EU Set to Imposes Sustainability Director Duty on EU and Foreign Companies

EU legislators have agreed on a new piece of draft legislation that imposes a due diligence obligation on company directors to assess, identify, and evaluate risks, and implement mitigation strategies in respect to human rights and environmental supply chain issues. Negotiators of the EU Parliament and European Council, two key legislative bodies of the EU, reached agreement of the text, making it almost certain that the requirements will become law throughout the EU. 

The Corporate Sustainability Due Diligence Directive (CSDDD) sets out obligations for large companies on their actual and potential adverse impacts on human rights and the environment, in regard to their own operations, those of their subsidiaries, and those carried out by their business partners. 

Once the draft legislation, the original version of which is here, is finally approved by the Parliament’s Legal Affairs Committee and the European Parliament as a whole, as well as by the European Council, which represents EU governments, it will apply to EU and non-EU companies which have certain turnover and companies in particular sectors. It will impose fines of up to no less than 5% of net worldwide turnover and will establish a civil liability regime for damages.

Obligations

This means companies will have to mitigate their negative impact on human rights and the environment in areas such as child labour, slavery, labour exploitation, pollution, deforestation, excessive water consumption or damage to ecosystems. It also means companies, including the financial sector, will need to adopt a plan to ensure their business model complies with limiting global warming to 1.5 degrees, the basis of the Paris Agreement, the legally binding international treaty on climate change agreed in 2015 by 194 countries.

Directors of companies within scope will need to set up and oversee the implementation of sustainability and ESG due diligence processes and integrate due diligence into corporate strategy. When acting in the interest of the company, they will have to take into account human rights, climate and environmental consequences of their decisions and the likely consequences of any decision in the long term. When setting any variable remuneration linked to the contribution of a director to the company's business strategy and long-term interests and sustainability, companies have to duly take into account the fulfilment of the obligations by the director concerned.

Scope

The legislation will apply to EU companies and parent companies with more than 500 employees and a worldwide turnover higher than 150 million euros (group 1). They will also apply to companies (group 2) with over 250 employees and with a turnover of more than 40 million euros if at least 20 million are generated in one of the following sectors: manufacture and wholesale trade of textiles, clothing and footwear, agriculture including forestry and fisheries, manufacture of food and trade of raw agricultural materials, extraction and wholesale trade of mineral resources or manufacture of related products and construction. It will also apply to non-EU companies and parent companies with equivalent turnover in the EU. For companies in group 2, the rules will apply two years later than for group 1.

As such, SMEs will not fall under the scope of the directive.

Enforcement

In terms of enforcement, these revised rules will form part of the body of duties placed on directors through existing member states' laws.

Once the legislation has passed the EU legislative process, as a directive, it will be up to the EU’s 27 member states to implement it into domestic law, which they are required to do. Each country’s supervisory authority will monitor company compliance with the obligations and will be able to investigate and impose penalties on non-compliant companies.

The new legislation, the CSDDD, will complement the EU’s Corporate Sustainability Reporting Directive (CSRD), which came into force in January 2023. This legislation imposes strengthened mandatory sustainability disclosure requirements on companies operating in the EU, with companies within scope required to start reporting in 2024. The CSDDD and the CSRD are closely linked, with both pieces of legislation working together to reinforce corporate sustainability disclosure requirements and corporate responsibility. 

Summary of Companies Within the CSDDD’s Scope

Large EU limited liability companies:

Group 1: Companies with 500+ employees and net EUR 150 million+ turnover worldwide (which will include about 9,400 companies)
Group 2: Companies with 250+ employees and net EUR 40+ million turnover worldwide, and operating in defined high impact sectors, e.g. textiles, agriculture, extraction of minerals (which will include about 3,400 companies).

 Non–EU companies: Third country companies active in the EU with turnover threshold aligned with Groups 1 and 2, generated in the EU (which will affect about 4,000 companies in total).

 Small to Medium Enterprises

Micro companies and SMEs are not concerned by the proposed rules. However, the proposal provides supporting measures for SMEs, which could be indirectly affected.