Introduction

The highly anticipated Corporate Sustainability Due Diligence Directive (CS3D) is making its way through the first set of trialogues on 8 June 2023 stepping closer to implementation. This legal insight dives further into what the new Directive means for businesses and how it complements current and future regulations. The insight will also give you a better idea of the scope of the new Directive, and how it will apply to business and directors.

What the CS3D means for businesses:

The CS3D aims to foster greater transparency and accountability for companies’ supply chain impacts. The sheer scale and complexity of global supply chains can pose challenges in the identification of human rights and environmental risks. The CS3D aims to clarify company obligations regarding their own actual and potential impacts on the human rights and environment and covers the company’s operations, subsidiaries, and value chain.

The scope of the CS3D remains to be clarified. European Parliament (‘Parliament’) and the European Council (‘the Council’) have offered two potential solutions. As explored below, Parliament has proposed a lower the employee number and turnover threshold, abandoning the concept of high- impact sectors from Parliament’s original proposal. Whereas the Council has opted for a phased-in approach favouring the high-impact sectors.

Parliament scope:

The CS3D applies to EU incorporated companies with 250 employees or more, with a turnover in excess of €40 million. Additionally, the CS3D will apply to those companies that are the parent company with at least 500 employees and generate over €150 million in net turnover.

The rules would only apply to companies created under legislation outside the EU would only apply these rules if the turnover is higher than €150 million, where €40 million was generated within the EU, this includes any turnover generated by third parties with whom the company and/or its subsidiaries have entered into a vertical agreement in the EU in return for royalties. These rules are also applicable where the ultimate parent company with 500 employees or more and matches the turnover as described above.

Council scope:

The Council wishes to impose a phased-in approach over a five-year period. It proposes that three years from implementation of the Directive, very large EU companies exceeding 1000 employees with a €300 million net worldwide turnover will need to comply. Non-EU companies with €300 million net turnover generated in the EU will also be included in the first phase.

Four years after entry into force, the Council’s proposal applies the Directive to Group 1 (all EU limited liability companies with 500+ employees and €150 million and net turnover worldwide).

Five years after implementation the Directive is to be introduced to companies in Group 2 which includes other limited liability companies (operating in defined high impact sectors), with an excess of 250 employees and €40 million in worldwide net turnover would fall into the scope.

Non-EU companies active within the EU with a threshold generated in the EU matching those outlined in Groups 1 and 2.

Defined high-impact sectors:

Article 2.1(b) identifies the following sectors as ‘high impact’:

i) Manufacture of textiles and leather (including footwear products) and wholesale trade of textiles, clothing and footwear

ii) Agriculture, forestry and fisheries and manufacture of food products and raw agricultural materials, live animals, food and beverages.

iii) Extractionofmineralresourcesandthemanufactureofbasicmetaland non-metallic mineral products and fabricated metal products. Including the wholesale trade of mineral resources.

What will the Directive mean for businesses?

The CS3D will make it mandatory for businesses to develop appropriate due diligence frameworks to address their human rights and environmental impacts. It will cover the company’s operations, subsidiaries, and value chain operations carried out by third parties directed by the company. The definition of ‘value chain’ still has to be finalised in the CS3D. The most significant change to the due diligence requirements is the imposition of obligations on companies to provide data and information risks within their value chains which are linked to human rights and environmental impacts. This is relevant when it comes to the assessment of environmental, social, and governance risks and investments.

Under the CS3D, companies are obliged to implement a climate change transition plan in line with new Corporate Sustainability Reporting Directive (CSRD) reporting requirements. This is likely to have a significant impact on businesses. Currently, some businesses fail to account for human rights and environmental impacts across value chains due to lack of access to data and information on these issues. Under the CS3D, where a company fails to comply, they may be liable to pay large fines sanctions. Sanctions have also been discussed but are yet to be introduced into the Directive. The European Parliamentary Research Service (EPRS) has suggested that the maximum limit should not be less than 5% of the company’s net worldwide turnover in the business year preceding the fining decision.

What the Directive means for Directors:

Directors will have to oversee the set-up, implementation and monitoring of due diligence. They must also integrate due diligence into the corporate strategy with consideration of the views of stakeholders. The draft of the Directive Article 25 and 26 outline the Directors’ duties, these are not confirmed yet.
Article 25 introduces a Director’s duty of care. Directives will have to fulfil their duty to act in the best interest of the company and take into account the consequences of their decisions for sustainability matters, including where applicable, human rights, climate change and environmental consequences, including in the short, medium and long term.

Article 26 sets up the overseeing of due diligence. Directors are responsible for putting in place and overseeing due diligence, with due consideration for relevant input from stakeholders and civil society organisations. The directors shall report to the board of directors in that respect.

Parliament has also suggested that it is the Director’s responsibility to oversee the climate change obligations.

What the Directive means for business relationships:

The Directive extends companies’ obligations to their business relationships and requires companies to take steps to manage risks associated with them. This includes contractual assurances to limit or mitigate potential adverse impacts on human rights and the environment. Where adverse impacts on Human Right or environment cannot be avoided, the company is required to refrain renewing existing contracts or entering any new contracts. The Directive is applicable to company’s operations, subsidiaries, (in)direct established value chains.

Administrative supervision:

Member States will designate an authoritative body to supervise companies with Directive compliance. If a company fails to comply, the body will impose proportionate and dissuasive sanctions which could include fines and compliance orders. In order to ensure a coordinated approach, the Commission will set up a European Network of Supervisory Authorities consisting of national body representatives.

Civil liability only covers established business relationships, not negligible or merely ancillary indirect business relationships in the company’s value chain. The CS3D states that companies should not be held liable for failing to prevent or cease harm at the level of indirect business relationships, provided contractual cascading and assurance was used and measures were in place to verify compliance.

Companies would be found liable in circumstances where the verification of compliance or other measures were not adequate to prevent, mitigate or bring to an end or minimise the extent of the adverse impact.

Strengthening due diligence:

The complementary nature of the CS3D extends the applicability of the Directive. The newly introduced CSRD (entered into force January 2023) extended the number of companies originally covered by the Non-Financial Reporting Directive from 11,700 to 50,000. By acting as a corollary to the current Directives and regulations there is greater protection created for the protection of human rights and environmental rights. The CS3D introduces rules on principal, actual or potential adverse impacts relating to the company’s value chain (that is, its operations, products and services, business relationships and supply chain), as well as rules on actions taken, and the result of such actions, to prevent, mitigate or remediate actual or potential adverse impacts.

Furthermore, by complementing the Sustainable Finance Disclosure Regulation and the Taxonomy regulation, the Directive imposes new obligations to disclose data on risks within value chains with respect to human rights or environmental impacts. The CS3D complements existing legislation such as the Prevention of Human Trafficking Directive (2011/36/EU) and the Environmental Liability Directive (2004/35/EU) which introduced sanctions and remediation mechanisms for victims of companies’ impacts. One only shortcoming of these laws is that they fail to impose an obligation on companies to be proactive in their due diligence or monitor their value chains. The CS3D will therefore increase company accountability over value chain impacts significantly.

What are the benefits of the CS3D?

The CS3D has created numerous rules and obligations for companies to comply with. By complying with the Directive business can expect a harmonised EU legal framework which generates greater legal certainty and levels the playing field. By providing necessary data on value chains, greater trust can be generated with business and therefore, generate stronger relationships. In addition to providing necessary information on value chains, businesses will have more oversight of their potential negative impacts on human rights and be able to manage their risks and reputation better.

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