New corporate responsibility rules for EU companies

The proposal for the Corporate Sustainability Due Diligence Directive was adopted on 23 February 2022. The Directive’s aim is to anchor human rights and environmental considerations in the operations and corporate governance of those companies in scope.

The Directive’s objectives will be achieved by imposing a number of new obligations on large EU-headquartered companies and a number of others headquartered outside the EU, but active within the union.

The Directive imposes additional duties on directors of companies in scope of the legislation to conduct corporate due diligence, as well as on directors who join the board of a company acquired following a merger and acquisition (M&A) process.

The rules will apply to a company’s own operations, its subsidiaries and its value chains – both direct and indirect established business relationships.

New obligations

The Directive establishes a corporate due diligence duty which at its core is a duty to identify, bring to an end, prevent, mitigate and account for negative human rights and environmental impacts in the company’s own operations and those of its subsidiaries and value chains.

Certain large companies will also need to have a plan to ensure that their business strategy is compatible with limiting global warming to 1.5°C in line with the Paris Agreement.

The costs of implementing the due diligence procedures will be borne by the relevant companies.

In order to comply with the corporate due diligence duty, companies need to:

• integrate due diligence into policies;
• identify actual or potential adverse human rights and environmental impacts;
• prevent or mitigate potential impacts;
• bring to an end or minimise actual impacts;
• establish and maintain a complaints procedure;
• monitor the effectiveness of the due diligence policy and measures; and
• publicly communicate on due diligence.

When it comes to M&A, the shareholders and directors of target companies will need to demonstrate that they have complied with these duties as prospective purchasers will be adding this to the list of areas on which they conduct due diligence prior to potential acquisitions.

Prospective purchasers are likely to seek some form of warranty protection in acquisition agreements in relation to a target company’s compliance with the terms of the Directive up to the point of sale, and shareholders will need to be confident that they are in a position to stand over any such warranties.

Directors’ duties

It is recognised in the Directive that in order to ensure that due diligence becomes part of how companies function, company directors must be involved. It is on that basis that the Directive introduces further duties to establish and supervise the implementation of due diligence measures into the company’s corporate strategy.

Duties include setting up and overseeing the implementation of the due diligence processes and integrating due diligence into the corporate strategy.

For directors of Irish companies, this builds on the existing directors’ duties as set out in the Companies Act 2014, most notably the duty to act in the best interest of the company. It also places an additional duty on directors to take into account the consequences of their decisions on sustainability issues, including, where appropriate, human rights, climate change and the environment, across the short, medium and long term.

In the context of M&A, any directors to be appointed to a target company upon acquisition will need to be aware of the ongoing duties imposed on them by virtue of this Directive. Their ability to assume these additional duties upon their appointment will be linked to the level of comfort they have been able to obtain with regards to the compliance of any existing or resigning directors with the obligations of the Directive.

Companies in scope

The requirements of the Directive will not apply to all EU companies, but are expected to apply to several thousand large organisations and those in high-impact sectors.

Companies will be divided into two groups, with the rules applying both to large EU limited liability companies and to third-country companies which generate turnover in the EU equivalent to the defined revenue thresholds for EU companies.

Group 1, which is expected to catch around 9,400 EU and 2,600 non-EU companies, will consist of businesses with more than 500 employees and turnover in excess of €150 million.

Group 2 captures companies with at least 250 employees and turnover of €40m or more operating in ‘high-impact’ sectors including textiles, agriculture and extraction of minerals. Around 3,400 EU companies and 1,400 non-EU companies will fit into this group, and the Directive will apply to this group two years later than companies in group 1.

Enforcement

The Directive will be enforced through administrative supervision and civil liability.

EU member states will have to designate an authority to supervise and impose effective, proportionate and dissuasive sanctions, including fines and compliance orders.

The European Commission will also set up a network of supervisory authorities to ensure a coordinated approach to the implementation of the Directive.

Separately, member states will have to make sure victims are compensated for a companies’ failure to comply with the obligations of the new proposals.

The directors' duties rules will be enforced through existing member states' laws, and the Directive does not propose the introduction of an additional enforcement regime in the event that directors do not comply with their obligations.

Next steps

The proposal will be presented to the European Parliament and the European Council for approval. Once adopted, member states will have two years to transpose the Directive into national law and communicate the relevant texts to the European Commission.