Provisional agreement reached on European supply chain law

Last Thursday (14 December), the European Council and European Parliament reached a provisional agreement on the content of the CSDD. This is a decisive step towards an agreement on a European supply chain law. With the CSDDD, the European Union is pursuing the ambitious aim of obligating companies to comply with human and environmental rights within their own business area as well as along the entire supply chain.

The provisional agreement reached on 14 December 2023 mainly concerns the scope of application of the CSDDD [1], a (civil) liability clause for companies, the threat of sanctions and the legal interests protected by the CSDDD. As expected, the agreement provides for significantly stricter rules in several areas than the German Supply Chain Due Diligence Act (“LkSG”), which came into force on 1 January 2023.

According to the European Council press release, the institutions involved have agreed on the following key points in the negotiations:

Which companies fall within the scope of application?

According to the European Council's press release, the CSDDD will apply to companies with more than 500 employees and a global annual net turnover of 150 million euros. The CSDDD will also apply to non-EU companies if they achieve a net turnover of € 150 million in the EU three years after the entry into force of the CSDDD. To ensure clarity and transparency, the European Commission will publish a list of non-EU companies falling within the scope of the CSDDD.

A temporary exclusion of the financial sector from the scope of the CSDDD is also foreseen in the agreement. However, this is not intended to be a final decision. Rather, the CSDDD will include a review clause for a possible future inclusion of this sector based on a sufficient impact assessment.

What do companies need to consider now?

The CSDDD imposes far-reaching due diligence obligations on companies regarding compliance with environmental and human rights in their supply chains. In particular, the agreement provides for a significant strengthening of environmental protection (compared to the LkSG) and considers, among other things, all measurable environmental impacts such as harmful soil changes, water or air pollution, harmful emissions, excessive water consumption and other impacts on natural resources. This is a significant difference from the LkSG. The LkSG has so far focused strongly on the protection of human rights.

The due diligence obligations to be complied with essentially relate to the entire supply chain, taking preventive and remedial measures and reporting on them. Companies must take appropriate account of both the upstream supply chain (e.g. extraction of raw materials) and the downstream supply chain (distribution, disposal). If environmental and/or human rights violations by a supplier are not prevented or stopped, the ultima ratio – as in the LkSG – may even be the termination of the business relationship with the supplier.

Unlike the LkSG, the agreement also includes a civil liability clause. This is intended to allow people affected by human rights violations to sue companies for violations along the supply chain. The agreement provides for a period of five years during which those affected (including trade unions and non-governmental organizations) can bring claims in connection with the violation of the due diligence obligations. The agreement also provides for (procedural) simplifications regarding evidence or procedural costs.

What potential sanctions do companies face?

In addition to a civil liability clause, the European authorities have also agreed on other sanctions. Companies that fail to comply with their due diligence obligations may be subject to sanctions by national supervisory authorities (including fines of a minimum maximum of 5% of their worldwide annual net turnover). The agreement also stipulates that compliance with the CSDD due diligence obligations may be used as a criterion for the award of public contracts and concessions.

Does the agreement have a direct impact on German companies and/or companies that do business in Europe?

However, the proposed CSDDD does not (yet) have a direct impact on the practice of German and/or European companies. Firstly, the proposed directive still must be adopted and approved in an ordinary legislative procedure. Secondly, EU directives do not have direct legal effect for companies and private individuals. This is because the EU member states must first transpose the content of the adopted directive into national law (within a planned transposition period of two years). German legislator will therefore has to pass a corresponding law or amend the LkSG accordingly (this option is much more likely). Realistically, this is unlikely to happen before 2025/2026.

How should companies react now?

Although the tightening of the European CSDDD is not expected to take effect for another year or two, German companies should start preparing now. Companies should therefore

• deal with both the due diligence requirements of the LkSG and those of the CSDDD (from 1 January 2024, the scope of application of the LkSG will be reduced to companies with generally 1,000 employees - previously 3,000 employees) and
  
  
• align their compliance management systems and their standard contracts (Code of Conduct, General Terms and Conditions of Purchase and Sale, etc.) with these requirements.

Even if the implementation of the due diligence obligations and the revision of the internal compliance structures will entail (considerable) additional financial and personnel costs, this is particularly true for smaller companies (“SMEs”). Firstly, many of these companies will also fall under the scope of the (amended) LkSG in the medium term (a tightening of the scope now seems certain). On the other hand, it has been observed for some time that larger companies use various contractual clauses to ensure that their contractual partners fully comply with their due diligence obligations in the area of human rights and environmental protection (“trickle-down effect”).