One step closer to a sustainable EU; the European Parliament adopts the revised CSDDD proposal

On 24 April 2024, the European Parliament adopted the compromised version of the proposed ‘Corporate Sustainability Due Diligence Directive’ (CSDDD, also referred to as the CS3D), following the approval of the compromised text of the CSDDD by the European Council on 15 March 2024. This marks a crucial advancement for the European Union (EU) in the process of establishing mandatory so-called ‘Environmental, Social, Governance’ (ESG) obligations into law on a more substantive level.

With the adoption of CSDDD by the European Parliament, the EU is nearing the completion of this much debated regulatory instrument that brings the EU a significant step closer in its ambitious aim of ensuring mandatory compliance with human and environmental rights by companies.

From a broader ESG perspective, the sustainability due diligence obligations enshrined within the CSDDD complements the reporting obligation stemming from the ‘Corporate Sustainability Reporting Directive’ (CSRD). If the Council will formally endorse today’s outcome in its final vote on 23 May 2024, substantive mandatory ESG obligations will be incorporated within EU law. This would make the CSRD and CSDDD the backbone of EU ESG law.

Curious about the legislative impact of the CSDDD on your company? Please see our main takeaways below.

AIM OF THE CSDDD

The CSDDD establishes rules outlining the obligations for large companies concerning both existing and potential adverse effects on the environment and human rights throughout their entire business chain of activities. Companies will not only have to identify, assess, prevent, mitigate, end, and remedy their adverse impact on human rights and the environment but also the conduct of their upstream and downstream partners.

In particular, the CSDDD imposes a mandatory sustainability due diligence obligation for in-scope companies. This due diligence requirement not only concerns the conduct of a company’s direct contractual business partners, but also its entire supply chain. Yet, it is important to note that the definition of ‘’downstream chain of activities’’ has been narrowed by deleting the references to the disposal of the product, and by limiting it solely to business partners who carry out activities for the company or on behalf of the company.

Furthermore, to effectively ensure compliance, the CSDDD also imposes penalties and civil liability for infringing those obligations, which we will discuss more in-depth further on. Moreover, Article 15 of the CSDDD also obliges companies to implement a climate change reduction plan that ensures alignment of their business model and strategy with the Paris Agreement.

ALTERED SCOPE OF APPLICATION

Originally, the CSDDD was proposed by the Commission to apply to companies exceeding the number of 500 employees and a net worldwide turnover of EUR 150 million or for companies exceeding the number of 250 employees and a net worldwide turnover of EUR 40 million of which 50% was gained in so-called ‘high-risk sectors’. However, on 1 June 2023 the European Parliament voted to amend this scope by setting the threshold for:

a) companies with more than 250 employees and a net worldwide turnover exceeding EUR 40 million, regardless of the sector; and for
b) ultimate parent companies with more 500 employees and a net world turnover exceeding EUR 150 million

By and large, this amendment corresponded with the thresholds for international groups of companies under Article 40a(1) CSRD. Following the provisional agreement with the Council on 14 December 2023, however, this threshold was raised once again. The CSDDD was set to apply to EU-based companies with more than 500 employees and a net worldwide turnover exceeding EUR 150 million, whereas the threshold for non-EU companies was set at a net worldwide turnover over EUR 150 million generated in the EU, three years from the entry into force of the directive.

After a lengthy discussion within the European Council, the Member States decided to increase the thresholds once more and thus limit the scope of the CSDDD to larger companies only. Based on the text proposal of the European Parliament’s Committee on Legal Affairs (JURI) of 15 March 2024, the scope of the CSDDD (subject to the final endorsement by the European Council) will in due time become applicable to large companies with over 1,000 employees and an annual global net turnover exceeding 450 million euros, and larger companies as set out in section 3 below. It must be noted that an ultimate parent company, which on standalone basis does not fall into the scope of the CSDDD, nevertheless could fall under the scope of the CSDDD in case the group as a whole exceeds the number of 1,000 employees and has a net worldwide turnover of more than EUR 450 million.

Due to the increased threshold for in-scope companies, less companies fall within the scope of the CSDDD. Moreover, the ‘’high-risk’’ sector approach, seen in the Commission’s proposal, has been deleted and will no longer apply. Instead, Article 13(1a)(c) of the CSDDD shall issue guidelines for companies on, among other things, “sectoral risk factors, including those associated.”

‘Small- and medium-sized enterprises’ (SMEs) seem to fall outside the scope of the CSDDD. Nonetheless, SMEs will likely be impacted indirectly, as companies within the scope are required to apply the due diligence obligation across their entire value chain. Therefore, even though the definition of ‘’downstream chain of activities’’ has been limited to business partners who carry out activities for the company or on behalf of the company, it can still be the case that companies not directly meeting the scope of the CSDDD will be impacted indirectly.

In that regard, it must be observed that, generally speaking, other ESG instruments with a wider scope could nevertheless impose specific/additional due diligence obligations, resembling risk-identifying obligations or obligations that relate to the due diligence process. For example, the CSRD includes a reporting obligation on the company’s sustainability due diligence obligation, and Article 8(1) and Article 10(1)(2)(h) of the EU Deforestation Regulation include a specific due diligence obligation, whereas the due diligence obligation under the Critical Raw Materials Act refers to other voluntary due diligence guidelines and the reporting obligation under the CSRD. Thus, even companies that fall outside the scope of the CSDDD could nevertheless be subject to ESG reporting and other due diligence (or in essence similar requirements) obligations.

IMPLEMENTATION AND APPLICATION

It is important to note that the proposed CSDDD does not (yet) have a direct impact on companies operating in the EU. First of all, the European Parliament’s text of the CSDDD must be formally approved by the European Council, which is expected on 23 May 2024, as the final step in the legislative process. Subsequently, the CSDDD enters into force following the twentieth day of its publication the EU Official Journal. Secondly, the EU Member States must transpose the content of the adopted CSDDD into national law within a designated transposition period (set out in Article 31 CSDDD) as EU directives do not have direct legal effect on companies.

Moreover, the provisions of the CSDDD will start to apply in a cascading time-frame, meaning that it will have a phased entering into force as set out in the table below:

OBLIGATIONS

The due diligence obligations that must be adhered to primarily pertain to business partners who carry out activities for the company or on behalf of the company, encompassing preventive and remedial actions, as well as comprehensive reporting. Companies are required to consider both the upstream supply chain and the downstream supply chain. In cases where environmental or human rights violations by a supplier are not averted or ended, the ultima ratio, may involve terminating the business relationship with that supplier. Yet, under the adjusted CSDDD, such termination will be a last resort, where the in-scope company itself would set an appropriate timeframe in its preventive or corrective action plan. Additionally, termination will be assessed against whether it would result in manifestly more serious adverse impacts. Moreover, the agreement entails a substantial enhancement of environmental protection measures. It encompasses a comprehensive consideration of all measurable environmental impacts, including detrimental soil changes, harmful emissions, water or air pollution, excessive water consumption, and other impacts on natural resources.

Furthermore, the CSDDD contains a risk-based approach. Following Articles 7 and 8 of the CSDDD, an in-scope company is only obligated to take measures if it is directly accountable for CSDDD-related risks. Otherwise, the responsibility falls under a general duty of care for the in-scope company. In contrast to the proposed amendments by the European Parliament, the duty of care for directors of in-scope companies is not covered by the CSDDD. Nevertheless, it is up to the discretion of EU Member States to incorporate such duty of care into their national implementation of the CSDDD.

Moreover, following Article 15 of the CSDDD, companies falling within its scope must establish a transition plan as per Article 19a of the CSRD, which is aimed at restricting global warming to a maximum of 1.5°C in accordance with the Paris Agreement. Additionally, these companies must implement a climate change mitigation transition plan aimed at aligning their business model and strategy with efforts to transition to a sustainable economy in line with the Paris Agreement.

PENALTIES AND CIVIL LIABILITY

The CSDDD aims to ensure compliance through the means of both private enforcement and public enforcement, through the means of, for example, administrative penalties.
Regarding private enforcement, the CSDDD does not impose a specific duty of care towards directors to include sustainability objectives within their business decision. This is new in comparison the Parliament’s initial stance in 2023. However, Member States are not prohibited from imposing such a duty of care, nor does the CSDDD preclude judges to rule that neglecting the impact of sustainability within business decisions breaches a director’s duty of care through the means of open norms following from national law.

Furthermore, the CSDDD introduces an additional civil liability mechanism to ensure access of justice to persons that are affected. It sets a five-year period to bring claims by those adversely impacted, including trade unions or civil society organizations. Following the discussion in the trialogue, the CSDDD provides for (procedural) simplifications on the disclosure of evidence, injunctive measures, and the costs of proceedings for claimants. Lastly, the CSDDD requires companies that have identified adverse impacts on the environment or human rights by some of their business partners to terminate those business relationships when these impacts cannot be prevented or ended. Yet, such termination will be a last resort, where the in-scope company itself would set an appropriate timeframe in its preventive or corrective action plan. Additionally, termination will be assessed against whether it would result in manifestly more serious adverse impacts.

Moreover, an in-scope company can be held liable for damages caused to a natural or legal person in case it intentionally or negligently fails to comply with its obligations under the CSDDD. Nevertheless, an in-scope company cannot be held liable for damages caused by its business partners in its chain of activities.

In addition to a civil liability clause, the CSDDD also imposes other sanctions. In that regard, the CSDDD requires Member States to designate a national competent supervisory authority to launch inspections and, if necessary, impose sanctions. These sanctions include, among others, “naming and shaming”, and turnover-based fines (up to 5% of net worldwide turnover according to article 20 CSDDD). In case companies do not pay these fines, the CSDDD also imposes several injunctive measures. Finally, CSDDD compliance can also be used as a criterion for the award of public contracts and concessions.

RELATIONSHIP WITH THE CSRD

As said, the sustainability due diligence obligations in the CSDDD and the sustainability reporting obligations in the CSRD form, in essence, the backbone of EU ESG law. Whereas the CSDDD focuses on continuously identifying and addressing adverse human rights and environmental impact, the CSRD requires companies to report on their sustainability impact pursuant to the principle of double materiality. Therefore, the aim of the CSDDD cannot be seen entirely separate from the purpose of the CSRD. Unsurprisingly, the European legislator also observed this relationship between those two instruments.

For example, it follows from recital 44a of the CSDDD that in case companies fall both under the scope of the CSDDD and at the same time are subject to report on their due diligence process pursuant to the CSRD, the reporting obligation under the CSRD shall be understood as the requirement for companies to describe how they implement due diligence within the meaning of the CSDDD. Furthermore, like the CSRD, Article 6a(2) of the CSDDD also allows in-scope companies to prioritise their due diligence process on the basis of severity and likelihood of the concerned adverse human rights or sustainability risks. Moreover, Article 15(3) CSDDD provides that companies that are subject to report a transition plan for climate change mitigation pursuant to the CSRD shall be deemed to have complied with the same obligation set out in Article 15(1) CSDDD. Thus, a climate transition plan pursuant to the CSRD may also be relied upon under the obligations pursuant to the CSDDD.

Do you require more information about the CSDDD and its specific impact on your company, do not hesitate to reach out to our CSDDD experts Pauline Kuipers, Matthias Spilker, Alexandre Vuchot, Felix Schmidtke, and Sander Wagemakers. We happily assist to enable you to achieve your company’s ESG ambitions. Want to read more? We also highly recommend the article on the CSDDD in relation to the ‘Lieferkettengesetz’, LKGS (in German) written by our German colleagues.