The European Union lawmakers have completed the group of many sustainability and circularity-focused initiatives introduced during the last legislative cycle. The Corporate Sustainability Due Diligence Directive (CSDDD) is a significant step towards promoting sustainable and responsible business practices and more transparent company operations. This Directive completes the Corporate Sustainable Reporting Directive (CSRD) from December 2022, which updates the process of how and what companies report in their non-financial statements, according to European sustainability standards.
Approved by the Council recently and by the European Parliament in April 2024, this directive mandates large companies operating within the EU to integrate the safeguarding of human rights and environmental due diligence into their operations and global value chains. The new rules will ensure that companies in scope address the adverse human rights and environmental impacts of their actions in- and outside Europe.
This Proposal highlights the key aspects of the CSDDD, its most important implications for businesses, and the expected outcomes for various stakeholders, including customers.
Background and Legislative Journey
Environmental and social responsibility is not new. Member states have long been scrutinizing company behaviour, take for example France’s Duty of Vigilance Law or Germany’s Supply Chain Due Diligence Act: different rules made it hard for EU-wide suppliers to operate, hence there was a need for a harmonized EU-wide framework. Consequently, in February 2022, the European Commission presented its proposal and after a lengthy discussion between the co-legislators, the European Parliament and the Council reached a political agreement in December 2023. And this has recently been stamped formally by both bodies. The directive will now be published in the EU’s Official Journal and the enter into force 20 days later, giving Member States two years to transpose it into their national law, after which, on a gradual basis, companies will quickly come under scrutiny.
Scope and Applicability
Though initially the scope covered more companies, the CSDDD now applies to large EU companies with more than 1,000 employees – original proposal targeted companies with more than 500 employees – and a net turnover exceeding EUR 450 million worldwide (instead of the initial EUR 150 million). It also affects non-EU companies with significant operations in the EU, especially those generating more than EUR 450 million in turnover from their EU activities. Although micro-companies, small and medium-sized enterprises (SMEs) are not directly covered, they may still be impacted as part of the supply chains of larger companies.
Core Requirements of the CSDDD
The directive establishes a corporate duty of due diligence that encompasses several key obligations:
- Risk-Based Due Diligence: Companies must develop and implement – and must of course bear the costs of such developments – a due diligence policy that integrates human rights and environmental considerations. This policy should include procedures for identifying, assessing, and addressing actual and potential adverse impacts across the company’s operations, subsidiaries, and value chains. In-scope companies must develop a so-called climate transition plan, too, showing that the company’s business model is compatible with the transition to a sustainable economy and with the limiting of global warming. Businesses must also bear transition costs, including expenditure and investments to adapt a company’s own operations and value chains to comply with the due diligence obligation.
- Stakeholder Consultation: Meaningful engagement with stakeholders – through a transparent complaints’ procedure –, including employees, affected communities, and civil society organizations, trade unions, workers’ representatives, is required throughout the due diligence process.
- Prevention and Mitigation: Companies are required to take appropriate measures to prevent or mitigate identified adverse impacts. These measures should be proportionate to the severity and likelihood of the impact and may include contractual clauses, training, financial support for SMEs, and, as a last resort, terminating business relationships if necessary.
- Remediation: If a company causes or contributes to an adverse impact, it must provide remediation to restore affected persons, communities, or the environment to a state as close as possible to the pre-impact situation. Remediation can involve compensation, rehabilitation, and other forms of support.
- Monitoring and Reporting: Companies must refresh their due diligence assessments annually and publish an annual statement detailing their due diligence processes, findings, and actions taken. This promotes transparency and accountability, allowing stakeholders to make informed decisions.
- The CSDDD is also important for financial market participants, to be read together with the Sustainable Finance Disclosures Regulation from 2019, in as much as their reporting obligations concern only upstream activities.
Enforcement and Compliance
Once transposed into national laws, enforcement will also be carried out by the designated national authorities. These authorities will have the power to impose sanctions, including fines and other penalties, for non-compliance. Very important for companies that the directive establishes civil liability provisions, ensuring that victims of adverse impacts can seek compensation through legal channels. The CSDDD states that Member States must ensure that victims get compensation for damages resulting from an intentional or negligent failure to carry out due diligence. Such out-of-contract liability will likely generate a great deal of interest among consumer organizations, and the more concerned and sensitive consumers.
Where possible, class actions will gather interested parties and if we look at cartel-related civil litigation, one can fathom a great deal of private suits starting very soon.
At the EU level, the European Commission will set up a European Network of Supervisory Authorities to ensure a coordinated approach to enforcement across Member States. This network will facilitate the sharing of best practices and support the uniform application of the directive.
Implications for Businesses
Though application is further down the road, compliance may take several years because of the intricate global value chains of companies. The CSDDD represents a paradigm shift in how businesses operate within the EU, with significant implications for corporate governance, risk management, and stakeholder engagement. Key implications include:
- Increased Legal Certainty and Uniformity: The directive provides a harmonized legal framework across the EU, reducing the fragmentation of national due diligence regulations and creating a level playing field for businesses. This uniformity is expected to enhance legal certainty and reduce compliance costs for companies operating in multiple EU countries.
- Enhanced Reputation and Trust: By demonstrating a commitment to human rights and environmental sustainability, companies can build greater trust with customers, investors, and employees. This can lead to increased customer loyalty, better access to finance, and a more motivated workforce.
- Risk Management and Competitiveness: Implementing robust, well-established, documented and prepared due diligence processes can help companies identify and mitigate risks early, reducing the likelihood of legal disputes and reputational damage. This proactive approach can also enhance business resilience and competitiveness in a rapidly evolving market,
- Global Influence: The CSDDD sets a high standard for corporate due diligence that could influence international norms and practices. As EU companies implement these requirements, their global business partners may also be encouraged or required to adopt similar standards, promoting sustainability beyond the EU’s borders.
Practical Implications on Corporate Governance
As an important compliance task, the proper application of Corporate Sustainability Due Diligence (CSDD) increases the liability of a company’s top management. Reshaping an existing compliance system to incorporate sustainability factors, ensuring timely commencement of the pre-compliance phase may require the involvement of a dedicated team or more professionally, mandating a third party advisory firm with expertise in sustainability, legal and compliance while having industry knowledge.
Once a dedicated team is engaged, relevant sustainability criteria shall be identified first across the company’s entire value chain: e.g.: by reviewing and assessing internal regulations and contracts throughout their entire value chain.
Based on the general compliance project plans, the team may set up a comprehensive due diligence checklist followed by a thorough risk assessment process, involving the identification and prioritization of environmental, social, and governance risks based on their potential impacts. This all shall based on the data collected through stakeholder interviews and issue-spotting review of documents and policies.
Once the key risk factors are known, focused compliance audits shall be conducted, with reports summarizing findings, key risks, and recommendations for improvement. This recommendation may form the basis of further action plans, including actionable recommendations, clear sustainability goals, key performance indicators (KPIs), and a practical implementation plan outlining steps, resources, and timelines for the company to comply with CSDDD.
For the proper completion of these relatively complex management tasks, a specialized third-party compliance-focused law firm may provide valuable assistance. The timely start of a pre-compliance phase of CSDD, ensures effective management of sustainability risks and opportunities.
By Pal Belenyesi, Of Counsel, Dentons, and Robert Szuchy, Managing Partner, and David Adamov, Associated Lawyer, BSLaw Budapest
