On March 3, 2021, the German Federal Cabinet adopted an act on corporate due diligence obligations in supply chains (“Due Diligence Act”; sometimes also referred to as “Supply Chain Act”) (“Government Draft”). The Government Draft was presented by the Federal Ministry for Economic Cooperation and Development (Bundesministerium für wirtschaftliche Zusammenarbeit und Entwicklung – “BMZ”) and the Federal Ministry of Labor and Social Affairs (Bundesministerium für Arbeit und Soziales – “BAS”) after coordination with the Federal Ministry of Economic Affairs and Energy (Bundesministerium für Wirtschaft und Energie – “BMWi”). It is expected to be adopted by the legislature during summer 2021. The Due Diligence Act would then enter into force on January 1, 2023.
The key content of the Due Diligence Act would include, in particular, the following:
- For German companies with 3,000 employees (from 2024: 1,000 employees), new human rights‑related due diligence standards are defined for risk management, particularly for their international supply chains. The aim is particularly to improve the protection of work-related human rights as well as the environment through targeted prevention and remediation measures.
- The due diligence obligations are structured as “best efforts obligations” (Bemühenspflicht). According to the legislative grounds, companies should not be subject to an obligation concerning a specific result (Erfolgspflicht); in other words, they do not have to guarantee that no human rights or environmental rights are violated in their supply chains. However, they must be able to demonstrate that they have implemented the statutorily defined due diligence obligations in a way that is appropriate and practicable with regard to the individual situation of the respective company. In consultation with the BMWi, the BAS is to be authorized to specify individual due diligence requirements in more detail by legislative decree.
- Regulatory control and enforcement mechanisms will be introduced, as well as new provisions on administrative fines.
- The civil-law enforcement of claims by injured parties before German courts is to be facilitated by making it possible to authorize unions and non-governmental organizations to conduct litigation by way of representative action (Prozessstandschaft).
Similar to the planned Corporate Sanctions Act (see our 25 September, 2020 Client Alert), the draft bill would have far-reaching effects on the due diligence obligations of companies and on their risk management and compliance systems.
Some other European countries have to a certain extent already introduced laws that, in part, establish similar due diligence obligations for companies. Parallel to the German legislative procedure, the European Union (EU) is working on a European regulation. According to the ideas of the responsible EU Commissioner for Justice and Rule of Law, Didier Reynders, and the European Parliament—which formulated non‑binding key points of an EU Directive—the EU Directive should establish even more far-reaching obligations and be applicable to a much larger number of companies (see our 23 March, 2021 Client Alert). According to the current time schedule, the EU Directive would be adopted in the year 2024. Then it would be subsequently implemented into national law by the Member States.
INTENSE POLITICAL DISCUSSIONS
The introduction of a Due Diligence Act relating to supply chains in Germany was agreed upon in the coalition agreement.
The response to the now-available Government Draft has been mixed. While individual companies welcome the draft law in principle, large business associations in particular voice strong criticism. Non‑government organizations do not believe the Government Draft goes far enough. It is possible that the Government Draft will be amended in the parliamentary procedure.
WHAT PROMPTED THE PLANNED DUE DILIGENCE ACT
Among the factors triggering the draft bill are the UN Guiding Principles on Business and Human Rights (so‑called Ruggie Principles) and the OECD (Organization for Economic Co‑operation and Development) Guidelines for Multinational Enterprises. The Government Draft emphasizes the responsibility of Germany, based on its high international economic integration, to work toward an improvement of the human rights situation along the supply chain. The Government Draft says that, indeed, the responsibility to respect, protect, and comply with human rights lies basically with the States. However, companies also have a responsibility to respect human rights.
ESSENTIAL CONTENT OF THE DUE DILIGENCE ACT
Which companies are affected?
The Due Diligence Act would apply
- to companies, regardless of their legal form,
- with their head office, principal place of business, administrative headquarters, or registered seat in Germany (local nexus), and
- generally with more than 3,000 employees (including temporary staff and employees at subsidiaries).
From January 1, 2024, onwards, the scope of application should be expanded to companies with more 1,000 employees (Sec. 1 (1) s. 2 Due Diligence Act).
What is the “supply chain”?
The Due Diligence Act defines the term “supply chain” broadly. The supply chain, according to Sec. 2 (5) Due Diligence Act, encompasses
- all products and services of a company,
- all steps, both domestically and abroad, for the manufacturing of the products and the rendering of the service, beginning with the raw material extraction, and all the way to delivery to the ultimate customer,
- the activity of the company in its own business area, domestically and abroad,
- the activities of direct suppliers, and
- the activities of indirect suppliers.
What is protected?
Corporate due diligence obligations focus on labor-related human rights risks. Nature conservation and environmental protection are mainly, but not solely, covered from a human rights perspective.
The Due Diligence Act identifies as human rights risks situations in which there are likely violations, in particular, of the following prohibitions (Sec. 2 (1)–(4) Due Diligence Act):
- Prohibition of forced labor and slavery,
- Prohibition of child labor including the areas of prostitution, pornography, and drug trafficking,
- Prohibition of non-compliance with occupational labor protection under national law in case of danger of accidents or work-related health hazards,
- Prohibition of disregard of freedom of coalition (establishment of and activity in and by labor unions),
- Prohibition of unequal treatment (for example, on the basis of descent or religion),
- Prohibition of causing certain damage to nature and the environment that adversely affects people’s livelihoods or is harmful to health, and
- Prohibition of the manufacture of mercury-added products and the production and use of certain banned chemicals.
These are referred to collectively as “Human Rights.”
What must companies do?
Companies should comply with “human rights”-related due diligence obligations (Sec. 3 (2) Due Diligence Act). According to the legislative concept, this is a new category of corporate “best efforts obligation” (Bemühenspflicht). Companies should not be subject to an obligation concerning a specific result (Erfolgspflicht). This means that they do not have to guarantee that no human rights or environmental rights are violated in their supply chains. However, they must be able to demonstrate that they have implemented the statutorily defined due diligence obligations in a way that is appropriate and practicable with regard to the individual situation of the respective company. Which measures are appropriate is, in principle, a matter for companies to assess on their own responsibility. With regard to individual topics, clarification through official guidelines as well as through legal decrees is to be expected (Sections 9 (4), 14 (2), 20 Due Diligence Act).
Furthermore, the scope of the measures to be taken should depend on how great the company’s sphere of influence is when it comes to human rights risks or violations existing in the individual case. The basic principle is: The closer companies are confronted with any problematic situations, the more measures they would be required to take. The same applies accordingly, the more serious or more likely the violation of human rights is.
The Due Diligence Act primarily establishes a responsibility of the companies for their own business areas as well as in relation to direct suppliers. With respect to indirect suppliers, only reduced due diligence obligations on an ad hoc basis in the context of risk management (Sec. 9 Due Diligence Act) must be complied with.
The following duties of care in particular are of central importance:
Risk management and regular risk analysis
Companies must set up an appropriate and effective system of risk management and anchor it through organizational measures, including clear responsibilities in business processes (Sec. 4 Due Diligence Act). The aim is to recognize human rights risks, prevent the violation of legal protections, or, in any case, to end or to minimize it.
Part of the risk management is the appropriate risk analysis for ascertaining the risks for the protected legal positions in the company’s own business area and with direct suppliers (Sec. 5 Due Diligence Act). The risk analysis must take place at least once a year. The results must be communicated to the board of management.
Policy statement and preventive measures
Companies must adopt a policy statement on their human rights strategy, out of which, among other things, it must be evident how the company meets its obligations and what risks it has identified (Sec. 6 Due Diligence Act).
In addition, the company must take appropriate preventive measures in its own business area and vis-à-vis direct suppliers, for example, in the form of training sessions, risk-based control measures, or contractual assurances concerning compliance with human rights standards (Sec. 6 Due Diligence Act).
Remedial measures and grievance procedure
Should the company ascertain, within its own business area or at direct suppliers, that a violation of human rights standards has occurred or is imminent, it must take remedial measures in order to prevent, stop, or minimize such violation (Sec. 7 (1) Due Diligence Act). Depending on the severity of the violation, and in the case of lack of success through remedial measures, the company can even be obligated to end the business relationship (Sec. 7 (2), (3) Due Diligence Act).
Additionally, the companies must set up an impartial grievance procedure that brings to notice any indications of human rights risks and violations in their own business areas, and at direct suppliers as well as indirect suppliers (Sections 8 (1), 9 (1) Due Diligence Act). The confidentiality of the identity, and the protection from discrimination or punishment must be ensured in favor of those users availing themselves of the procedure (Sec. 8 (4) Due Diligence Act).
With regard to indirect suppliers, Sec. 9 Due Diligence Act defines special due diligence requirements, besides the inclusion of notifications in the grievance procedure. Should it acquire substantiated knowledge about a possible violation of a legal protection or an environment-related obligation at indirect suppliers, a company must, as the occasion warrants, among other things, conduct a risk analysis, take appropriate prevention measures, and create and implement a concept for the minimization and avoidance of the violation (Sec. 9 (3) Due Diligence Act).
Documentation and reporting
The companies are obligated to continuously document the fulfillment of the due diligence requirements and to preserve this documentation (Sec. 10 Due Diligence Act). They must explain, in a publicly accessible report, which human rights risks were identified and which remedial measures were taken (Sec. 10 (2)–(4) Due Diligence Act).
Enforcement and Administrative Fines
The Federal Office of Economics and Export Control (Bundesamt für Wirtschaft und Ausfuhrkontrolle – “BAFA”) should be responsible for the enforcement of the Due Diligence Act. BAFA must monitor compliance with the obligations and, if necessary, impose administrative fines in the case of violations (Sections 12 et seq. Due Diligence Act). BAFA is given investigative powers (for example, search or seizure) for this purpose.
The Due Diligence Act defines a large number of new statutory provisions on administrative fines (Sec. 24 Due Diligence Act). The range of administrative fines is scaled according to the type of violation. In principle, fines of up to EUR 800,000 can be imposed. For legal entities and associations of persons, the fine range is increased for specific administrative offenses, so that fines of up to EUR 8 million can be imposed (Sec. 24 (2) Due Diligence Act in conjunction with Sec. 30 (2) s. 3 Administrative Offenses Act). If the average annual turnover of the company exceeds EUR 400 million, fines of up to two percent of the worldwide average annual turnover of the economic entity (including group companies) could be imposed (Sec. 24 (3) Due Diligence Act).
According to general rules of the Administrative Offenses Act, in the case of violations, any economic benefits arising from disorderly conduct could also be skimmed off (Sections 30 (3), 17 (4) Administrative Offenses Act).
Depending on the amount of the legally enforceable fine, companies can be barred from awarding public contracts for up to three years (Sec. 22 Due Diligence Act).
Representative action for civil law damage claims
The Due Diligence Act does not contain any special regulations with regard to the applicable law to any civil law claims, or with regard to the (international) jurisdiction of German courts. Injured persons whose exceedingly important legal protections are violated are, however, permitted to authorize a domestic trade union or non-governmental organization for the judicial assertion of their claims in Germany (Sec. 11 Due Diligence Act). With the statutory recognition of this special representative action (Prozessstandschaft), the risk of human rights-related civil lawsuits against German companies would generally be increased.
Whether the Due Diligence Act will undergo changes in the further legislative session and possibly win the requisite majorities, remains open at the moment. It can be expected that there will be intense discussions. In view of the already existing regulations in other European countries, as well as efforts at the EU level toward stronger regulation with regard to international supply chains, boards of management should continuously monitor their internal risk management systems in this area and, if necessary, adjust these systems to any new requirements.