Provisional agreement reached on EU Corporate Sustainability Due Diligence Directive – Christmas gift or lump of coal for U.S.-based multinationals?

Yesterday, the European Council and the Parliament reached a provisional agreement on the Corporate Sustainability Due Diligence Directive (CS3D), after a grueling 18-hour session.

The CS3D is mandatory human rights due diligence legislation. It aims to enhance the protection of the environment and human rights in the EU and globally. The Directive will set obligations for thousands of companies – including U.S.-based multinationals and their EU subsidiaries – in respect of actual and potential adverse impacts on human rights and the environment. 

In this post, we describe the contours of the provisional agreement reached based on official press releases, secondary sources and our conversations with people in the know.

The Directive was proposed by the European Commission in February 2022, as described in our earlier Alert.

Subject entities

The Directive will apply to EU companies that have more than 500 employees and a net worldwide turnover of €150 million. 

Non-EU companies will be picked up if they have €300 million of net turnover generated in the EU. The Directive will apply to these non-EU companies three years after the Directive enters into force (analogous to the extended non-EU company phase-in period under the Corporate Sustainability Reporting Directive). The European Commission will be required to publish a list of non-EU companies that come within the scope of the Directive. 

The Directive also will also apply to EU companies with over 250 employees and turnover exceeding €40 million if at least €20 million is generated in one of the following sectors designated as high risk:

• manufacture and wholesale trade of textiles, clothing and footwear;
• agriculture, including forestry and fisheries;
• manufacture of food and trade of raw agricultural materials;
• extraction and wholesale trade of mineral resources or manufacture of related products; and
• construction.

The Directive also will apply to non-EU companies and parent companies with equivalent turnover in the European Union.

The financial sector – banks, insurance companies and asset managers – will have a limited due diligence obligation, reportedly limited to their own operations and supply chains (the upstream) and not including clients or investments. The applicability to the financial sector was one of the most hotly debated aspects of the Directive. However, there will be a review clause for possible future full inclusion of this sector based on an impact assessment.

Due diligence requirement

The Directive will require due diligence regarding actual and potential adverse impacts on the environment and human rights. Companies will have to identify, assess, prevent, mitigate, bring to an end and remedy their adverse impacts and those of their upstream and downstream partners on people and the planet. This includes activities relating to production, supply, transport, storage, design and distribution. The Directive will only partially cover downstream activities. The Parliament’s press release cites as examples distribution and recycling. Further sales and use of goods are reportedly excluded.

Required due diligence elements noted in the official press releases include policies, risk-management systems, contractual assurances, complaints mechanisms, publicly communicating on due diligence policies and regularly monitoring the effectiveness of due diligence policies and measures. As part of the due diligence process, companies also will be required to carry out meaningful engagement, including a dialogue and consultation with affected stakeholders.

As a last resort, companies that identify adverse impacts on the environment or human rights by a business partner will be required to end the business relationship if the impacts cannot be prevented or ended.

EU member states will be required to create portals dedicated to companies’ due diligence obligations that provide information on content and criteria, related Commission guidance and information for stakeholders.

Included rights and prohibitions

Covered impacts will include, among others, child labor, slavery, labor exploitation, pollution, deforestation, excessive water consumption and damage to ecosystems. 

Annex I to the Directive will contain a list of specific rights and prohibitions that constitute an adverse human rights impact when they are abused or violated. The compromise adds new elements to the human rights obligations and instruments listed in the Annex, in particular for vulnerable groups and International Labour Organization core conventions, which can be added to the list by European Commission delegated acts once they have been ratified by all EU member states.

The provisional agreement also adds to the Annex references to other UN conventions: the International Covenant on Civil and Political Rights, the International Covenant on Economic, Social and Cultural Rights and the Convention on the Rights of the Child.

The compromise also clarifies the nature of environmental impacts covered by the Directive as any measurable environmental degradation, such as harmful soil change, water or air pollution, harmful emissions or excessive water consumption or other impacts on natural resources.

Climate transition plan

Large EU companies will be required to adopt a climate transition plan aligned with the Paris Agreement. This requirement includes the financial sector. Companies with over 1,000 employees will receive financial benefits for implementing the plan, by linking director remuneration to the plan's implementation.

Civil liability and penalties

The provisional agreement reinforces access to justice. Affected persons will have five years to bring damages claims relating to adverse impacts. Claims will be able to be brought by trade unions and civil society organizations on behalf of affected persons. The Directive will limit the cost of proceedings for claimants. 

There will not be civil liability for failing to comply with a climate transition plan.

Enforcement will be at the member state level. Member state supervisory authorities will be able to launch inspections and investigations and impose penalties on non-compliant companies, including “naming and shaming,” injunctive measures and fines of up to 5% of their net worldwide turnover. 

Public procurement

Compliance with the CS3D may be considered when awarding public contracts and concessions.

Next steps

Yesterday’s agreement is a political agreement. The final text of the Directive needs to be agreed upon and then endorsed and formally adopted by both the Council and Parliament. The Directive is expected to be signed before EU elections, which take place in June. 

Once signed, the Directive needs to be transposed into national law by the EU member states. The member states are expected to have two years for transposition. Therefore, it is expected that company obligations will begin in 2027. 

Five quick observations

• A significant number of U.S.-based multinationals will be swept into the Directive, either at the EU subsidiary-level or the parent level (i.e., enterprise-wide). However, in the latter case, it appears there will be an especially long runway for compliance.
• Be mindful of the multiplier effect. The Directive will have impact well-beyond subject companies, as those companies impose heightened requirements on their value chains.
• Some of the details of the Directive still need to be worked out in technical discussions. Those discussions are expected to go on for several weeks. As Yogi Berra said, “It ain’t over till it’s over.”
• Some EU member states already have mandatory human rights due diligence requirements, namely France and Germany. The Directive will substantially expand the number of impacted companies in those countries. 
• As a Directive, member states can “gold plate” when they transpose the Directive into national law. Will any do so? That will come into focus over the next couple of years. 

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