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Supply Chain Due Diligence in the EU and Germany: Navigating the Evolving Landscape

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The EU economy is linked to millions of workers worldwide through global supply chains. This imposes both a responsibility and an opportunity for EU companies to positively impact workers’ rights and environmental standards. In early 2023, Germany took a step towards responsible supply chains with the new Act on Supply Chain Due Diligence (Lieferkettensorgfaltspflichtengesetz “LkSG“), as covered in our earlier post. Now, the EU is in the advanced stages of adopting the Corporate Sustainability Due Diligence Directive (“CSDDD“), aiming to harmonize companies’ due diligence obligations regarding human rights and environmental matters throughout the EU.

As of October 2023, there are three distinct CSDDD proposals. The most recent draft of the European Parliament from 1 June 2023 serves as the foundation for the ongoing trilogue discussions, intending to reconcile differences among the proposals. Given the active legislative process, it is pivotal to understand that the current CSDDD draft could undergo changes. Nonetheless, the CSDDD’s formal adoption is anticipated before 2023 concludes. Once ratified, EU member states will have two years to transpose the directive into their domestic law. In Germany, this will likely necessitate modifications and expansions to the LkSG.

The CSDDD, when compared to Germany’s LkSG, introduces further requirements, which we will explore in this blog post. Key distinctions in the European Parliament’s CSDDD draft include:

  • Broadening the scope of affected entities.
  • Extension of the covered supply chain.
  • Enhanced liability paired with stricter sanctions.
  • Further focus on climate considerations.
  • Management’s personal responsibility and variable compensation.

Delineating the Changes Between CSDDD and LkSG

Scope Expansion Under CSDDD

Many more businesses will be covered by the CSDDD than by the German LkSG. Approximately 13,000 companies inside the EU and approximately an additional 4,000 companies incorporated outside the EU are in scope. The CSDDD encompasses both EU-based companies and companies from third countries, provided certain thresholds of employees and turnover are met.

For companies constituted under the laws of EU member states, the directive applies if the company falls under Group 1 or Group 2:

In contrast, the German LkSG has no turnover threshold and applies from 3,000 employees, which will reduce to 1,000 as of 2024.

Both the LkSG and CSDDD address non-EU companies. The LkSG applies to non-EU companies with a German branch employing at least 3,000/1,000 employees. In contrast, the CSDDD draft targets companies even without an EU presence, provided they meet the relevant turnover thresholds within the EU:

From Supply Chain to Comprehensive Value Chain

Also in its scope of examination, the CSDDD goes beyond the LkSG. The term supply chain as defined in the LkSG is limited to due diligence measures within the company’s own business area and its suppliers. However, the CSDDD broadens this scope to the entire value chain. This means due diligence requirements will cover a company’s own business activities, as well as those of its subsidiaries, extending to both the upstream and downstream sections of value chains.

  • The upstream value chain includes all activities of a company related to product manufacturing, such as raw material extraction, and provision of services.
  • The downstream value chain includes all activities conducted by business partners regarding distribution, transportation, storage, and disposal.

New Liability Risks and Stricter Sanctions

A glaring divergence between the two legislations arises in civil liability. While the LkSG explicitly excludes civil liability, it is included in the current CSDDD draft. The idea behind it: ensuring an even more effective enforcement of due diligence obligations. The CSDDD draft enables affected parties to directly file claims against companies for damages stemming from human rights violations or environmental harm within the value chain. Sanctions in case of violations of due diligence obligations have already been the case under the LkSG in Germany. However, with the CSDDD, these sanctions extend further. They may include fines of up to 5% of the annual group turnover, public disclosure of the violation naming the company (“naming and shaming”), banning the sale or export of products, and more.

An Intensified Climate Mandate

Both law texts aim to protect human rights and the environment. Yet, the CSDDD adopts a more holistic approach with regard to climate protection due diligence. The European Commissions’ draft required companies to develop plans aligning their business strategies with sustainability and limiting global warming to 1.5 degrees Celsius (Paris Climate Agreement). In the Parliaments’ draft, the obligations go further, demanding a detailed business model and strategy aligning with the EU’s goal of climate neutrality by 2050 and a 55% emission reduction by 2030. Notably, such requirements are absent in the LkSG.

Management’s Role

One of the central points of discussion in the ongoing trilogue meetings concerns the responsibility of company management for sustainability. While the European Commission advocates for stricter accountability, including direct and personal responsibility for putting in place and overseeing the due diligence actions, the European Parliament’s draft weakens these responsibilities.

Another point of discussion revolves around management compensation: A company’s action plan to align its business strategy and model with the 1.5 degree target will also include variable compensation for the company’s management to provide appropriate financial incentives.

The final outcome remains uncertain at this stage, but management is expected to have some oversight role in CSDDD-mandated due diligence – possibly similar to the LkSG’s obligations for staying informed about the results of risk analyses. As the discussions progress, we are closely monitoring the developments.

Practical Takeaway

As we await the European overhaul, Germany’s LkSG has been in force since the beginning of 2023. The LkSG serves as a valuable practice to prepare for the new CSDDD. Companies already compliant with the LkSG’s provisions are well on their way to tackle the CSDDD’s new challenges.

For companies potentially falling within the scope of the new CSDDD, we recommend the following check list to assess alignment with the most important LkSG requirements and readiness for the CSDDD:

  • Has your company established a risk management system that allows for regular risk analyses within the company’s own business area and among its suppliers? With the new CSDDD, risk analysis becomes even more important, serving as the linchpin of supply chain due diligence.
  • Has your company designated a Human Rights Officer or an equivalent to oversee risk management? Are these individuals adequately trained?
  • Does your company have an internal complaint procedure for disclosing human rights and environment-related risks and violations?
  • Has your company issued a policy statement addressing its strategy on human rights and environmental matters?

Time to Make a Move

While the CSDDD and LkSG share foundational similarities, the former introduces noteworthy alterations and tightened standards. These changes span from broadened applicability to comprehensive due diligence obligations, and the introduction of civil liability and heightened environmental obligations. For companies, this shift is a call to action, drawing on lessons already learned from LkSG compliance. With the adoption of the CSDDD on the horizon, Baker McKenzie is here to help. As experts in the field of ESG, compliance and investigations , we are committed to guiding clients through the evolving landscape of corporate accountability in supply chain management.

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Author

Anahita Thoms heads Baker McKenzie's International Trade Practice in Germany and is a Member of our EMEA Steering Committee for Compliance & Investigations. Anahita focuses her practice on global investigations, particularly in the fields of international trade law and data protection. She has significant experience advising on internal compliance programs, accompanying internal and external investigations and self-disclosures in cases of breaches of sanctions, export control and foreign investment review, closely collaborating with the competent authorities. She also has considerable experience in the area of data protection and business and human rights.

Author

Kimberley Fischer is a member of the International Trade Practice in Baker McKenzie's Berlin office. She joined the Firm in 2022. Kimberley studied law at the Ruprecht Karls University of Heidelberg and the Universidad de Deusto (Spain), with a focus on public international law and human rights. Prior to joining the Firm, Kimberley completed her legal traineeship at the Higher Regional Court of Frankfurt am Main, the German Federal Foreign Office in Berlin and at an international law firm in Brussels and Frankfurt am Main. She also gained significant experience in public (international) law as a research assistant at the University of Heidelberg and at a reputable law firm.

Author

Alexander Ehrle is a member of the Firm's International Trade Practice in Baker McKenzie's Berlin office. Alexander studied law at the Universities of Heidelberg, Montpellier (France), Mainz, Munich and New York (NYU) specializing in Public International and European Law. He worked as advisor and member of a delegation of a developing country at the United Nations before qualifying for the German bar. He spent his clerkship with the Higher Regional Court in Berlin, the German Ministry of Foreign Affairs in Berlin and Tokyo as well as an international law firm in Frankfurt and Milan. He wrote his doctoral dissertation on the structural changes of public international law and their conceptualization in academic discourse basing his research on the governance of areas beyond national jurisdiction. Alexander is admitted to practice in Germany and New York.

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