...Scope of the Directive

The Directive extends to both EU and non-EU entities2.  Two types of EU incorporated companies are covered: (a) those with more than 500 employees and a net annual turnover in excess of €150 million; and (b) those with more than 250 employees and a net annual turnover in excess of €40 million (midcap firms) where at least half of that turnover is generated from certain high-impact sectors (such as textiles, agriculture and mineral extraction).3  The Directive only extends to midcap companies after a two year transition period.

Non-EU companies will need to comply with the Directive if they generated: (a) more than €150 million in the EU in the year preceding the last financial year; or (b) more than €40 million in the EU in the year preceding the last financial year (midcap firms), where at least half of the company’s worldwide turnover was derived from the high-impact sectors.4

Due diligence requirements

The Directive requires EU Member States to impose obligations on companies to conduct mHREDD through: (a) integrating due diligence into their policies; (b) identifying actual or potential adverse impacts; (c) preventing and mitigating potential adverse impacts; (d) ending and mitigating the extent of actual adverse impacts; (e) establishing a complaints procedure; (f) monitoring the effectiveness of due diligence measures; and (g) communicating publicly on due diligence.

The scope of the mHREDD obligation extends to a company’s own operations, those of its subsidiaries and its “established business relationships” in the value chain (Article 1). The term “established business relationships” initially seems akin to the concept of “relations commerciales établies” under the French Loi de Vigilance. However, “established business relationship” is defined in the Directive as a “direct or indirect” business relationship “which is expected to be lasting, in view of its intensity or duration and which does not represent a negligible or merely ancillary part of the value chain”. Accordingly, the Directive’s mHREDD obligation extends beyond just those entities with whom the company has a direct contractual relationship (e.g. tier 1 suppliers) to other value chain participants...

...Civil liability

Few provisions will attract as much attention as those which address civil liability. Under Article 22, Member States will be obliged to ensure that a company is liable for damages if it: (a) fails to comply with articles 7 and 8 (which require companies to take action to address actual or potential adverse impacts); and (b) such failure led to damage.

Interestingly, companies will not be liable for damages caused by an adverse impact “arising out of the activities of an indirect partner with whom it has an established business relationship (emphasis added)” so long as the company has taken the specific measures prescribed in articles 7 and 8 of the Directive concerning contractual assurances, unless it was unreasonable in the circumstances to expect that the action taken (including to verify compliance by business partners with a contractual obligation) would be adequate to prevent, mitigate, bring to an end or minimise the extent of the adverse impact.

This incorporates an objective ‘reasonableness’ standard into the defence. While it will be for the relevant courts to determine what is reasonable in all the circumstances, it is clear that companies will not be able to simply incorporate contractual obligations into their contracts with direct business partners without more, relying upon ‘contractual cascading’ to ensure these obligations reach indirect business partners. In many cases, depending on the risks, this will not be reasonable and therefore sufficient for the defence. As noted above, the Directive requires periodic monitoring of the effectiveness of measures put in place...

Directors’ Duties

Under Article 25, Member States will also be required to ensure that directors of EU companies are obliged to take into account sustainability matters including human rights, climate change and the environment in the “short, medium and long term” when fulfilling their duty to act in the best interests of the company.12  Once this provision has been transposed into the domestic law of Member States, non-compliance may lead a breach of directors’ duties.

Timing

The Directive will now proceed through a formal legislative process and will be debated in the EU Parliament and EU Council of Ministers. Once it becomes law, EU Member States will have two years to transpose the Directive’s requirements...