Luxury and ESG: Navigating the New EU Legal Landscape in the Fashion and Luxury Goods Industry

Due to the increased importance of sustainability, environmental protection and social factors in recent years, the luxury industry has found itself at a crossroads of tradition and transformation. Once characterized primarily by exclusivity, creativity, craftmanship and heritage, the sector is now increasingly influenced by the global push towards a sustainable lifestyle and ethical practices. It is not only consumer awareness and changing consumer behavior towards sustainability, which influence companies' strategic decisions and reshape investor expectations. It is also the governments and regulators, which introduce new laws, as well as new liability regimes, which impose significant pressure on the luxury industry. It is essential for companies operating in the fashion and luxury goods sector to adhere to the new legal requirements and compliance standards and at the same time maintain the brand prestige and profitability. Product sustainability is increasingly becoming a value-creating factor throughout the entire life cycle of a product. From sourcing and production to product characteristics and final disposal—both consumers and investors are willing to invest in companies or products that are both luxurious and ethical.

Environmental and Social Responsibility and Legal Challenges

The Fashion Industry has a major impact on the environment and human rights. The apparel sector is—according to the European Environment Agency ¹—responsible for approximately 10% of the global CO2 emissions, more than international flights and maritime shipping combined. Textile production account for approximately 20% of polluted water worldwide. Washing synthetic clothing, for example, is responsible for 35% of all primary microplastics released into the environment which measures up to a release of an estimated 0.5 million tons of microfibers into the ocean every year. In addition, especially the sourcing of various raw materials entails negative environmental and social impacts. In the EU, only 1% of used clothes are recycled into new clothes.

EU legislation aims to address the adverse environmental and social impacts, with a number of strategic and legislative initiatives to reduce harm and waste and improve the circular economy². and. Although some luxury brands already support the fight against pollution, climate change and social inequalities through various measures, the increasingly strict EU Legislation creates major challenges and liability risks for the industry as a whole³:

Greenwashing (Green Claims Directive & CSRD)

Greenwashing describes the practice of creating a false or misleading impression that a company's products, practices or policies are particularly environmentally friendly or sustainable. Put differently: Greenwashing occurs, for example, when companies advertise their products as "greener" than they are. The same phenomenon exists with the terminology "Pinkwashing" for companies who falsely advertise to be LGBTQ-friendly or "Bluewashing" for those who falsely claim a special commitment to responsible social practices, or "ethics-washing" for particular ethical procurement claims.

Attention around Greenwashing has gained massive traction recently in the consumer goods industry—engaging in such practices now entails material risks of legal action, as well as public boycotting. Litigation based on Greenwashing allegations has steadily increased in the last years.⁴ In Germany, for example, the Federal Court of Justice (FCJ)⁵ established a standard for the legitimacy of environmental benefit claims, thereby significantly increasing the legal requirements of including climate neutrality claims in advertisements.⁶ In this case, a German fruit gum producer advertised its products to be carbon-neutral due to the involvement of an external compensation mechanism but, in the court's view, did not sufficiently flag this on its products. The FCJ therefore ruled that the advertisement mislead customers into believing that the production process itself was carbon neutral. The judgment is setting new standards for advertisements and paving the way for potential litigation across industries in Germany. The fashion and luxury goods industry is no exception—given its high-profile and role model function for society, it can be particularly easily affected by Greenwashing allegations.

Across the globe, authorities are seeking ways to tackle greenwashing claims. In the UK, the Competition & Markets Authority published a Green Claims Code⁷ to help businesses comply with consumer protection law. The Australian Competition and Consumer Commission⁸ has published its own principles-based guidance for businesses making environmental claims.

The EU is currently trying to battle Greenwashing through new EU Directives, such as the "Directive to empower consumers for the green transition", which link Greenwashing to collective redress mechanisms, this can be a major financial and reputational risk for a brand. The aim of the directive is to create transparency and ensure informed consumer purchases by guaranteeing that a product is as environmentally friendly as advertised.⁹ The Commission has also proposed a Directive on the substantiation and communication of explicit environmental claims, the so-called "Green Claims Directive". See more here.

Another EU instrument for promoting transparency around the environmental impact of a company is the "Corporate Sustainability Reporting Directive ("CSRD")", obliging companies to publish reports on social and environmental risks they are facing. These obligations to publish include, e.g., information on the resilience of the company's business model and strategy to tackle sustainability risks, plans ensuring the compatibility with the 1.5°C global warming target under the Paris Agreement, and time-bound sustainability targets. Violations of the reporting obligation can trigger substantial fines. For further information on the CSRD and its public enforcement, please refer to our previous Client Alert.¹⁰

Supply Chain due diligence

Compliance with an increasing number of environmental and social regulations and standards is essential but can be challenging for luxury brands, whose complex supply chains usually span multiple countries and jurisdictions.

The new EU Directive on Due Diligence in the Supply Chain (CSDDD)¹¹ obliges companies to engage in due diligence to ensure environmental protection and respect for human rights in every single part of their supply chainUnder the CSDDD, companies must take various steps to manage actual and potential adverse impacts of their activities on human rights and environmental matters, arising from (i) their own operations, (ii) the operations of their subsidiaries, and (iii) the operations of their business partners in their chains of activities. That could include, among other things, the integration of duties of care into company policies and management systems, as well as the identification and evaluation of detrimental Human Rights and Environmental Impacts. Companies are also responsible for assessing the implemented measures' effectiveness. The directive will apply progressively to large companies, and will ultimately be applicable to EU-companies with more than 1,000 employees and a global net turnover of more than EUR 450 million and for non-EU-companies that generate a net turnover of more than EUR 450 million from sales within the territory of the European Union.¹²

Companies need to upgrade their compliance efforts to comply with the new regulation and to ensure that they adopt a risk-based approach to their supply chain, mindful that the CSDDD creates significant potential risks for their reputation and sanctions like fines or civil liabilities. [see our Client Alert here]

Related legislation as well as voluntary initiatives addressing specific issues are rapidly rising up the agenda of responsible supply chain management and sourcing. The CSDDD provides that if a provision of the directive conflicts with another EU legislative act pursuing the same objectives provides for more extensive or more specific obligations, the other act shall prevail. Relevant legislation could include the EU Deforestation Regulation, which targets forest goods including leather and rubber, obliging companies to carry out risk assessments and due diligence to identify the forest source of the product. See our summary here: Companies putting the good on the EU market for the first time should expect scrutiny from private parties, as well as potential confiscation, exclusion from public contracts or fines of up to 4% of the company's EU turnover. In a similar vein, the EU Forced Labour Regulation and US UFLPA focus on forced labour in the supply chain, requiring companies to have clear evidence of supply chain sourcing. Voluntary initiatives also target specific materials, including cotton, gold, precious gems, cashmere and copper.

Packaging

Not only will companies be required to report on their circular resource use under the CSRD, other new rules will also require greater scrutiny of packaging and design. The EU Eco-design for Sustainable Production Regulation (ESPR) entered into force in July 2024 and is the cornerstone of the Commission's approach to more environmentally sustainable and circular products. It sets "ecodesign" requirements for almost all categories of physical goods. In addition, the luxury goods client typically has high expectations of packaging, which will in future have to comply with EU rules adopted by the European Parliament in April 2024 to reduce, reuse and recycle packaging, with a focus on the entire life cycle and a range of sustainability measures from minimum recycled content, reduction of packaging, bans on single use containers in the hotel, restaurant and catering sector by 2030. These rules sit alongside a range of other measures, from the plastic levy to other material-specific rules and voluntary initiatives.

Sustainable Finance Disclosure Regulation (SFDR)

Private equity investors and investment funds also currently focus strongly on ESG criteria and increasingly invest in luxury brands that demonstrate strong sustainability practices. In September 2023, the EU Sustainable Finance Disclosure Regulation (SFDR) came into force, obliging financial market participants to provide information regarding their sustainability risks and the impact of investment products sold in the EU. As a result, many luxury brands are enhancing their CSR and ESG reporting to attract investors pursuing green finance. Reporting can contain the risk of intentional or unintentional Greenwashing, and therefore imply certain types of compliance and liability risks.

Interestingly, as many companies have been struggling to comply with the SFDR standards given that they left substantial room for interpretation, the European Commission is currently re-assessing the SFDR in an effort to identify loopholes and other concerns relating to the EU's fight against greenwashing.¹³ See also here

Financing and M&A in the Luxury Sector influenced by ESG

The increasing societal focus around the importance of sustainability, environmental protection and social factors has not just influenced legislative developments but also led to the appearance of various new business concepts. Investor expectations related to ESG criteria massively influence the financing of a company or a company's products, as well as the M&A market in the luxury industry.

Green Finance

Green Finance encompasses a variety of financial products, including green bonds, sustainable funds and loans that are directed towards projects of a company with positive environmental impact. Green Finance is on the rise and of significant importance also for brands operating in the luxury industry as investor's expectations turn to investing and addressing environmental challenges while also benefiting from the growing demand of sustainable practices.

Green bonds and loans are especially designed to support projects with environmental benefits. A number of luxury goods brands have explored sustainability-linked bonds with a focus on targets around climate goals and raw material certifications, with penalties for failure to achieve the relevant targets.

M&A Transactions involving ESG Criteria

ESG Legislation also plays a major role in M&A transactions as investments in sustainable companies are increasing, especially within the private equity sector, given that compliance with ESG-related requirements is highly relevant to avoid regulatory fines and other major liabilities. Assessment of sustainability risks remains an important criterion in company valuations and acquisition decision-making process. Accordingly, ESG due diligence is now included in various aspects of contract negotiations, e.g., inclusion of legal (sometimes soft) guarantees, affirmative covenants for compliance around sustainability topics, determination of deal breakers, etc. In the same vein, post M&A litigation may also become more relevant as violations of guarantees or misleading statements regarding the sustainability of the company being purchased may result not only in external fines but also in disputes between the parties to the transaction.

Outlook

While the luxury industry faces compelling opportunities to innovate and lead, there are equally substantial ESG challenges. By addressing ESG challenges proactively, luxury brands can build a more resilient and sustainable future and mitigate litigation and reputational risks at the same time, and even identify innovative business models and attractive new business opportunities going forward.

_{1 The impact of textile production and waste on the environment (infographics) | Topics | European Parliament (europa.eu)
2 e.g. Textiles strategy - European Commission (europa.eu)
3 See our previous client alert: https://www.whitecase.com/insight-alert/esg-consumer-retail-industry-key-legal-issues-and-risks.
4 See our previous client alert: https://www.whitecase.com/insight-alert/esg-consumer-retail-industry-key-legal-issues-and-risks.
5 BGH I ZR 98/23.
6 https://www.whitecase.com/insight-alert/german-federal-court-justice-significantly-increases-standard-legitimate.
7 See our previous client alert: UK clampdown on greenwashing | White & Case LLP (whitecase.com)
8 See our previous client alert: ACCC announces its Compliance and Enforcement Priorities for 2024/25 | White & Case LLP (whitecase.com)
9 https://environment.ec.europa.eu/topics/circular-economy/green-claims_en.
10 Mind the Gap: A Comparative Analysis of the CSRD, the CSDDD and the SFDR as Green Deal 2.0 (2024 to 2029) unfolds | White & Case LLP (whitecase.com)
11 https://commission.europa.eu/business-economy-euro/doing-business-eu/sustainability-due-diligence-responsible-business/corporate-sustainability-due-diligence_en.
12 https://commission.europa.eu/business-economy-euro/doing-business-eu/sustainability-due-diligence-responsible-business/corporate-sustainability-due-diligence_en.
13 https://finance.ec.europa.eu/sustainable-finance/disclosures/sustainability-related-disclosure-financial-services-sector_en.}

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_{This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.}

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