Incoming Changes for Corporate ESG Accountability in European Union

Morgan Lewis
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Morgan Lewis

Companies doing businesses in the European Union should note an important development that could introduce a duty of care for companies. On 10 March 2021, the EU Parliament approved an outline proposal for an EU Directive on Mandatory Human Rights, Environmental and Good Governance Due Diligence (Directive). The proposal, if implemented, would become EU law, after which member states would have two years to implement it. The Directive would have a significant impact on corporate accountability within the European Union.

The proposal follows a period of heightened political awareness, in Europe and worldwide, of 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. The EU Parliament resolution containing recommendations to the EU Commission noted that “around the globe there are around 25 million victims of forced labour, 152 million victims of child labour, 2,78 million deaths due to work-related diseases per year and 374 million non-fatal work-related injuries per year,” and that, according to a Commission study, “only 37% of business respondents currently conduct environmental and human rights due diligence.” 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.

The Directive is aimed at ensuring that companies operating in the internal market “fulfil their duty to respect human rights, the environment and good governance and do not cause or contribute to potential or actual adverse impacts on human rights, the environment and good governance through their own activities or those directly linked to their operations, products or services by a business relationship or in their value chains, and that they prevent and mitigate those adverse impacts.”

The Directive refers to the respect of democracy and fundamental rights focusing particularly on human rights and environmental issues. It would apply to businesses incorporated, domiciled, or established in the European Union, and to non-EU enterprises doing business in the European Union (e.g., selling goods or services). The entire business supply chain is impacted: subsidiaries, suppliers, partners, subcontractors, and customers. The Directive would need to be implemented by member states to require businesses to do the following:

  • Carry out effective due diligence with respect to human rights, the environment, and good governance in their operations and business relationships
  • Perform ongoing monitoring to identify and assess whether their operations and business relationships cause or contribute to any human rights, environmental, or governance risks
  • Publish a statement to confirm if a company is satisfied that it does not cause or contribute to any relevant risks and the methodology that led to this conclusion
  • Publish the risk assessment, which would be subject to review if new risks emerge or whenever the company enters into a new business relationship that may present a risk
  • Where risks are identified, establish and publish a due diligence strategy and evaluate the effectiveness and appropriateness of the strategy and its implementation annually, revising it if necessary
  • Ensure that their business strategy and policies are in line with their due diligence strategy
  • Ensure that their business relationships put in place and carry out human rights, environmental, and good governance policies that are in line with their due diligence strategy (for example, by means of framework agreements, contractual clauses, audits, or the adoption of codes of conduct); companies are to regularly verify that subcontractors and suppliers also comply with these obligations
  • Establish a grievance process in relation to any human rights, environmental, or governance risks which complies with the “effectiveness criteria” set out in United Nations Guiding Principle 31

Victims of business-related adverse impacts are often not sufficiently protected by the law of the country where the harm has been caused. Therefore, the Directive states that victims of human rights violations will have the right to take companies to court in the European Union.

Companies will be obliged to consult trade unions, indigenous peoples, and civil society when developing their required due diligence plans.

Remedies shall be determined in consultation with the affected stakeholders and may consist of financial or nonfinancial compensation, reinstatement, public apologies, restitution, rehabilitation, or a contribution to an investigation.

EU member states can adopt specific and voluntary sectoral or cross-sectoral due diligence action plans at both national and EU levels.

EU member states would designate one or more competent and independent authorities responsible for the supervision of the application of the Directive that would have the power to carry out investigations to ensure that companies comply with the obligations set out in the Directive. The competent national authorities could impose proportionate fines calculated on the basis of a company’s turnover; temporarily or indefinitely exclude companies from public procurement, state aid, or public support schemes; or resort to the seizure of commodities and other appropriate administrative sanctions.

The Directive will not affect other applicable subcontracting, posting, or supply chain liability frameworks established at the national, EU, or international level. Compliance by a company with its due diligence obligations under this Directive will therefore not exonerate it from or weaken its obligations under other liability frameworks.

SUMMARY

The proposed Directive could have significant consequences for companies based and operating in the European Union. Although the proposal has yet to be implemented, companies should monitor its progress and potentially consider its relevance to their global ESG initiatives and policies, particularly as they relate to human rights and environmental issues.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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