On 23 February 2022, the long-awaited proposal for a directive on corporate sustainability due diligence was published. The proposal contains obligations for companies regarding human rights and environmental adverse impacts of their own operations as well as the operations of their subsidiaries and the value chain operations of companies that they have an established business relationship with. We discuss the highlights of the proposal in this article.

Directive's scope

The proposed directive does not differentiate between listed and non-listed companies and will be applicable to:

• EU-incorporated companies with more than 500 employees and a net worldwide turnover of more than EUR 150 million;
• EU-incorporated companies with more than 250 employees and a net worldwide turnover of more than EUR 40 million of which at least 50% is generated in sectors where a high risk of human rights or environmental damage has been identified, such as agriculture, textiles or mining (subject to a two-year transition period);
• third country-incorporated companies that generate a net turnover of more than EUR 150 million in the EU; and
• third country-incorporated companies that generate a net turnover of more than 40 million of which at least 50% is generated in a high-risk sector (this group is also subject to a two-year transition period).

Companies within the scope of the proposed directive will not be required to guarantee, in all circumstances, the prevention or suspension of adverse impacts. Instead, an "obligation of means" applies in principle, and this requires that companies take appropriate measures which are reasonably expected to prevent or minimise the adverse impact of the operations. If such measures are not being taken, however, the company can be held liable for resulting losses. The proposal also sets out a specific duty of care for directors in this respect.

Material obligations to conduct due diligence and take appropriate measures

The proposal sets out specific actions for companies to take as part of their corporate sustainability due diligence. Companies may rely on industry schemes and multi-stakeholder initiatives to support the implementation of their due diligence. The European Commission may issue further guidelines on how companies should fulfil the obligation to take the proposed due diligence actions, which are:

Identify the operations that fall within the scope of the requirements

Companies are required to identify the operations within the scope of the due diligence requirements. These requirements apply to all the operations of the company and its subsidiaries and to any value chain operations carried out by entities that the company has an established business relationship with.

A direct or indirect business relationship qualifies as an "established business relationship" if it is, or is expected to be, lasting, and does not only represent a negligible or ancillary part of the value chain. The proposal defines the value chain as all "activities related to the production of goods or the provision of services by a company, including the development thereof, and including the use and disposal of the product". It includes all "related activities of upstream and downstream established business relationships of the company". Companies should reassess at least every 12 months which business relationships qualify as "established" in this respect.

The proposal moreover provides for a specific clarification on the scope of the value chain of certain financial institutions. Such value chain is limited to the activities of the clients receiving loans, credits or other financial services. Small and medium-sized enterprises (SMEs) can be disregarded.

Companies falling within the scope of the proposal because they generate more than 50% of their turnover in a high-risk sector, can limit the relevant operations to those relating to that high-risk sector.

Integrate due diligence in corporate policies

Due diligence must be integrated in all of the company's corporate policies, and a specific due diligence policy must be in place.

Identify adverse impacts

Companies must take appropriate measures to identify actual and potential adverse human rights impact and adverse environmental impacts.

As part of the identification process, companies must carry out consultations with potentially affected stakeholders, where relevant. The proposal defines stakeholders as the employees and "other individuals, groups, communities or entities whose rights or interests are or could be affected by the products, services and operations of the company, its subsidiaries and its business relationships".

Prevent, mitigate or end potential adverse impact

Companies are on the one hand required to take appropriate measures to prevent or mitigate the identified potential adverse impacts of the identified operations. Such measures may include a prevention action plan drawn up in consultation with the affected stakeholders. If a company has an established relationship with an SME, it may be required to support such SME in helping the company taking the appropriate measures.

Moreover, any identified actual adverse impacts must be terminated. Only if such is not possible, impact must be minimized by, for example, compensating the damages of the affected communities or developing a corrective action plan.

Communicate

Companies will have to communicate annually on the above. EU incorporated companies will in principal fall under the exemption for companies that are subject to reporting requirements under Directive 2013/34/EU.

Complaints procedure, supervision and sanctions

The proposal requires companies to develop a complaints procedure under which appropriate follow-up should be facilitated. The complaints procedure should be open to affected persons, trade unions and representatives of the employees working in the value chain, and civil society organisations.

As part of the framework put in place by the proposal, EU member states must designate national supervisory bodies to monitor compliance with the requirement. These bodies may initiate an investigation on their own initiative or in response to substantiated concerns from others. The bodies will have powers including to order the suspension of infringements of the regulations, impose monetary sanctions based on the company's turnover, and adopt interim measures to avoid severe and irreparable harm.

Liability of the company and accountability of directors

Companies may be held liable to pay damages if a violation of the relevant regulation has caused losses. The proposal in this respect seems to suggest a general obligation to prevent, or compensate for, any losses resulting from an adverse impact that has been or should have been identified. Actions by parties with which a company has an established business relationship may be attributed to the company.

The establishment and oversight of the due diligence is placed under the company directors' responsibility. Directors must consider relevant input from stakeholders and ensure that the corporate strategy takes into account the actual and potential adverse impacts identified. As part of their duty of care, directors are to take into account short, medium and long-term consequences of their decisions for sustainability matters.

Combating climate change

Companies must furthermore adopt a plan to ensure that their business model and strategy are compatible with the transition towards a sustainable economy and with the limiting of global warming to 1.5 degrees Celsius in line with the Paris Agreement. The latter appears to imply that such plan may need to evolve with, for example, new insights in the so-called carbon budget, as opposed to steering to a specific aim such as carbon neutrality by 2050.

If the company has identified climate change as a principal risk for, or a principal impact of, its operations, emission reduction objectives should be part of the plan. Although the current proposal would appear to go further, in the context of financial institutions in particular, similar considerations of risk for the company have led to other adopted or draft legislation as well. For example, the 2021 banking package proposal contains a new proposed article 72(2) of the Capital Requirements Directive. This new article provides that the management body should develop specific plans and quantifiable targets to monitor and address the risks arising in the short, medium and long term from the misalignment of the business model and strategy of the institutions, with the relevant Union policy objectives or broader transition trends towards a sustainable economy in relation to environmental, social and governance factors.

Furthermore, if directors receive variable remuneration linked to the company's business strategy and long-term interests and sustainability, the fulfilment of the above obligations should be used as a performance indicator.

Next steps

The proposal will now be discussed, and possibly amended, by the European Parliament and the Council. After adoption, member states will have two years to transpose the directive into national legislation.

The 2021-2025 coalition agreement of the new Dutch government, presented in December 2021, already provides for the introduction of national legislation on corporate social responsibility (CSR). Such legislation will be in line with the legislation of neighbouring countries and the implementation of possible EU regulations.

We refer to our recent article on the proposal to update the Dutch Corporate Governance Code, which proposal provides that the board should consider, and report on, the impact the company's operations have in the value chain.