The clock starts ticking for companies following approval of the corporate sustainability due diligence directive

The EU corporate sustainability due diligence directive reached the end of a long and intricate legislative process at European institutions on May 24. All that remains now is its publication in the EU Official Journal (OJ) and its entry into force 20 days later. This much-debated and complex act which is highly impactful for companies was materially amended in the final stage of the legislative process.

With the aim of clarifying a few key elements of the approved wording, in the Sustainable Garrigues Dialogs, Garrigues partners Eva Díez-Ordás and Cecilia Rosende discussed the main issues in the European directive together with José María Campos, head of the Legal Department of the Spanish Employers’ Confederation (CEOE) and chair of the Legal Affairs Committee at Business Europe, at a roundtable introduced by Sergio González Galán, corporate/contract law, and M&A partner at Garrigues.

In his presentation speech, González Galán underlined the key issues that were later discussed in the Dialog, such as the directive’s scope of application, the involvement of stakeholders or the liability regime.

Aware of the worry this directive is causing for impacted companies, González Galán emphasized that, at least, it has avoided a wide range of legislation that would have been approved by each EU country in the absence of a common directive. This issue was also discussed by José María Campos, who noted that a key moment is approaching: uniform transposition of the directive across the various EU member states. And he mentioned he was pleased that the directive’s negotiations had finally produced a single market clause protecting certain articles of the directive to ensure that they are transposed uniformly in every country.

New obligations for companies

Eva Díez-Ordás, labor and employment partner at Garrigues and member of its ESG Committee, recalled the two essential obligations that the directive sets out for in-scope companies: to carry out risk-based due diligence and adopt a transition plan for climate change mitigation.

On the specific requirements in the new rules, Campos highlighted the commitment and efforts made by European companies to protect human rights and the environment, and stressed that the appropriate forum for the adoption of these measures are multilateral organizations, given that, otherwise, the international activity of European companies will be governed according to different rules from the rest, which could mean a competitive disadvantage on global markets compared with companies from other jurisdictions under different regulations.

Indirectly impacted companies

Campos introduced another important point: how the directive impacts companies not included in its scope themselves but operating with companies having to comply with its obligations. This is precisely where the “chain of activities” concept (downstream and upstream partners) comes into play to ensure that the obligations are observed by all companies interacting with in-scope companies. It is innovative and one of the most highly debated issues in the directive.

Campos explained that in-scope companies must ensure that every company in the chain of activities is in compliance, which could have a strong impact for small and medium sized companies. Díez-Ordás wondered whether these companies that are going to be impacted indirectly are fully aware of everything that this implies and are ready to confront the challenge.

Campos highlighted the importance of making things easy for them by drawing up guidance and mapping risks. CeciliaRosende, conflict resolution partner in the Garrigues Litigation and Arbitration Department, recalled that the European Commission is going to draw up standard contractual clauses that may be included in contracts, along with guidelines to assist companies. These clauses and guidelines may come too late, however, bearing in mind that the directive gives a 30-month time limit for producing them.

A best-efforts rather than a results obligation

Rosende affirmed that liability for companies is one of the directive’s star measures, although not every breach is going to give rise to liability: only if the company breaches its obligations to prevent and bring impacts to an end, and where it has not acted diligently.

She recalled in this respect that companies’ obligations to identify prevent, mitigate, bring to an end and remedy adverse human rights and environmental impacts is a best-efforts rather than a results obligation. Rosende noted that what a company has to be able to evidence is that it has been diligent and, if an adverse effect is identified, it must endeavor to bring it to an end.

Controversial penalty rules

The penalty rules in the EU directive have also sparked debate. Campos regretted that instead of being applied on the harm caused, the penalties were going to take the form of a fine equal to 5% of the parent company's worldwide net consolidated turnover. In his words, “this breaks down the relationship between conduct and harm”. He also explained that it should have been taken into account, for example, that not all industries have the same profit margins on their sales, which means that penalties based on a percentage of their turnovers will have varying impacts.

Exclusion of the financial industry and inclusion of franchises

Campos also welcomed the fact that the financial sector was finally excluded from the obligation to carry out due diligence on its "downstream" clients, among other issues, due to the enormous difficulty involved in controlling all the business of its clients, who carry out activities outside the financing itself, which, in his opinion, would have meant a significant loss of competitive advantage compared with finance providers in countries outside the EU.

Another prominent innovative feature of the directive is the inclusion of franchises in the scope of the act at the end of the legislative process, as Rosende recalled.