On 23 February 2022, the European Commission published its much-anticipated draft corporate sustainability and due diligence directive (the Draft Directive). The Draft Directive sets out a proposed EU standard for human rights and environmental due diligence (HREDD) which, importantly, would apply to any US-based company and its subsidiaries if those group companies have aggregate annual net turnover in the EU of:
- more than EUR 150 million (Group 1); or
- more than EUR 40 million with at least 50% of net worldwide turnover generated in a “high-risk” sector which includes textiles, clothing and footwear, agriculture, forestry, fisheries, food & extractives (Group 2).1
Notably, the HREDD applies even if the US-based companies and their subsidiaries do not have a physical presence in the EU, if the above net turnover threshold is met.
The Draft Directive requires both Group 1 and Group 2 companies to take appropriate measures to identify, and mitigate, actual and potential adverse human rights and environmental impacts arising from their own operations anywhere in the world (not just in the EU) and, where related to their value chains, from their “established business relationships”.
EU Member States are required by the Draft Directive to:
- designate a supervisory authority to supervise compliance with the due diligence and climate change-related obligations with adequate powers and resources to request information, carry out investigations, order remedial action, and impose fines;2 and
- ensure that individuals and entities can bring civil claims.3
The Draft Directive provides for director responsibility and accountability in relation to EU companies' HREDD programmes.4 Group companies that meet the turnover threshold will also be required to appoint an EU-based representative to liaise with EU supervisory authorities.
While the Draft Directive remains subject to further legislative scrutiny and approval, it provides the most detailed insight yet as to the scope and form of prospective HREDD obligations, and it provides a helpful template for corporates to continue developing their due diligence policies and procedures designed to identify, assess and mitigate adverse human rights and environmental impacts – both in their operations and in their value chains.
Furthermore, the Draft Directive will have implications for US-based banks, insurers and other financial institutions which meet the EU net turnover threshold. They will have to undertake further due diligence on clients and their subsidiaries to whom they extend loans, credit and other financial services5 in line with the Draft Directive's requirements.
Growing HREDD Trend Globally
The overall message is clear: mandatory HREDD is coming, and companies based in the US should already be anticipating upcoming HREDD legal obligations and preparing for increasing stakeholder expectations in this area. Although HREDD laws initially focused on child labour and slavery (UK, Australia, California), the trend is for a broader and more global view of human rights and the environment. We see this with recent laws passed in the past year in Norway, Germany and the Netherlands (see our Past Blogs on national HREDD movements in Germany and the Netherlands). Japan is also expected to release human rights guidelines for businesses sometime this year.
In the United States, companies are subject to various federal and state laws and regulations relating to human rights matters and environmental matters. For example, at the US federal level, the Alien Tort Statute gives US federal courts jurisdiction over lawsuits filed by foreign nationals for torts committed in violation of international law - no matter where the harm occurred or who inflicted the harm. In addition, the US Tariff Act and certain related legislation and orders prohibit or restrict the importation of merchandise mined, produced or manufactured in any foreign country by “convict labor” or “forced of indentured labor”. See our blog posts here for our discussion on the Uyghur Forced Labor Prevention Act and here on the Withhold Release Order issued by the Customs and Border Protection on Silica-based products produced by Xinjiang manufacturer. At the US state level, the California Supply Chain Act requires disclosure of steps to eradicate slavery and human trafficking from supply chains. In New York, the proposed New York Fashion Sustainability and Social Accountability Act, if adopted, would require companies with over $100M in global revenues to map their supply chain and disclose environmental and social responsibility criteria in public reports. We discussed the Fashion Sustainability and Social Accountability Act in our blog post here.
On the environmental front, there are a number of federal and state laws and regulations designed to protect air and water quality, endangered species and against hazardous waste. Notably, with respect to climate-related risks, a recent proposal from the US Securities and Exchange Commission would require listed companies to include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition. We discussed the proposal in our blog posts here and here.
Key Highlights of the Draft Directive
DUE DILIGENCE OBLIGATIONS
Key takeaway: Fundamentally, the Draft Directive would require Group 1 and Group 2 companies to implement HREDD measures that cover their entire value chains, looking beyond Tier 1 suppliers to include “established business relationships” throughout the value chain. This includes contractors, subcontractors and other entities in the supply chain. This will add further complexity to supply chain risk assessments and ongoing supply chain risk management in practice.
Key takeaway: The Draft Directive provides for directors of applicable EU-based subsidiaries of US-based companies to take into account “human rights, climate and environmental consequences” in acting in the best interests of a company. This includes a requirement to ensure a company’s business model and strategy are compatible with the 1.5 °C goal of the Paris Agreement. This appears to be more expansive than existing and anticipated national HREDD laws.
Key takeaway: The Draft Directive provides that Member States shall implement rules on sanctions for non-compliance, ensure such sanctions are “effective, proportionate and dissuasive” and may include financial penalties based on a company’s turnover.
NEW CIVIL LIABILITY REGIME
Key takeaway: A new civil liability regime could set the stage for an increase in human rights and environmental related litigation (e.g., brought by civil society organisations). Furthermore, this regime will have implications for existing national due diligence laws that do not currently provide for such a regime (e.g., the German Supply Chain law).
MODEL CLAUSES AND GUIDANCE
Key takeaway: It is anticipated that the European Commission will issue guidance and a set of voluntary model clauses to support companies in complying with their obligations under the Draft Directive. Our previous Blog on ABA model clauses provides insights into the types of voluntary model clauses that are already available in a supply chain context.
Timing and Implementation
The Draft Directive will now be presented to the European Parliament and the Council for approval. Once adopted, Member States will have two years to transpose the Directive into national law.
How Can Your Organisation Prepare for the Requirements in the Draft Directive?
The outline of the due diligence obligations in the Draft Directive gives a good indication of the scope and likely expectations of the design and implementation of a human rights and environmental due diligence programme. US-based groups who are likely to be in scope should start to map, align and leverage their existing policies and procedures to the requirements in the Draft Directive (particularly those set out in Articles 5-11) to identify gaps and areas for enhancement and improvement ahead of the adoption of the Draft Directive. For many large companies, designing and implementing appropriate systems and controls and embedding them into “business as usual” could be, in many cases, a multi-year multi-stakeholder exercise, and so it is imperative for companies to prepare for these new obligations in haste.
More generally, businesses can position themselves for the Draft Directive and other mandatory HREDD laws emerging at a national level by:
- Integrating human rights into group policies and strategic planning processes;
- Disclosing how human rights considerations are integrated into strategies, policies and procedures;
- Carrying out a human rights impact assessment and taking proportionate counter-measures, as well as communicating internally and externally on what measures have been taken;
- Reviewing and reinforcing complaints mechanisms and speak-up programmes;
- Ensuring the business is well equipped to deal with ‘crises’;
- Reviewing the extent to which their board is equipped to address supply chain risks; and
- Reviewing the role, resources and expertise of the legal and compliance functions, who should play a key part in addressing these new challenges.
Read more of our Business and Human Rights perspectives here.
1 Group 1 companies are subject to a lesser due diligence obligation (they are only required to focus on severe adverse impacts relevant for their sector) and do not, for instance, have specific obligations to address climate change as prescribed for Group 2 companies.
2 The supervisory authority may initiate an investigation on its own accord or as a result of “substantiated concerns” communicated to it. Where there is a failure to comply, the supervisory authority shall grant the company concerned an appropriate period of time to take remedial action where possible. Failing rectification, it can impose pecuniary sanctions (Article 18).
3 Member States must allow individuals / entities to raise “substantiated concerns” and ensure they have access to a court or other impartial body to raise their concerns (Article 19).
4 This would apply to directors of subsidiaries based in the EU but not, for example, directors of the US-based parent company.
5 “Other financial services” are not expressly defined in the Draft Directive.