First Look at the Commission’s Proposal for a Corporate Sustainability Due Diligence Directive

Introduction

1. On 23^rd February 2022, the European Commission published a Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937[1] (the “Proposal”).
2. The Proposed Directive lays out a number of obligations for in-scope companies concerning human rights and environmental adverse impacts arising from their operations, the operations of their subsidiaries and other entities. Most of such obligations focus on human rights and environmental due diligence duties.
3. In this small text, we will take a small look at the background of this Proposal, its main contents and whether it is the game-changer in European company law many had feared or hoped for.

 

Background

4. The introduction of environmental and human rights concerns in corporate governance in the European Union law has a decade-long history, and has thus far mainly materialised in the introduction of mandatory disclosure duties for various types of companies through a variety of acts since 2014.
5. The central legal acts for environmental and social disclosure are the Non-Financial Reporting Directive (“NFRD”)[2] and its proposed amendment in the Corporate Sustainability Reporting Directive (“CSRD”)[3], the Sustainable Finance Disclosure Regulation (“SFDR”)[4] and the Taxonomy Regulation (the latter does not foresee disclosure duties per se, but it is a central text to all others)[5].
6. Without entering into much detail, the existing mandatory disclosure framework does not target corporate governance directly, but rather tries to shape corporate action towards achieving certain policy goals (what some would call nudging or targeted disclosure duties), by requiring companies to disclosure certain aspects of its internal and external lives on ESG-related issues[6].
7. However, there have been, for many years, calls to adopt more forceful measures, with the Commission seemingly ready to legislate directly on corporate purpose[7].
8. Two important lines of action had been developing in the past two years, one concerning rules on directors’ duties and another on rules on due diligence across supply chains.
9. To that end, the Commission procured two studies, one concerning possible changes in directors’ duties and corporate purpose rules in order to align them with sustainability concerns (“Directors’ Duties Study”)[8]; and another on the pertinence of new due diligence requirements in order to identify, prevent, mitigate and account for actual or potential human rights and environmental impacts of companies’ operations all across their supply chain (“Due Diligence Study”)[9].
10. Such studies were followed by an open public consultation[10], which ran from October 2020 to February 2021, and which contained questions on both lines of action – directors’ duties and due diligence.
11. Finally, one year after the public consultation ended, the Commission published its Proposal for a Directive on Corporate Sustainability Due Diligence.
12. The introductory text to the proposal restates many of the concerns expressed in the aforementioned studies, especially in the Due Diligence Study. As we will see at the end of this text, the Commission decided that major changes to rules on directors’ duties and remuneration were not necessary and the proposed Directive focuses essentially in due diligence duties.
13. After emphasising the well-known fact that EU companies operate in a complex world and rely on an intricate web of global value chains, where environmental and human rights abuse are not always under their control, the Commission claims that voluntary action has not resulted in large-scale improvements across sectors[11]. As a consequence, claimed the Commission, negative externalities emerge and certain EU-based companies are associated with environmental or human rights issues[12].
14. The Commission further indicated that the aforementioned public consultation indicated that there was “wide acknowledgment” among stakeholders on the need for a EU legal framework for due diligence in environmental and human rights issues[13].
15. As such, the Commission justifies the introduction of this Directive as necessary to improve corporate governance practices to better integrate risk management and mitigation process of human rights and environmental impacts, avoid fragmentation of due diligence practices, increase corporate accountability and improve access to remedies[14].

Contents of the Proposal

16. The Proposed Directive sets its purpose right at the outset, with its Article 1 indicating it contains rules on:
    1. “obligations for companies regarding actual and potential human rights adverse impacts and environmental adverse impacts with respect to their own operations, the operations of their subsidiaries, and the value chain operations carried out by entities with whom the company has an established business relationship”; and
    2. “liability for violation of these obligations”.
17. In what concerns subjective scope, as laid out in Article 2, the Directive applies to companies formed in accordance with the legislation of a Member State which fulfil one of the following conditions:
    1. more than 500 employees and a net worldwide turnover over EUR 150 million in the past year; or
    2. more than 250 employees and a net worldwide turnover over EUR 40 million in the past year, as long as 50% of such turnover is generated in a variety of key sectors, essentially manufacture and sale of textiles, food and other agricultural products and mineral resources[15].
18. These quantitative (turnover) and qualitative (sector) thresholds also apply to third country companies, with the following difference – EUR 150 or 40 million net turnover in the European Union.
19. The main duty established by the Directive is found in Article 4, according to which Member States shall ensure that in-scope companies conduct human rights and environmental due diligence, materialised in one of the following actions:
    1. Integrating due diligence into all of their corporate policies and having in place a due diligence policy (Article 5);
    2. Taking appropriate measures to identify actual or potential adverse impacts on human rights or on the environment arising from their own operations, those of its subsidiaries or of their established business relationships (Article 6);
    3. Taking appropriate action to prevent or mitigate potential adverse impacts on human rights or the environment or to bring actual adverse impacts to an end or minimise their extent (Articles 7 and 8);
    4. Establishing and maintain a complaints procedure (Article 9);
    5. Monitoring the effectiveness of their due diligence policy and measures (Article 10); and
    6. If not covered by the NFRD, publicly communicate on the fulfilment of due diligence duties (Article 11).
    7. A further duty binding in-scope companies but not qualifying as “due diligence duty” under Article 4, is foreseen in Article 15, according to which some in-scope companies shall adopt a plan to ensure that the business model and strategy of the company are compatible with the global climate goals of the Paris Agreement.
20. The list is detailed and relies upon a central concept in the proposed Directive, that of “adverse impact” on either human rights or the environment.
    1. Article 3(b) defines an “adverse environmental impact” as one resulting from the violation of one of the prohibitions and obligations laid out in one of the international environmental conventions listed in Annex, Part II of the Directive, including, inter alia;
       1. A number of obligations laid out in conventions such as the Nagoya Protocol, the Convention on International Trade in Endangered Species, the Minamata Convention or the Vienna Convention on the protection of the Ozone Layer; while
    2. Article 3(c) defines an “adverse human rights impact” as resulting from the violation of one of the rights or prohibitions listed in the Annex, Part I Section 1, as enshrined in the international conventions listed in the Annex, Part I Section 2, including, inter alia:
       1. Adverse impacts on rights to dispose of a land’s natural resources, right to life and security, prohibition of torture, cruel, inhuman or degrading treatment, right to liberty and security, prohibition of arbitrary or unlawful interference with privacy, freedom of thought, conscience and religion, several workers’ rights and rights of the child, among many others, as listed in a number of human rights and fundamental freedoms conventions, such as the Universal Declaration of Human Rights, the International Covenant on Civil and Political Rights, the International Covenant on Economic, Social and Cultural Rights, and many other fundamental conventions.
    3. Another important issue is the fact that many of the due diligence rules listed above, especially the ones in Articles 6 to 8 – identification of potential or actual adverse impacts, prevention of potential impacts and ceasing of actual adverse impacts – apply to adverse impacts arising not only from the activities of the in-scope companies or their subsidiaries, but also from their “established business relationships” when occurring along their value chain (Article 6(1)).
       1. What does this mean? It means any person with whom the in-scope company has a lasting commercial agreement, or to whom it provides financing, insurance or reinsurance, or that performs business operations related to the products or services of the company for or on behalf of the company (Article 3(e) and (f)).
       2. Such “established business relationship” occurs along the “value chain”, meaning that it concerns any activities related to the production of goods or the provision of services by a company, including product or service development and related activities of upstream of downstream established business activities (Article 3(g)).
       3. While we can clearly see here an effort by the EU legislator to be as comprehensive as possible, one can expect several interpretational hurdles in very nuanced situations.
    4. Articles 17 and 18 foresee the designation of supervisory authorities to supervise compliance with the aforementioned obligations, which can request information, carry out investigations or impose fines. It is unclear what kind of supervisory authorities are expected to take up this mantle.
    5. In an interesting rule, Article 22 indicates that Member States shall ensure that companies are liable for damages if they failed to comply with the aforementioned obligations of preventing and mitigating potential human rights and environmental impacts arising from their operations and, as a result of such failure, an adverse impact occurred and led to damage. This liability is slightly qualified in certain situations when it results from the activities of an indirect partner when it is unreasonable to expect that the action attempted by the company would be adequate to prevent, mitigate, bring to and end or minimise the adverse impact.
    6. The civil liability of the companies is without prejudice to that of its subsidiaries and any direct and indirect business partners or special human rights civil liability rules.
    7. It will be interesting to see the interaction between this provision and national civil liability rules, which differ somewhat between Member States.
    8. Finally, Article 25 foresees a “directors’ duty of care”, indicating that Member States shall ensure that, when fulfilling their duty to act in the best interest of the company, directors take into account “the consequences of their decisions for sustainability matters, including, where applicable, human rights, climate change and environmental consequences, including in the short, medium and long term”, with the second paragraph indicating that “Member States shall ensure that their laws, regulations and administrative provisions providing for a breach of directors’ duties apply also to the provisions of this Article”.
    9. Furthermore, Article 26 indicates that Member States shall ensure that directors of in-scope companies are responsible for putting in place the due diligence actions referred to in Article 4 and 5.
    10. It remains to be seen how this will be transposed to national laws and if it will be of any consequence, i.e., if and by whom can directors be sued by breach of this duty of care – if only by the shareholders and a very limited number of stakeholders, this change will be essentially cosmetic and its enforcement will likely be dependent upon the will of a small number of people. If the legitimacy to sue the directors for breach of this duty of care is perceived as including a wider array of potential plaintiffs, this could be overly onerous and specific (national) rules to determine legitimacy in court and burden of proof would have to be in place.

 

Directors’ Duties and Remuneration: Much Ado About Nothing?

29. As indicated above, there had been quite an intense waiting on this potentially major piece of legislation, bringing the incorporation of ESG concerns in EU law to a new chapter, away from mere disclosure duties and towards more forceful rules.
30. Depending on the perspective, this possible move towards effective action would either be desirable (forcing companies to do their share in protecting environmental, social and human rights concerns) or undesirable (as an unrealistic and counterproductive interference in their autonomy).
31. In that regard, there was great anticipation following the 2020 Studies and the prospective of significant changes in how company law interacts with environmental and social concerns.
32. However, while most concerns laid out in the Due Diligence Study seem to have been reflected in this Proposal, the anticipation around the Directors’ Duties Study was certainly misplaced by all, supporters and deriders alike.
33. Indeed, let us recall that the Directors Duties Study and the public consultation foresaw important changes in basic tenets of company law, namely (i) changes to the content of directors’ duty of care, in order to deprioritise shareholder interest and take into account the interests of all stakeholders which are relevant for the long term sustainability of the firm; (ii)rules on enforcement mechanisms outside of traditional board and corporate structures, with the possible inclusion of other stakeholders; (iii) changes in remuneration policies through rules incentivising long-term value creation; and (iv) change rules on board composition, requiring members with expertise in ESG issues.
34. The hopes or fears that the fundamental core of directors’ duty of care or that rules on director remuneration would be significantly affected by a new act did not materialise. In fact, the introductory text of the Proposal referred to the various “different policy options” in the area of due diligence, directors duties and remuneration but decided the essentially focus on due diligence.
35. In the end of the day, the Commission preferred a more “focused and targeted” approach than the big changes seemingly brewing in past documents[16]. The core of this Proposal is due diligence obligations, relegating any meaningful changes in the content of directors’ duties to the background.
36. Despite its focus on due diligence, the Commission still claims that this proposed Directive “significantly” reduces directors’ duties “by linking them closely to the due diligence obligation”[17] (though it is not clear what the Commission means by this) and that the current version will still allow to move “decisively” towards the “overall objective to better exploit the potential of the single market to contribute to the transition to a sustainable economy and foster long-term sustainable and responsible corporate behaviour”[18].
37. Rules introducing ESG metrics in the remuneration of directors are also a bit more timid that expected, with Article 15(3) indicating that Member States shall ensure that companies take into account the fulfilment of the climate targets of the Paris Agreement when setting variable remuneration when such variable remuneration is linked to the contribution of a director to the company’s business strategy and long-term interests and sustainability.
38. While one could argue that Articles 25 and 26 of the proposed Directive fulfil the ideas referred to above in Paragraph 33, as they change the content of the directors’ duty of care and establish rules on enforcement mechanisms (though fait ones), their limited scope can be perceived in two ways:
    1. For those enthusiastic about seismic changes in the content of directors’ duties and remuneration and their alignment with sustainability objectives, the proposed Directive will have fallen short, adding Articles 25, 26 and 15(3) as mere appendages or symbolic provisions with likely little effect; or
    2. For those more uneasy with such changes, this proportionate approach by the Commission will have been a welcome decision, drawing this Directive from utopic and counterproductive impulses back to the ground.

 

Brief Concluding Remarks

39. While the proposed Directive introduces important (and some might say, long overdue) rules on environmental and human rights due diligence for major companies, its falls short of the anticipation created by the Commission’s activity in the past years.
40. By including a wide array of subjects in the scope of due diligence duties, beyond mere subsidiaries of in-scope companies, it tries to really encompass the entire supply chain and it might bring some interesting change in EU based companies’ behaviour.
41. There are no “seismic” changes to directors’ duties and remuneration (except when instrumentalised towards due diligence obligations pursuant to the proposed Directive), a choice explicitly acknowledged by the Commission itself.
42. The proposed Directive will now go through the normal legislative procedure, with a transposition deadline of two years after adoption by the European Parliament and the Council.

 

 

 

[1] European Commission, Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937, available

[2] Directive 2014/95/EU of the European Parliament of the European Parliament and of the Council of 22  October 2014, amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups, OJ L330/1, 15.11.2014.

[3] European Commission, Proposal for a Directive of the European Parliament and of the Council amending Directive 2013/34/EU, Directive 2004/109/EC, Directive 2006/43/EC and Regulation (EU) No 537/2014, as regards corporate sustainability reporting, (21^st April 2021), COM(2021) 189 final, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A52021PC0189.

[4] Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector, OJ L317/1, 09.12.2019.

[5] Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, OJ L198/13, 22.06.2020.

[6] The NFRD requires large undertakings to draft a ‘non-financial statement’ in which the in-scope undertaking should disclose its policies on environmental, social and employee matters, as well as on respect for human rights, anti-corruption and anti-bribery matters, the outcome of such policies, the principal risks associated to the aforementioned matters as well as indicate the key performance indicators relevant to its particular business (Article 19a(1) NFRD), also containing an additional disclosure duty of disclosing the undertaking’s gender, age or educational diversity policy in management and supervisory bodies (article 20(1)(g) NFRD). The aforementioned proposed amendments put forth by the CSRD will expand the scope of matters to be disclosed and of disclosing companies.

The SFDR imposes various disclosure obligations on market participants and financial advisers, including publication of sustainability risk policies and inclusion thereof in remuneration policies (Articles 3 and 5 SFDR), disclosure of due diligence policies (Article 4 SFDR), inclusion of sustainability information in pre-contractual information (Articles 6 and 7 SFDR) or specific disclosure duties in green finance instruments.

[7] The 2021 Sustainable Finance Strategy issued by the Commission is one of the most recent documents hinting at that. Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, Strategy for Financing the Transition to a Sustainable Economy, COM/2021/390 final, 06.07.2021.

[8] This study, found here, Ernst & Young (for the European Commission), Study on directors’ duties and sustainable corporate governance: final report, July 2020, available in https://op.europa.eu/en/publication-detail/-/publication/e47928a2-d20b-11ea-adf7-01aa75ed71a1/language-en, caused quite a stir, as it emphasised the excessive focus of EU publicly listed companies on short-term maximisation of shareholder value rather than in the long-term interests of the company, and that the corporate structures in place incentivised such short-termism, sidelining sustainability as a strategic priority. It was the object of various criticisms, on both technical and political grounds.

[9] British Institute of International and Comparative Law, Civic Consulting, London School of Economics (for the European Commission), Study on due diligence requirements through the supply chain: final report, January 2020, available in https://op.europa.eu/en/publication-detail/-/publication/8ba0a8fd-4c83-11ea-b8b7-01aa75ed71a1, which was a bit less controversial.

[10] Such public consultation, which ran up to February 2021, can be found here https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12548-Sustainable-corporate-governance/public-consultation.

[11] Proposal, 1-2.

[12] Proposal, 2.

[13] Proposal, 18-19.

[14] Proposal, 3.

[15] Article 2(b)(i) to (iii) list the manufacture of textiles, leather and related products (including footwear), and the wholesale trade of textiles, clothing and footwear; agriculture, forestry, fisheries (including aquaculture), the manufacture of food products, and the wholesale trade of agricultural raw materials, live animals, wood, food, and beverages; and the extraction of mineral resources regardless from where they are extracted (including crude petroleum, natural gas, coal, lignite, metals and metal ores, as well as all other, non-metallic minerals and quarry products), the manufacture of basic metal products, other non-metallic mineral products and fabricated metal products (except machinery and equipment), and the wholesale trade of mineral resources, basic and intermediate mineral products (including metals and metal ores, construction materials, fuels, chemicals and other intermediate products).

[16] Proposal, 21.

[17] Proposal, 21.

[18] Proposal, 21.