Amid calls for increased accountability by businesses for human rights and environmental breaches, the European Union has set out a proposal for a directive on corporate sustainability due diligence. In-House Perspective assesses the potential impact of such a directive on organisations and the direction of mandatory human rights due diligence more generally.

Recent years have seen growing calls for businesses to be held more accountable for human rights and environmental breaches by themselves and by those in their supply chains, and for standards of corporate governance to be raised.

Many governments have responded positively to such calls, particularly in Europe, where several countries have introduced measures to increase corporate accountability. France, for example, has its Corporate Duty of Vigilance Law, while in Switzerland, there are new due diligence requirements to combat child labour and in regards to minerals and metals from conflict zones. The UK has its Modern Slavery Act; Germany passed its Supply Chain Duty of Care Act in June 2021; and Norway passed its Transparency Act in summer 2021 too. The Dutch adopted a Child Labour Due Diligence Law in 2020, meanwhile, which is due to come into effect in 2022.

Belated action at EU level

It’s therefore perhaps surprising that it took the European Commission nearly a year to publish a proposal for a directive on corporate sustainability due diligence after an outline proposal was approved by the European Parliament back in March 2021.

The delay may in part be due to the Commission’s Regulatory Scrutiny Board – an independent body advising the College of Commissioners at an early stage of the legislative process – giving two negative opinions on the Commission’s draft impact assessment.

Shirley Magniez-Pouget, International Organisations Liaison Officer of the IBA Human Rights Law Committee and a senior business and human rights consultant at DLA Piper, says ‘there has been much controversy about the fact that the European Commission was considering combining human rights mandatory due diligence with new directors’ duties in a single instrument’.

However, EU Member States will indeed be expected to introduce provisions integrating the existing duty of care of directors to act in the best interest of their companies with a need to take into account the consequences for sustainability of their decisions. Directors will also be expected to put in place and oversee human rights and environmental due diligence through the adoption of due diligence policies and engagement with stakeholders, and to adapt their organisations’ corporate strategy to embed human rights and environmental due diligence.

The new directive will require large businesses who do business in the EU to carry out comprehensive due diligence of their operations and direct and indirect business relationships, both in and outside of the EU, and to publish a statement to certify that they have identified no potential or actual risk to human rights or the environment.

Companies must implement a code of conduct and a prevention action plan to minimise the risk of human rights or environmental violations. Within this they should set out a timeline of action, with qualitative and quantitative indicators to measure improvement. They will also need to ensure, through contractual clauses, that their business partners comply with their code of conduct and prevention action plan, while also requiring these partners to apply similar contractual provisions in their own business relationships.

If there’s an adverse impact that can’t be mitigated, businesses can impose a temporary suspension of the business relationship and, if the risk of adverse effects is unlikely to be minimised in the short term, the contractual relationship should be terminated.

Companies will have to introduce a complaints procedure to allow stakeholders – defined widely to include anyone whose rights or interests may be affected by the adverse impact of a company’s business on human rights or the environment – to raise concerns about a potential or actual adverse effect on human rights or the environment and to envisage transparent and clear follow-up activities.

EU Member States will need to designate one or more national supervisory authorities responsible for ensuring compliance with the due diligence obligations. These must have adequate power and resources, and be able to: carry out investigations and request information; order violations to cease; impose interim measures to avoid irreparable harm; impose remedial actions; and impose pecuniary sanctions, based on companies’ turnover.

Small- and medium-sized businesses (SMEs) are excluded from the reach of the legislation. However, their business partners could impose on them contractual provisions according to which they will need to comply with preventive and remedial measures. To this end, the proposal for the directive requires contractual provisions negotiated with SMEs to be fair, reasonable and non-discriminatory.

In a globalised market economy, with fragmented supply chains, market forces do not always have sufficient incentives to protect human rights and environmental values, and legislation mandating a due diligence process for these could force companies to internalise these costs, says Maria Pia Sacco, formerly a senior legal adviser with the IBA’s Legal Policy & Research Unit and a senior legal advisor with RP Legal & Tax in Italy.

‘This law could also contribute to harmonisation and to legal certainty,’ she adds. ‘A harmonised framework could level the playing field and reduce the regulatory costs for multinationals operating in multiple jurisdictions.’

The idea for the new legislation largely emerged because it was felt voluntary due diligence and national or sectoral legislation are not adequate to tackle recurring issues such as child or forced labour, pollution and corruption.

Indeed, says Abhijit Mukhopadhyay, Committee Liaison Officer on the IBA Corporate Counsel Forum and President (Legal) & General Counsel at London-headquartered Indian conglomerate the Hinduja Group, voluntary measures have not helped in the protection of human rights, leading to some companies failing to protect or even respect human rights or the environment ‘There is still widespread forced and child labour, corruption [and] de-forestation [among other things], which I hope can be addressed going forward with this legislation.’

There seems to have been a positive response to the proposals from civil society, says Ifsa Mahmood, a barrister at Kings Chambers specialising in public and human rights law. ‘It is also reported that many businesses support the legislation as it will help provide clarity and level the playing field.’

Compliance with human rights and environmental standards makes good business sense as it can increase the value and standing of a company, she adds. 

Proponents of this legislation say it’s necessary for three main reasons, says Sarah Ellington, a legal director at DLA Piper. ‘It will provide legal certainty and harmonisation of on-the-rise fragmented legal obligations across the EU; create a level playing field for companies operating in the EU; and help companies enhance their leverage throughout their value chains.’

She warns, however, that if corporates are increasingly expected to integrate environmental, social and governance (ESG) issues into business strategies, legislation that would force European companies to meet unrealistic expectations and obligations could be counter-productive. 

‘The European Parliament’s resolution on a proposed text for the directive included, for example, a provision for full traceability throughout the entire supply chain,’ says Ellington. ‘At the moment, even the most ESG-savvy businesses are still heavily dependent on mass-balance systems and very few have mapped past tier 1 or tier 2 suppliers,’ she adds.

The biggest benefits of the legislation are that it’s comprehensive and will be implemented alongside a number of enforcement measures, says Mahmood. ‘The due diligence duty will require a company to consider its entire “value chain” which is a broad concept and includes entities with which a company has direct and indirect business relationships.’

Meanwhile, the creation of civil liability for companies will provide much needed access to justice for victims, believes Mahmood. ‘The legislation will therefore enable better engagement with human rights due diligence which should have a much more central role in the activities of a company,’ she says.

On the downside, she adds, given the scope of the due diligence regime envisaged, ‘it is likely to require structural change in companies, and states, to ensure the compliance and monitoring systems that meet the requirements of the proposed directive are in place; this may place a considerable burden on SMEs’.

Subhead: The complexities of compliance

In the context of increasing human rights due diligence laws at the national level, companies are required to respect a multiplicity of human rights with related but distinct legal requirements, says Magniez-Pouget. ‘This trend toward due diligence laws is, in turn, raising concerns about increasing reporting costs and diverting resources away from tackling the issues themselves.’

Cumbersome due diligence reporting requirements are likely to draw away the necessary resources for embedding authentic rights-respecting cultures in companies, create a box-ticking mentality and be a sticking point for the legislation’s effectiveness, she says.

‘Human rights due diligence is not solely a reporting exercise: it is a journey,’ adds Magniez-Pouget. ‘It requires a shift away from traditional risk management strategies to a focus on rights and the perspectives of those who may be affected by the operations of the company. Innovative approaches are often needed to address the root causes of issues, whose success often depends on a number of externalities.’

For Magniez-Pouget, forcing a strict regulatory regime on businesses risks a situation where responsible businesses withdraw from ‘difficult’ jurisdictions, rather than putting in place long-term solutions to make a positive difference.

To be effective, says Sophie Kemp, Head of Public Law at Kingsley Napley in the UK, the proposed directive will need to follow through on its promise of real, dissuasive sanctions for non-compliance.

The most likely sticking point will be the extent to which the sanctions are effective. Compliance will be best ensured by a range of flexible sanctions, which the proposed EU directive envisages, she says, given the combination of sanctions and civil liability that has been put forward. By way of comparison, ‘The UK’s Modern Slavery Act has been criticised for its lack of “teeth” due to an absence of remedy for non-compliance,’ she explains.

Mahmood agrees that what’s proposed – sanctions of penalties issued by independent monitoring bodies within states – will be an important tool to ensure effectiveness, and that penalties should be sufficiently onerous to encourage compliance.

Of particular importance, however, is the civil liability of companies that have failed to act in line with their due diligence obligations and have caused or contributed to the harm that arises from this, she says. ‘The opportunity to take companies to court in the EU will offer victims a direct avenue for redress. It will be important to ensure the evidential obligation for victims is not too onerous; there have been interesting suggestions relating to rebuttable presumptions in favour of victims which requires companies to prove they have acted in line with their due diligence duties. Additionally, victims should be given sufficient time to bring their claims.’

She says the legislation should include detailed rules, backed by clear guidance, as to the requirements of a company’s due diligence regime, to ensure legal certainty for both companies and those affected by their activities.

‘Regarding the content, there should be an emphasis upon stakeholder involvement in the design and implementation of a company’s due diligence regime,’ says Mahmood. ‘There should also be a focus upon transparency through strict monitoring and reporting obligations on companies. In my view, both of these criteria will bolster the demand for preventative measures to be taken by companies.’

Some believe the establishment of national bodies responsible for the promotion of the legislation and the monitoring of its implementation will hold the key to enabling compliance.

‘The French vigilance law [of 2017] did not provide for such a body, leaving monitoring to the civil society only,’ says Magniez-Pouget. ‘Secondly, the French government did not enact an implementation decree for that piece of legislation, which left businesses with many unanswered questions as to what exactly is expected from them.’

She believes that EU Member States will need to dedicate adequate resources to support businesses as they go on their human rights mandatory due diligence journey, including by providing clear guidance, tools and incentives to ensure compliance with the spirit, and not just the letter, of the law.

‘Businesses need a common approach to mandatory human rights due diligence,’ adds Magniez-Pouget. ‘That includes a combination of both principles and rules on key provisions, with clarity on the scope of duty bearers, human rights and environmental obligations covered by the legislation, and the level of due diligence expected as a legal standard of care. The basis on which enforcement action may be taken, and by whom, will need to be set out clearly.’

Due diligence and in-house lawyers

In-house lawyers will have a greater responsibility towards their company when this legislation is introduced, says Mukhopadhyay.

In-house lawyers are already expected to manage compliance issues under existing legislation, he adds, but it would be wise for them to undertake immediate internal due diligence to ensure that if and when the legislation is introduced, all necessary steps have been taken to ensure their business is compliant from the outset.

In-house lawyers should engage with the board to embed the protection of human rights and the environment in their way of doing business, says Sacco. ‘These principles should be reflected in their policies, code of conduct and internal procedures.’

‘Human rights and environmental due diligence should be a process in which companies put at the centre of their actions the protection of people and the planet,’ she adds. ‘Compliance with the law should not be reduced to a checklist approach but will require a cultural shift. In house-lawyers have the privilege to lead this revolution.’

In-house lawyers should act as wise counsellors and look for emerging trends, potential risk – and not only regulatory risk – and opportunities, she says, and for this reason, many in-house counsel may have already started to embed the protection of people and the planet into their work.

‘ESG is the new buzzword and many companies have already reflected these standards, the UN Sustainable Development Goals and the UN Guiding Principles on Business and Human Rights in their policies and practices,’ explains Sacco.

To avoid ‘social washing’ – where companies exaggerate or mislead their credentials in this area – ‘it is important to put the protection of people and the planet at the centre of the business activity, to engage with stakeholders and local communities and to be transparent about what has been done and what needs to be improved,’ she says.

Due diligence is an ongoing process, which requires the identification of risks and adverse effects, and the adoption of measures to mitigate or address these risks. ‘The paradox of this process is that, especially at the beginning […] and more generally in complex value chains, zero risk is not necessarily a good sign,’ explains Sacco. ‘It may be the result of a lack of commitment and fear of looking deep enough. It takes vision to understand that!’

With the proliferation of legally binding due diligence requirements and torts liability laws, the management of human rights risks is shifting from corporate social responsibility, procurement and operations to legal departments, Ellington says. ‘Human rights have become a legal issue. In-house counsels of large companies, alongside other business units, and with the support of external counsel, are already engaged in the management of human rights risks.’

The proposed EU legislation is likely to build on existing soft law norms, such as the UN Guiding Principles on Business and Human Rights and the Organisation for Economic Cooperation and Development Guidelines for Multinational Enterprises, as well as current national laws, she says. Legal departments would therefore be well advised to anticipate regulatory developments and strengthen their internal systems of control to ensure human rights harm to affected stakeholders is prevented, and so that the standard, when it comes into force, is less onerous.

In practice, this can involve, for example, mapping of supply chains; identifying and assessing actual and current human rights risks including through meaningful and ongoing stakeholder consultation; integrating the findings of the human rights impact assessment into internal and external systems of controls; taking actions to prevent and mitigate risks, including by exercising leverage to mitigate the impacts where the business is not able to directly control them; establishing non-judicial grievance mechanisms in line with the effectiveness criteria set out in the UN Guiding Principles on Business and Human Rights; and tracking and reporting on the effectiveness of the responses.

The proposed directive would, in the short-term, present an additional burden for in-house lawyers as they get to grips with the requirements, says Kemp, although it’s difficult to anticipate the exact level of that burden before the proposal is finalised.

‘However, in the medium-longer term, the corporate community has made a number of calls in favour of mandatory legislation that creates a level playing field for companies, harmonises requirements and provide legal certainty,’ she says. ‘Corporates often find it difficult to navigate between the requirements of soft and hard law and between the current disparate standards. This takes up both time and resource. The proposed directive [aims to] harmonise standards.’

In-house lawyers should ensure that policies regarding human rights and ESG are developed and embedded within the organisation, she says. ‘A proactive “culture of compliance” is best, which ultimately requires buy-in from conscious stakeholders around the organisation. Stakeholders should have a good understanding of the risks posed by non-compliance and the opportunities posed by having a strong grasp of the standards.’

Although there are already measures to prevent money laundering, corruption, modern slavery, and other ills in jurisdictions around the world – which are no doubt being complied with – new legislation at EU level is still needed, believes Mukhopadhyay. ‘Separate legislation backed by proper reporting of existing non-compliance will definitely lead to a better world, as we have a duty towards future generations to come [to] leave behind a healthy and peaceful world with enough resources,’ he concludes.