The EU proposal for a directive on corporate sustainability due diligence, which the European Commission released on 23 February 2022 and which would require large companies operating in the EU to conduct human rights and environmental due diligence throughout their value chains, represents a significant development for business and human rights.
While there has, unsurprisingly, been a deluge of immediate and insightful commentary on the proposal as a whole, there has to date been comparatively little discussion on its specific provisions regarding contractual assurances on business and human rights within value chains. These provisions are part of a much larger, global trend for business and human rights – and are essential to understand as they are likely to have wide-ranging and profound repercussions on corporate sustainability both in the EU and around the world.
There has, in recent years, been an increasing trend towards the inclusion of business and human rights and environmental clauses within commercial contracts, including in a number of high-profile agreements such as the Host City Contract for the 2024 Olympic Games in Paris (which requires the Host City to respect human rights in accordance with the United Nations Guiding Principles on Business and Human Rights). The inclusion of such clauses has been driven in large part by reputational considerations but also, to some extent, to minimise the potential liabilities that may arise in this regard – and has had the important effect of hardening business and human rights responsibilities into legally binding, enforceable obligations between contracting parties.
The draft EU directive – which proposes a mandatory requirement for large companies operating in the EU to conduct human rights and environmental due diligence by identifying, preventing, mitigating, bringing to an end and accounting for negative human rights and environmental impacts in their own operations, subsidiaries and value chains – is likely to significantly increase this trend as it proposes to mandate and incentivise companies that fall within its scope to seek contractual assurances from business partners in relation to human rights and corporate sustainability.
Key provisions of the EU draft directive on contractual assurances
Articles 7 and 8 of the draft directive propose a requirement for each company covered by its scope to seek contractual assurances from a business partner with whom it has a direct business relationship that it will ensure compliance with the company’s code of conduct and, as necessary, a sustainability / human rights prevention or corrective action plan, including by seeking corresponding contractual assurances from its partners to the extent that their activities are part of the company’s value chain (in what is referred to in the draft as ‘contractual cascading’). Importantly, when such contractual assurances are obtained, the draft directive also requires these to be accompanied by appropriate measures to verify compliance, including in particular through suitable industry initiatives or independent third-party verification by an auditor.
Contractual assurances also play a key role in the draft directive as a proposed defence against damages in claims alleging failure to prevent or bring to an end adverse human rights and environmental impacts. In particular, article 22(2) of the draft directive provides that companies that have sought the relevant contractual assurances and carried out the appropriate measures to verify compliance would not be liable for damages caused by an adverse impact arising as a result of the activities of an indirect partner with whom it has an established business relationship, unless it was unreasonable, in the circumstances of the case, to expect that the action actually taken, including as regards verifying compliance, would be adequate to prevent, mitigate, bring to an end or minimise the extent of the adverse impact.
The provisions on contractual assurances clearly play a central role within the draft directive as they propose both (i) an important mandatory requirement for companies in order to comply with their obligation to prevent and stop adverse human rights and environmental impacts, and (ii) a key defence for companies seeking to avoid liability for adverse impacts in certain circumstances.
Given this central role in the draft, there have unsurprisingly been questions – and in some instances criticisms – from businesses and civil society alike regarding their proposed operation. Businesses will wish clarity for instance on the exact nature of the contractual assurances that are envisaged, which explains why the European Commission has confirmed that it will adopt guidance about model contractual clauses. On the other hand, some members of civil society have expressed concerns that the proposed defence could potentially be abused as a way for certain companies to ‘pass the buck’ in cases of breach and, as a result, to perhaps not take their due diligence requirements as seriously as they should. These provisions – which will now, together with the rest of the draft directive, be considered by the European Parliament and the Council for approval – are therefore likely to be subject to a high degree of scrutiny, discussion and negotiation over the coming months.
It is already clear however that the draft directive’s proposed approach on contractual assurances – regardless of the precise form it will ultimately take – is likely to have a significant impact in the following ways in particular:
- It will greatly increase the already existing trend of incorporating business and human rights and environmental clauses within commercial contracts – as it will provide a further, strong incentive for companies to incorporate such clauses in their commercial arrangements including in some instances pre-emptively before the draft directive becomes law;
- The increase in contractual provisions will, in practice, extend business and human rights and corporate sustainability requirements far beyond the largest companies operating in the EU which would be directly caught by the draft directive, as they will effectively transpose many of these standards to companies all around the world, particularly as a result of the ‘contractual cascading’ envisaged by the draft directive; and
- In light of the other parts of the draft directive and the wider trend towards enforcement in relation to business and human rights, those contractual provisions are unlikely to be ‘lettre morte’. In particular, there is a good argument to say that the draft directive’s requirement on companies to prevent, mitigate and bring to an end adverse human rights and environmental impacts would, by implication, prohibit companies caught by the EU directive from simply ignoring breaches of those provisions particularly where they are leading or could lead to violations. One would therefore expect, in due course, to see a significant amount of companies seeking to enforce or claiming under those provisions against business partners in order to comply and show compliance with the other requirements under the draft directive or in light of other considerations (including reputational) – which will, in turn, lead to a significant increase in human rights and environmental disputes between commercial parties (both before domestic courts and arbitral tribunals given the prevalence of arbitration clauses in a large number of commercial agreements).
While it of course remains to be seen how they would ultimately operate in practice, the draft directive’s provisions on contractual assurances are therefore likely to significantly impact businesses around the world in relation to human rights and sustainability – and further anchor these considerations into their operations and corporate governance.
For further information about human rights, corporate sustainability or this article, please contact Francois Holmey.
- This article was first published with Law 360 on 5 May 2022: Law360 (Paywall)