In what represents a significant development for business and human rights, responsible business conduct and sustainability, the European Commission released on 23 February 2022 its proposal for an EU directive on mandatory human rights and environmental due diligence. If adopted, the directive will have a substantial impact on the external corporate regulation and the internal corporate governance of the largest companies operating in the EU and their value chains all around the world – and will further integrate human rights and environmental considerations into businesses’ operations.
Until fairly recently, most of the substantive standards for businesses regarding human rights and sustainability have been set out in ‘soft law’ standards i.e. guidelines, such as the OECD Guidelines for Multinational Enterprises, the Global Compact and, crucially, the UN Guiding Principles on Business and Human Rights. Building on these, there have been a number of recent initiatives to make these standards legally binding both under international law – with the ongoing negotiation at the UN for an international treaty on business and human rights – and under national law, in particular in France and Germany which have both recently adopted mandatory human rights due diligence laws. The Commission’s draft directive represents the latest – and perhaps most wide-ranging – step towards a so-called ‘hardening’ of business standards regarding human rights and sustainability into legally binding obligations and would, if adopted, have a significant impact on large companies operating in the EU.
Due diligence obligations
In relation to external corporate regulation, the draft directive proposes a requirement for large companies 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. Large companies would be required in particular to:
- Integrate due diligence into all of their corporate policies and have in place a due diligence policy;
- Take appropriate measures to identify actual and potential adverse human rights and environmental impacts including, where relevant, through consultations with potentially affected groups such as workers
- Take appropriate measures to prevent or, where prevention is not possible, mitigate potential adverse human rights and environmental impacts including, where relevant, through a prevention action plan and contractual assurances from business partners
- Take appropriate measures to bring actual adverse impacts to an end, including by the payment of damages to affected persons, implementing a corrective action plan and seeking contractual assurances from business partners
- Establish and maintain a complaints procedure for concerns regarding actual or potential adverse human rights and environmental impacts
- Monitor the effectiveness of their due diligence policy and measures; and
- Publicly communicate on their due diligence.
Crucially, the proposed due diligence requirements extend not only to the company’s own operations but also to those of its subsidiaries and their ‘established business relationships’ within their value chains. This is therefore clearly very wide in scope and designed to encompass the operations of the multinational enterprise as a whole rather than simply those of a discrete legal entity.
Adverse human rights and environmental impacts are also defined fairly broadly, albeit by reference to violations of a list of specific rights and objectives under a number of international human rights and environmental law treaties such as the International Covenant on Civil and Political Rights, the International Covenant on Economic, Social and Cultural Rights, the Convention on Biological Diversity and the Convention on International Trade in Endangered Species of Wild Fauna and Flora (CITES).
Finally, and importantly, the draft directive also proposes additional requirements to combat climate change for the largest companies. In particular, those companies would be required to adopt a plan to ensure that their business model and strategy are compatible with the transition to a sustainable economy and with limiting global warming to 1.5 °C in line with the Paris Agreement. If climate change is identified as a principal risk for, or a principal impact of, the company’s operations the company would also be required to include emission reduction objectives in its plan.
In addition to external corporate regulation, the draft directive also contains a number of significant provisions regarding internal corporate governance for directors of large companies, which are clearly designed to further integrate human rights and environmental considerations into companies’ decision-making.
It provides in particular that when fulfilling their duty to act in the best interest of the company, directors of companies must take into account the consequences of their decisions on human rights, climate change and the environment, including in the long term. Directors are also responsible, under the draft, for putting in place and overseeing the company’s due diligence and for integrating due diligence into the corporate strategy. Interestingly, the draft directive also seeks to incentivise directors by tying their remuneration to a company’s actions on climate change, which is singled out in this regard over other considerations. In particular, it provides that where a variable remuneration is linked to the contribution of a director to the company’s business strategy and sustainability, companies must take into account the fulfilment of their obligations to combat climate change when setting variable remuneration.
The draft directive would only apply to large companies operating in the EU and would not directly impact small and medium sized enterprises (SMEs). More specifically, the draft proposes that it would only apply to (i) companies with more than 500 employees and a net worldwide turnover of €150 million (known as Group 1 companies), and (ii) companies with more than 250 employees and a net worldwide turnover of €40 million if at least half of their turnover comes from a high-risk sector such as the textile industry, mining and agriculture (known as Group 2 companies). Importantly, the draft directive also extends to non-EU companies whose net turnover in the EU meets the turnover thresholds of Groups 1 and 2 – so non-EU companies with significant operations in the EU should also familiarise themselves with the proposal as they would be directly affected by the rules.
It is estimated that the draft directive would currently apply to about 13,000 EU companies and 4,000 non-EU companies.
Crucially, the draft directive includes strong public and private enforcement provisions. In particular, the draft directive provides for:
- Sanctions from national authorities to ensure compliance, by requiring each member state to designate an authority that is able to impose fines and compliance orders to infringing companies; and
- Civil liability, by making companies liable for damages for failure to prevent, mitigate or bring to an end adverse human rights and environmental impacts.
In relation to civil liability, the draft directive allows for companies to rely on various defences for damages caused by an adverse impact arising from an indirect business partner with whom it has an established business relationship. In particular, it allows a company to avoid liability if it has sought contractual assurances from the business partner that it will ensure compliance with the company’s code of conduct and those contractual assurances are accompanied by appropriate measures to verify compliance, including through an independent third-party verification. Such independent third-party verification would, interestingly, need to be carried out under the draft by “an auditor which is independent from the company, free from any conflicts of interest, has experience and competence in environmental and human rights matters and is accountable for the quality and reliability of the audit”.
Much remains to be seen as to how exactly, if adopted, these enforcement provisions would work in practice, but there is little doubt that this would represent a significant shift away from relying solely or primarily on complaints through non-binding grievance mechanisms which have largely been the norm until now – and would, as a result, likely lead to much more litigation in this field.
The draft directive will now be considered by the European Parliament and the Council for negotiation and agreement on the final legislation. If and when it is adopted, EU member states will then have two years to transpose the directive into national law.
The draft seeks to transpose many of the key principles of the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises into EU law. In particular, it enshrines the UN Guiding Principles’ central ‘do no harm’ principle that businesses should respect human rights by preventing, mitigating, bringing to an end and addressing adverse human rights impacts arising from their operations throughout their value chains. It also transposes the ‘know and show’ approach adopted by the UN Guiding Principles, which requires due diligence to be carried out throughout a company’s value chain in order to identify potential and actual adverse impacts on relevant stakeholders as well as public communication in this regard.
A key difference with the UN Guiding Principles however is that the draft directive only includes large companies operating in the EU whereas the UN Guiding Principles provides that the responsibility to respect human rights applies fully and equally to all businesses (albeit that businesses’ policies and due diligence processes would take on different forms depending on their size). In this way, the draft directive follows the approach adopted in France’s Duty of Vigilance Law for instance which also limited the requirements to large companies. The draft directive also specifically lists out the specific human rights that it considers to be relevant for the purposes of the rules, whereas the UN Guiding Principles took a broader – albeit perhaps vaguer – approach by referring simply to ‘internationally recognised human rights’ (including as set out in the International Bill of Human Rights).
On the other hand, the draft directive in some ways goes further than the UN Guiding Principles by moving beyond human rights and incorporating key environmental considerations as well, in particular in relation to biodiversity, endangered species and pollution. It also adds important provisions on combating climate change which seek to align corporate behaviour with the Paris Agreement. Crucially, the draft directive would, if adopted, also make the rules legally binding and enforceable against all large companies operating in the EU. The two-fold enforcement mechanisms, through a public administrative action and civil liability, are clearly designed to ensure compliance with the rules and redress in cases of breach – and seek to address calls from a number of businesses for a level-playing field and calls from civil society for better access to justice.
There will be much commentary about the draft – and also, inevitably and understandably, questions and criticisms from both businesses and civil society about some of its provisions – and it remains, of course, to be seen how the draft will evolve in the coming months before the European Parliament and the Council. But there is little doubt that the directive would, if adopted, constitute a watershed for corporate sustainability and human rights across the EU and beyond.
For further information about human rights, corporate sustainability or this article, please contact Francois Holmey.
- This article was first published with Law 360 on 1 March 2022: Law360 (Paywall)