European Commission unveils landmark ESG regime: what you need to know
Proposed directive creates a legal duty to carry out human rights and environmental due diligence, write King & Spalding's Viren Mascarenhas, Douglass Cassel and Peter Hood
The European Commission (EC) has taken a significant step toward a mandatory human rights and environmental due diligence regime, proposing an EU law that would require a wide range of EU and non-EU companies to take steps to identify and address human rights and environmental harms and impose sanctions for non-compliance.
What would companies be required to do?
Companies within the scope of the directive would be required to carry out due diligence on human rights and environmental impacts in their operations and value chain. This extends to “upstream” impacts associated with direct and indirect subsidiaries and suppliers as well as “downstream” impacts, associated with the use and disposal of a product or service.
Specifically, companies would be required to carry out due diligence in accordance with the steps identified by the OECD Guidance for Responsible Business Conduct:
- Identify and assess actual or potential adverse human rights and environmental impacts;
- integrate due diligence into policies and management systems;
- prevent or (where prevention cannot be done) adequately mitigate potential adverse impacts;
- cease or (where cessation cannot be done) minimise actual adverse impacts;
- periodically assess the effectiveness of the due diligence policy and measures;
- publicly communicate on due diligence; and
- provide for remediation, including appropriate procedures for complaints by affected persons, trade unions and civil society organisations.
Companies would be required to have in place a strategy to ensure that their business plans are compatible with the 1.5 degree global warming target under the Paris Agreement. Companies for which climate is a principal risk will also be required to include an emissions target in their plans.
Which companies would the directive apply to?
The proposed directive would initially apply to:
- All limited liability companies domiciled in the EU with more than 500 employees and €150m annual turnover worldwide; and
- non-EU domiciled companies active in the EU with a turnover of €150m generated in the EU.
Two years following implementation, the threshold is set to be reduced to apply to EU companies with 250 employees and €40m annual turnover, and to non-EU companies with €40m annual turnover generated in the EU, in defined “high impact sectors,” such as extractive industries, agriculture and textiles.
The Commission estimates that the Directive would apply to approximately 13,000 EU companies and 4,000 non-EU companies.
What are the proposed sanctions for non-compliance?
The proposed directive envisages that member states will designate a domestic authority to ensure effective enforcement of administrative sanctions for non-compliance with due diligence obligations.
It also envisages a civil liability regime, enabling victims of adverse human rights impacts to obtain compensation for damage in the domestic courts of EU member states. Such claims will be limited to human rights harms in a company’s own operations and in the operations of its subsidiaries and established business relationships, provided that the harm could have been identified and prevented or mitigated with appropriate due diligence measures. The proposed directive envisages that member states will adapt their rules on civil liability to enable this, likely requiring changes to domestic law in relation to extra-territorial jurisdiction and separate corporate personality.
The proposed directive introduces new duties for the directors of qualifying EU companies, including to set up and oversee the implementation of human rights and environmental due diligence to be enforced through the existing law on directors’ duties in EU member states.
What is the status of the directive and when would it come into force?
Before coming into force, the directive must be approved by the European Parliament and the EU Council (comprising heads of state and government). In this context, it is relevant that the current parliament has already voted on and approved an even stronger proposal so is unlikely to block the proposed directive altogether and may indeed seek to strengthen certain provisions.
Once approved, member states would have two years to implement the relevant domestic legislation.
The wider move towards mandatory human rights due diligence
The proposed directive is part of a range of measures being introduced in Europe that require large multinational businesses to implement effective human rights and environmental due diligence. Such legislation has been in force in France since 2017, although it applies only to a small number of large French companies. Germany has recently adopted mandatory human rights due diligence legislation which is broader in scope and due to come into force in 2023. Due diligence reporting regimes recently came into force in Norway and Switzerland. There are parallel developments in the common law which may enable claims in negligence against companies in the UK where they fail adequately to implement a public commitment to due diligence resulting in a human rights or environmental harm.
Over time, a legal requirement to implement human rights and environmental due diligence will come to apply to an increasingly large number of multinationals based, or doing business, in Europe. The expectations of stakeholders are developing in tandem, as they increasingly require companies to comply with internationally recognised standards such as the UN Guiding Principles on Business and Human Rights and OECD Guidelines for Multinational Enterprises.
It takes time to implement adequate human rights and environmental due diligence. Waiting until the directive (or one of the other, domestic measures) comes into force runs the risk of leaving it until too late to introduce the necessary systems and processes, exposing a company to the risk of administrative penalties, civil liability and reputational damage.
To get ahead of the curve, companies doing business in Europe should take steps now to:
- Review the sufficiency of existing policies, systems and processes to identify and address adverse human rights and environmental impacts. This will include looking both at its own operations and value chain; and at how its products and services are used, including by third parties.
- Where gaps are identified, take steps to address these, in accordance with international standards, to ensure that adequate systems and processes are in place