (often globally operating) chemical companies have large sites and operations (and many employees) in Germany, and many of these companies by virtue of their size are subject to the Act and, thus, should take seriously their obligations under the Act as well as the potential for BAFA enforcement. Even if a chemical company does not surpass the employee threshold in Germany, the company will, no doubt, feel the ancillary effects of the Act because the Act is likely to apply to its customers. That means even small traders of chemicals or suppliers of a specific commodity may be required by their German customers to adhere to the same standards of conduct that are covered by the Act because the Act requires companies that are covered by the Act to oblige their suppliers through “contractual assurances” to exercise due diligence in their supply chains. This means in practice that the vast majority of chemical industry participants in Germany will be affected by the Act, either through the need to develop their own compliance programs or, alternatively, to address those imposed on them by their customers.
The Act covers 13 different human rights and environmental obligations, some of which are particularly relevant to companies active in the chemicals sector. In Europe, the chemicals sector is highly regulated, and the standards for handling chemicals are very stringent. In less regulated regions across the globe, local communities are often more susceptible to risks related to the handling of chemicals or the sourcing of raw materials. While the chemicals industry perhaps is not as vulnerable to human rights abuses as, say, the mining or agricultural sectors, human rights concerns are nonetheless significant within the sector, particularly in jurisdictions within the emerging markets where human rights concerns are prominent or environmental regulations are less developed or less likely to be enforced. Likewise, as a result of the adoption of the Act, chemical companies will, more than ever, need to assess their supply chain—including the upstream sourcing of raw materials and the upstream handling of chemicals—to assess the potential impacts to the environment of their suppliers. If a company covered by the Act has a supplier base negatively impacting the living conditions of local communities or harming the health of the persons working at or living close to the concerned premises, it will present risks to those companies covered by the Act.
Another risk to chemical and other companies covered by the Act arises from the fact that the Act prohibits the production and use of chemicals pursuant to Article 3 (1) (a) and Annex A of the Stockholm Convention on Persistent Organic Pollutants (“POPs”). POPs include a number of plant production products, industrial chemicals, dioxins and furans that produce highly toxic by-products of production and incineration processes. While many POPs are banned from production and use or are at least highly regulated in most industrialized countries, this may not be the case for suppliers in less regulated countries. Vetting a supplier’s compliance with POP restrictions will, accordingly, be a necessary part of the due diligence mandated by the Act.
Although the Act only requires a company to assess its own business operations and those of its direct suppliers in detail, even indirect suppliers may have to be reviewed from a human rights or environmental perspective where a company has substantiated knowledge (i.e., factual indications) with respect to the possibility of a risk at one or more indirect suppliers. Media or NGO reports can be sufficient to presume substantiated knowledge. As the chemicals sector has been subject to extensive media reports and criticism with respect to the impact of chemical production sites on local communities (e.g., with respect to illegal hazardous waste disposal), news coverage is also something to be mindful of.
Companies that are subject to the Act should already have implemented programs to comply with the due diligence obligations imposed under the Act, which requires a careful assessment of their supply relationships and any human rights or environmental risks. For companies that will be subject to the Act as of 1 January 2024, now is a good time to get a head start on developing and adopting a risk management system—with a view to similar, emerging legislation around the world. While BAFA may be lenient in its enforcement efforts while impacted companies get their arms around their compliance obligations, we do not expect to see the same approach in the years ahead.
Even companies that are not subject to the Act are advised to familiarize themselves with supply chain due diligence obligations, as they themselves may be suppliers to other chemical or other companies that are subject to the Act and will require their suppliers to respect human rights in their supply chain and show responsibility for the environment.
While the Act is on the forefront of supply chain due diligence law, as indicated above, the European Union has a similar initiative underway. On 23 February 2022, the European Commission adopted the proposal for the Directive, whose scope goes beyond the Act’s. The Directive, as currently proposed, not only has lower participation thresholds than the Act, and thus is likely to be more comprehensive in its scope of coverage, but also requires the risk analysis to cover the entire supply chain, including indirect suppliers. The draft Directive further provides that member states ensure that victims of human rights violations get compensation for damages resulting from the failure to comply with the due diligence obligations, and, as a result, potential monetary exposure could be significant in the case of a failure to adhere to the legislation. And with the increasing litigation we’re already seeing related to the environment and human rights, companies must be diligent and mindful of both issues throughout their supply chains.