ESG: Environment – Social – Governance
EU Supply Chain Act: Rapporteur Lara Wolters proposes significant tightening of the draft directive
The stage is set for tough negotiations: On 8 November 2022, the Dutch rapporteur on the European Supply Chain Act, Lara Wolters, submitted her draft report – which goes far beyond the European Commission’s proposal published in February this year.
Which provisions are affected?
The report recommends that provisions on the following be tightened, in particular:
- Target group: size of the relevant companies
- Definition of high-risk sectors
- Scope of application: value chain
- Definition of business relationships
- Liability issues at corporate governance level
- Increased climate protection
- Access to justice
Expansion of target group
Wolters proposes extending the scope of the Act to cover companies with 250 or more employees and an annual turnover of more than EUR 40 million, as well as publicly listed companies. Under the proposal, companies operating in high-impact sectors need only have more than 50 employees and EUR 8 million in annual turnover to fall under the EU Supply Chain Act if at least 30% of their company activities are carried out in such sectors.
By way of comparison, the Commission laid down thresholds of 500 or more employees and an annual turnover of EUR 150 million, or – for companies in high-impact sectors – 250 employees and an annual turnover of EUR 40 million, if at least 50% of their company activities are carried out in these sectors.
At the same time, the report extends the list of high-impact sectors, which would again significantly increase the target group. While the Commission defined agriculture, the textile industry and minerals as high-impact sectors, Wolters adds energy, construction, financial services and information technologies to the list.
Entire value chain as opposed to just upstream
The material scope of application is to be broadened further by using the term “value chain”, bringing both upstream and downstream activities under the purview of the EU Supply Chain Act. For comparison, the German Act on Corporate Due Diligence Obligations in Supply Chains (Lieferkettengesetz, “LkSG”) currently only covers upstream chains, i.e. raw materials extraction, production and retail. Since the Council and especially the German government take the position that the material scope of application should refer to “supply chains” – and therefore also only to the upstream chains – there are bound to be heated discussions about this wording.
While the Commission’s proposal wants to regulate due diligence along the supply chain for established business relationships, Wolter’s report calls for a due diligence responsibility to be applied to all business relationships along the value chain, without these having to be “established” and therefore “permanent” relationships. This would further expand the Act’s material scope to ensure that due diligence obligations also apply to sectors such as the textile industry, where supplier relationships often change quickly.
In this context, a provision on fair contractual terms is also intended to prevent the implementation of legal obligations from being shifted to weak parties at the start of the value chain. At the same time, companies would have to ensure that business partners comply with legal due diligence requirements and, above all, are able to comply with them in the first place. In a worst-case scenario, the company would have to provide technical and financial assistance to its business partners and prove that it has complied with this obligation. This obligation to ensure compliance by a company’s smaller business partners at the start of the supply chain with due diligence obligations is supposed to prevent them from not being able to shoulder the associated administrative and financial burdens, and being forced out of the market as a result.
Linking directors’ remuneration to the achievement of sustainability targets
The Commission’s current proposal of obligating companies to adopt a plan outlining the extent to which the company is pursuing the 1.5 oC target laid down in the Paris Agreement or its transition to a sustainable economy is also to be tightened. Wolters calls for more precise wording here, arguing that directors’ plans must include measures the company intends to take to combat climate change and reduce greenhouse gas emissions. According to the report, a significant portion of directors’ remuneration should be linked to the implementation of these measures, especially those to reduce greenhouse gases. However, this idea has met with hardly any support in the Council, so that at present there seems to be very little chance of directors’ remuneration being linked to the fulfilment of these obligations.
Increased climate protection
The draft report also recommends tightening the Commission’s proposal with regard to environmental protection, where it currently only covers actual or potential adverse impacts on the environment. Wolters wants environmental protection to be understood more broadly and to add obligations regarding climate change mitigation and adaptation measures. Her report also defines adverse environmental impacts more precisely. For example, in addition to the violation of one of the prohibitions listed in the Annex to the international environmental conventions, the proposed directive would also cover negative impacts on certain environmental categories. This means that any adverse effects on air, water, soil, biodiversity and animal welfare, climate or the transition to a circular economy could qualify as an environmental degradation. In this context, the report provides for remedial measures such as financial compensation or rehabilitation, to be taken by companies to compensate for adverse impacts. Wolters is thus responding to demands made by NGOs in this regard.
Access to justice
Wolters wants to allow stakeholders affected by human rights or environmental due diligence violations to take legal action before the European courts against the companies that committed these violations. She also advocates reducing the burden of proof in favour of the claimants. The latter would not have to submit evidence of the violation, but merely provide elements substantiating the likelihood of a company’s liability. It would then be up to the company in question to submit exculpatory evidence. It can be assumed that this point will also be hotly debated, as there are many voices in Parliament in favour of a safe harbour clause, and the German government is also likely to speak out against sweeping provisions enabling lawsuits to be brought against companies. With a safe harbour clause, companies could avoid liability by meeting certain criteria in a type of checklist.
The significantly more stringent proposals of rapporteur Lara Wolters are likely to trigger heated debate as the European Parliament determines its position, as well as among the Parliament, Council and Commission as they explore the possibility of a compromise. Some of the rules proposed by the Commission have already encountered resistance in the Council – and this is unlikely to subside given the stricter rules proposed in the report. Some Member States, for example, are demanding that the EU Supply Chain Act not cover financial services at all – not even in the weakened form proposed by the Commission. The Federal Association of German Industry (Bundesverband der Deutschen Industrie, “BDI”), for example, has already criticised the Commission’s proposal as unrealistic in scope, meaning that the proposed extension to include the value chain will no doubt also meet strong resistance. Intense debate can therefore be expected when it comes to the target group, the scope of application and the liability of companies, in particular.