Pressure mounts on EU regulator to deliver on Mandatory Human Rights, Environmental and Governance Due Diligence

On 10 March, the European Parliament (the "Parliament") passed a legislative initiative¹ (the "Parliament Initiative") for an EU directive on Mandatory Human Rights, Environmental and Good Governance Due Diligence ("MHRDD") for companies operating in the EU. This step by the Parliament puts pressure on the European Commission ("Commission") to move forward and propose a formal Proposal, which once adopted by the Parliament and the Council (representing the 27 Member States) will ensure that EU rules on MHRDD will be in place.

Although not binding on the Commission, the Parliament Initiative gives an indication of the substantive and procedural issues that the Commission will address in its formal legislative Proposal expected within Q2 2021.²

Sustainability on the European agenda

The Parliament Initiative follows a year of increased political discussions, in Europe and worldwide, on the need for a more sustainable and responsible economy and society where Environmental, Social and Corporate Governance ("ESG") is an integral part of companies' long-term business strategies.  It also follows the EU Green Deal, EU Non-Financial Reporting Directive, EU Conflict Minerals Regulation and EU Timber Regulation, all recognising the impact that companies operating in the EU can have on environment and society both within and outside of the EU.

International organisations, including the UN³  and the OECD,⁴  provide non-binding principles and standards on responsible business conduct that companies can endorse on a voluntary basis. EU rules on MHRDD would require companies to carry out risk assessments of their value chains and address any identified human rights, governance and environmental issues, with enforcement mechanisms and sanctions, and the increased risk of liability and damages in private litigation, giving "teeth" to such rules.

The legislative momentum for an MHRDD regime in Europe was set in motion in February 2020 by the "Study on due diligence requirements through the supply chain"  prepared for and published by the Commission, and accelerated in April 2020 when the Commissioner for Justice, Didier Reynders, announced that the Commission would publish a proposal for EU legislation on MHRDD in 2021.⁶  The Commission launched a public consultation which resulted in over 100 feedback submissions,⁷  highlighting the wide attention the legislation is gaining. The Parliament, committed to holding Commissioner Reynders to his word, has been leading the charge: in September 2020, its Committee on Legal Affairs issued the report,⁸  which has just been adopted by a very clear majority⁹  as the Parliament Initiative. The Parliament Initiative increases the pressure on the Commission to deliver a legislative proposal within Q2 2021, as promised. 

The Parliament Initiative sets out wide obligations and liabilities

The Parliament Initiative takes the form of a directive, which also appears to be the route the Commission will adopt. Unlike a regulation that is applicable in Member States immediately upon entry into force, a directive must be transposed into national law in order to be applicable. This gives each Member State a certain degree of flexibility in incorporating the directive in national law.    

The Parliament Initiative has two main pillars: (a) obligations for companies to conduct due diligence, and (b) rights for individuals and stakeholders to hold companies liable for non-compliance. 

Obligations on companies to take responsibility for their supply chains

"The exercise of due diligence requires undertakings to identify, assess, prevent, cease, mitigate, monitor, communicate, account for, address and remediate the potential and/or actual adverse impacts on human rights, the environment and good governance that their own activities and those of their value chains and business relationships may pose."¹⁰

The due diligence obligation requires companies to get to know their supply chains in detail and understand the risks that may be posed to: 

• human rights, including rights recognised in the Charter of Fundamental Rights of the European Union human rights and various other charters and conventions related to social rights, trade union activities and investment chains; 
• the environment, such as the impact on climate change, deforestation, water quality, the sustainable use of natural resources, biodiversity and ecosystems; and
• good governance, including corruption, bribery, illegal campaign contributions and non-compliance with local tax legislation.

The Parliament proposes a wide definition of value chains catching all business and investment activities including direct and indirect business relationships upstream and downstream.¹¹

The obligation would apply to all large companies operating in the EU. This includes private or state-owned companies operating under the law of a Member State, established in the EU or operating in the internal market. Further, the obligation would apply to publicly listed or "high-risk" Small and Medium-sized Enterprises ("SMEs") and companies providing financial services and products.¹²  

MEP Lara Wolters (S&D) recently¹³ noted that the due diligence obligation asks companies for their best efforts, and would not require an examination of every millimetre of their value chains and is not a "tick-box" exercise. As such, the Parliament Initiative would be about preventative measures, best practices and developing strategies requiring "companies to take proportionate measures based on the likelihood and severity of the impact, the sector of activity, the size and length of the value chain and size of the undertaking".¹⁴ 

Rights for individuals and stakeholders to hold companies liable for non-compliance

To put pressure on com panies to comply with the due diligence obligations, and to provide a remedial route for individuals and communities to seek damages, an MHRDD legislation will very likely include a liability regime. 

The Parliament Initiative provides that remedies would be set out at Member State level, in accordance with national law and "companies should be held liable for their actions and be fined for causing harm or contributing to it, unless they can prove that they have acted in line with due diligence obligations and taken measures to prevent such harm".¹⁵

The presumption of harm is in favour of the victim. Although the Parliament Initiative recognises that there needs to be a certain level of causation to create liability, it is evident that companies will need to have a good knowledge of their supply or "value" chains and a well-documented due diligence with measures to avoid harm in order to exculpate themselves. Importantly, simply performing due diligence as such will not relieve a company from potential liability. 

A national authority would be responsible for supervising and enforcing the rules. In addition, the Parliament Initiative envisages a regime which would include fines ("comparable in magnitude to fines currently provided for in competition law and data protection law"), and temporary or indefinite exclusion from public procurement, State aid and public support schemes, including schemes relying on Export Credit Agencies and loans. 

The Parliament Initiative further proposes that companies shall implement a grievance mechanism whereby stakeholders can "voice reasonable concerns regarding the existence of a potential or actual adverse impact on human rights, the environment or good governance". ¹⁶ Companies may be allowed to comply with the requirements by collaborating through "multi-stakeholder grievance mechanisms" or joining a Global Framework Agreement.

The Commission has indicated¹⁷ that it is considering a similar mechanism of two systems for liability: 

•  A civil liability regime; and
• An administrative enforcement system that would include sanctions applied at national level by national authorities. 

The Commission's Proposal would aim to clearly explain the remedies that Member States can impose.

Application to SMEs

Inclusion or non-inclusion of SMEs in the EU's future measures has been a frequently debated topic. In light of the Parliament Initiative, and following remarks by the Commission, it seems likely that certain SMEs will be subject to MHRDD as well. One of the main objectives of MRHDD legislation is to create a level playing field across the EU. This has two implications with respect to the scope: (i) the inclusion of non-EU companies and (ii) the inclusion of both large companies and SMEs. 

However, with respect to the principle of proportionality, the Parliament proposes that the rules should only apply to publicly listed SMEs or to SMEs operating in high-risk sectors.¹⁸  The latter may include industries with significant impact on human rights, the environment and good governance, such as the garment industry. Further, the Parliament Initiative suggests that SMEs shall be provided with specific guidance and technical assistance to facilitate compliance. 

Some stakeholders have proposed that the Commission should issue a list of "allowed" countries where SMEs may operate without conducting mandatory due diligence. The argument against such a mechanism is that adverse environmental impact, and human rights violations, are widespread and can exist in all countries. 

Conclusions and takeaways

There is no doubt that the winds are blowing in the direction of change in Europe, requiring a more responsible and sustainable approach to doing business in Europe and in third countries. A number of countries have their own measures already adopted or in the pipeline; for example, the French Duty of Vigilance Law¹⁹  and the currently proposed German Supply Chain Act.  The UK Government indicated that it would work towards strengthening the requirements under the UK Modern Slavery Act,²⁰ including reporting on modern slavery risks in supply chains (see here).²¹

At EU level, legislation is coming soon. The Commission intends to present its formal legislative Proposal in the coming months. The timetable being aimed for is adoption in 2021 and a possible entry into force in 2023, depending on the legislative act adopted, and further implementation required. There are a number of issues the Commission must resolve in its proposal, in particular, ensuring the proportionality of potentially burdensome due diligence requirements for the different companies covered and determining how companies should be held liable for harm by means of private actions, while at the same time ensuring an acceptable degree of legal certainty. 

A critical issue is the potential impact of MHRDD rules on companies, in particular the administrative and financial burden, as well as the impact on the overall economic growth in the EU. Studies including a recent report by the Financial Times Moral Money Forum have examined the negative effects of a short-term corporate governance approach ("short termism") on the long-term economic, environmental and social sustainability of companies. A general conclusion is that a more long-term corporate governance approach with a "retain-and-invest" strategy, such as that promoted by MHRDD legislation, may have a positive impact on corporate and financial performance ("CFP") and benefit the long-term productivity and competitive advantage of companies.  Other studies have shown that firms that had invested in ESG strategies and activities before the COVID-19 pandemic were more resilient to the economic crisis that it caused.  A justification invoked by the EU Institutions for legislation introducing MHRDD is that this would require companies to focus on long-term CFP and be better prepared for future crises. To limit the administrative and financial burden, the Commission has indicated that it aims to find a balance between MHRDD requirements and cost to individual companies and the EU as a whole. 

The Commission must also ensure that the new legislation fits with the current obligations set out in EU law, such as the Non-Financial Reporting Directive.  The EU law adopted is likely to be broader than existing national regulations, and will apply in addition to national requirements. Companies operating in EU countries will have to comply with the stricter requirements in force, whether based on national or EU requirements. 

Although the Commission's proposal is yet to be agreed, both in form and substance, and is bound to be subject to substantial discussion and amendment by the Parliament and Council before final adoption, nevertheless the newly adopted Parliament Initiative gives a valuable preview of the EU measures which are on the table. 
 

_{1 European Parliament, Corporate due diligence and corporate accountability European Parliament resolution of 10 March 2021 with recommendations to the Commission on corporate due diligence and corporate accountability (2020/2129(INL)), ("Parliament Initiative").
 The European Parliament's Right to Adopt Legislative Initiatives:
Although the European Commission holds a near exclusive right to propose new EU legislation, the Parliament and the Council may adopt legislative initiatives calling for the Commission to issue a legislative proposal. A legislative initiative does not oblige the Commission to act and propose the legislation requested. However, the Commission must justify a refusal to follow the Parliament's initiative.
2 European Commission, Initiative on Sustainable Corporate Governance.
3 UN Guiding Principles on Business and Human Rights, 2011 ; UN Principles for Responsible Investment.
4 OECD Due Diligence Guidance for Responsible Business Conduct, 2018; OECD Due Diligence Guidance for Responsible Business Conduct and OECD Guidelines for Multinational Enterprises, 2011.
5 European Commission, Study on due diligence requirements through the supply chain.
6 RBC Webinar, 29 April 2020.
7  European Commission, Initiative on Sustainable Corporate Governance.
8 Increased human rights supply chain scrutiny with UK and EU legislative proposals.
10 Article 1(2), the Parliament Initiative. 
11 Article 3(5), the Parliament Initiative.
12 Article 2, the Parliament Initiative. 
13 Euractiv Webinar – Towards a mandatory EU system of due diligence for supply chains – realities and consequences, 9 March 2021.
14 Parliament Press release, MEPs: Companies must no longer cause harm to people and planet with impunity, 11 March 2021 
15 Parliament Press release, MEPs: Companies must no longer cause harm to people and planet with impunity, 11 March 2021 and Recital 26 of the Parliament Initiative. 
16  Article 9, the Parliament Initiative.
17 Lucrezia Busa, Member of Commissioner Reynders' Cabinet, European Commission at the Euractiv Webinar – Towards a mandatory EU system of due diligence for supply chains – realities and consequences 9 March 2021.
18  Article 2(3), the Parliament Initiative. 
19 Loi n° 2017-399 du 27 mars 2017 relative au devoir de vigilance des sociétés mères et des entreprises donneuses d'ordre
20 The Federal Government, Supply Chain Act (Lieferkettengesetz), Greater protection for people and the environment in the global economy
21 See also the UK Home Office's requirements for publishing a modern slavery stated as updated by guidance issued in March 2021}

Aron Senoner (Associate, White & Case, Brussels) contributed to the development of this publication.

_{White & Case means the international legal practice comprising White & Case LLP, a New York State registered limited liability partnership, White & Case LLP, a limited liability partnership incorporated under English law and all other affiliated partnerships, companies and entities.}

_{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.}

_{© 2021 White & Case LLP}