On 14 December 2023, the two EU co-legislators, the Council of the EU and the European Parliament, provisionally reached an agreement on the Corporate Sustainability Due Diligence Directive (CS3D). In essence, the Directive sets out an obligation for companies to comply with human rights and environmental due diligence and provides for an enforcement mechanism with penalties and civil liabilities for non-compliance. The Directive will apply to both EU and non-EU companies that meet certain thresholds with respect to turnover and number of employees. Below, we explain the key elements of the provisional agreement.

Background

On 23 February 2022, the European Commission presented a legislative proposal of CS3D. The Council adopted its General Approach on 1 December 2022 and the Parliament adopted its position on 1 June 2023. Following intensive inter-institutional negotiations, the two EU co-legislators, the Council and the Parliament, reached a provisional agreement regarding certain thorny issues, as explained below, on 14 December 2023. However, since technical negotiations on the final details are still ongoing, certain elements of the Directive may change. The legal text is not publicly available at the time of writing this alert. 

Key elements of the agreement

Scope (companies): The Directive will apply to both EU companies and non-EU companies that meet certain thresholds with respect to turnover and number of employees.

  • EU companies incorporated under the laws of EU member states:
    • EU companies with more than 500 employees and a net worldwide turnover of more than €150 million (large companies).
    • EU companies with over 250 employees and a net worldwide turnover of more than €40 million if at least €20 million is generated in one or more high-risk sectors (e.g., textiles, agriculture).
  • Non-EU companies incorporated under the laws of a non-EU country: Non-EU companies with a netEU-wide turnover of more than €150 million. The Directive will only become applicable to these companies three years after the entry into force of the Directive, and the Commission must publish a list of the non-EU companies that fall under the scope of the legislation.

Small and medium-sized enterprises (SMEs) remain excluded from the scope of the Directive, but could be indirectly affected by the due diligence conducted by the companies under the scope.

Scope (chain of activities): Due diligence obligations will apply to companies’ own operations, those of their subsidiaries, and those of their business partners. In other words, the Directive covers chain of activities that companies engage in themselves or through upstream and downstream partners. Due diligence on downstream partners seems to be limited to transport, storage and disposal of products with the exemption of the sale of products.

Financial sectors: Financial sectors are covered by the Directive, but only with respect to their upstream partners. The agreement temporarily excludes financial services from conducting due diligence on downstream partners (i.e., customers). However, as a compromise, a review clause was added to be able to include downstream partners in financial sectors in the scope based on a “sufficient impact assessment”.

Climate change: Companies will have to adopt and put into effect, through best efforts, a transition plan for climate change mitigation to ensure that their strategy is compatible with limiting global warming to 1.5°C. Companies with more than 1,000 employees could link additional financial incentives, such as variable remuneration, to the fulfilment of the climate change mitigation plan.

Civil liability:  Companies will be liable for breaching due diligence obligations and victims will have the right to be compensated for damages. However, the liability will be limited to where damages were caused by companies’ intent or negligence. Those concerned by adverse impacts, including trade unions or civil society organisations, may bring claims within five years. The provisional agreement limits the disclosure of evidence, injunctive measures and costs of proceedings for claimants.

Penalties: EU Member States will designate a supervisory authority for the enforcement of the Directive. The national authorities will exchange best practices and cooperate at EU level within the European Network of Supervisory Authorities established by the Commission. They will be able to launch investigations and impose penalties on non-compliant companies, including “naming and shaming” and fines of up to 5% of their net worldwide turnover. If a company fails to pay fines, several injunction measures could be taken.

Public procurement: Compliance with the Directive could be qualified as a criterion for the award of public contracts and concessions.

Directors’ duties: The directors’ duties, which were stipulated in Article 25 (Directors’ duty of care) and Article 26 (Setting up and overseeing due diligence) of the Commission proposal, have been deleted.

Looking ahead

After technical negotiations, the Council and the Parliament will officially adopt the final text, which is expected to take place in the first quarter of 2024. Once the Directive enters into force (i.e., 20 days after its publication in the Official Journal of the European Union), the EU Member States will have two years to transpose the Directive into national law.

Mandatory supply chain due diligence in the EU

Various supply chain due diligence schemes already govern the placing of goods on the EU market, and several more are currently being adopted by the EU. In the context of the EU Green Deal, Carbon Border Adjustment Mechanism (CBAM), Deforestation Regulation and Battery Regulation entered into force in 2023. The EU is also currently working on Forced Labour Regulation. Other supply chain due diligence schemes are already in force, including Conflict Minerals Regulation, Timber Regulation,  Forest Law Enforcement, Governance and Trade (FLEGT) Regulation and Kimberley Process Certification Scheme for conflict diamonds. All of these schemes have one important thing in common: they all require manufacturers to obtain detailed information from their suppliers and from importers to know how the products they place on the EU market have been manufactured and be able to present documentary evidence to demonstrate it.

Selected list of our publications on due diligence

Any questions? Please do not hesitate to get in touch with Reed Smith’s trade, environment and ESG teams in Brussels or Munich Office, or your usual contact at Reed Smith.