Corporate Sustainability Due Diligence Directive: What are the new boundaries of the firm?

30 April 2024 - Dr Livia Ventura, Prince of Wales Global Sustainability Fellow, explains how the recently approved Corporate Sustainability Due Diligence Directive by the European Parliament will impact businesses across Europe and beyond.

In the context of shifting legal trends affecting boards globally, the Corporate Sustainability Due Diligence Directive (CSDDD) marks another step towards addressing the negative consequences on people and planet caused by companies. Its aim is to broaden a company’s civil liability for damages resulting from adverse impacts caused by its subsidiaries and suppliers in cases of intentional or negligent noncompliance with vigilance obligations.

This entails companies internalising their suppliers’ externalities, assuming responsibility for their actions and being subject to possible civil liability actions for damages caused by them. Consequently, it expands the firm’s boundaries (in terms of directors’ obligations and civil liability) beyond legal ones and the limits traditionally delineated by twentieth-century economic theories, which revolved around the costs associated with market coordination and management hierarchies. The boundaries of companies operating in Europe appear to be expanding in tandem with sustainability requirements provided by the law.

Given the extraterritorial application of CSDDD, senior leaders of all companies operating in the EU, or in the chain of activities of companies operating there need to be aware of such legislative development and should prepare for: i) setting up appropriate due diligence procedures to avoid adverse impacts throughout the supply chain and prevent civil liability claims and penalties; ii) implementing a climate change transition plan.

A long champion of sustainable development, especially in the wake of the UN 2030 Agenda for Sustainable Development^[1] and the Paris Agreement,^[2] the European Union (EU) has been working on initiatives aimed at achieving a sustainable economy, such as the Action Plan on Financing Sustainable Growth^[3] and the European Green Deal.^[4] To support these policies, the EU revised its rules applicable to the business sector and financial markets. At the same time, legislative tools have been notably shifting from voluntary measures through soft law (e.g., corporate social responsibility programs), to binding regulations through hard law. Examples include the Directive on Non-Financial reporting^[5] and the Shareholder Rights Directive II^[6] promoting long-termism in share ownership and shareholder engagement.

However, the EU has so far attempted to shift towards a more sustainable economy primarily by means of financial markets regulations (Regulation on Sustainability‐related disclosure in the financial services sector,^[7] Taxonomy Regulation ^[8]) and reporting requirements. Most recently, this effort culminated with the adoption of the Corporate Sustainability Reporting Directive,^[9] which aims to enhance sustainability-related disclosure and comparability through mandatory European Sustainability Reporting Standards,^[10] but it lacks direct substantial obligations to incorporate sustainability issues into the key decision-making process. Instead, its focus is primarily on compelling companies to retrospectively disclose their sustainability efforts.

Given this limitation, a second shift occurred when the focus moved to legislation that directly affects companies’ activities, decision-making and liability, resulting in the publication of a proposal for a directive on Corporate Sustainability Due Diligence.

While the core of the proposal was based on supply chain due diligence, it also included provisions dedicated to climate change and directors’ duties. The original text aimed to harmonise directors’ duties in European companies through a specific duty to put in place and oversee the implementation and integration of due diligence into corporate policies and strategy, and a broader duty of care that included consideration of sustainability matters in decision making activity. But both were deleted in the final text.

After several months of interinstitutional discussions, the provisional agreement reached in December 2023^[11] faced criticism ranging from potential costs and administrative extra-burden for companies, particularly SMEs, to disagreement on the scope of application and worries about the possible loss of competitiveness of European companies. These resulted in a deadlock in its adoption until a revised, lighter version was ultimately approved by the Council on 15 March 2024, and by the European Parliament on 24 April.

The main areas regulated include supply chain due diligence and climate change. The finalised proposal is applicable to European and foreign large companies, now restricted to those with over 1,000 employees and a net worldwide turnover exceeding EUR 450 million for two consecutive financial years, including the ultimate parent company of groups reaching that threshold. It mandates them to integrate plans and strategies into their policies and risk management systems to identify, assess, monitor, prevent, mitigate, end, or minimise actual or potential adverse human rights and environmental impacts arising from their own operations, as well as their subsidiaries and business partners throughout their supply chains.

Regarding climate change, the proposal requires the adoption and implementation of a climate change transition plan to ensure, through best efforts, that the business model and strategy are compatible with limiting global warming to 1.5°C.

Enforcement of the Directive is based on both public (oversight of national and European network of supervisory authorities which may impose penalties up to 5% of net worldwide turnover) and private (possible civil liability claims for breach of due diligence duties; company internal complaints and notification systems allowing third parties to raise concerns on adverse impacts) mechanisms.

The CSDDD harmonises laws in this field, aligning them with international standards on due diligence (UN Guiding Principles,^[12] OECD^[13]) and ensuring a level playing field within the EU internal market to avoid distortions of competition. Despite its downsizing from the initial proposal, it still positions the EU as a global leader in designing a legal framework for the transition to a sustainable and regenerative economy.

[1]https://sdgs.un.org/2030agenda

[2]https://unfccc.int/process-and-meetings/the-paris-agreement

[3]https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A52018DC0097

[4]https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=COM%3A2019%3A640%3AFIN

[5]https://eur-lex.europa.eu/eli/dir/2014/95/oj

[6]https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32017L0828

[7]https://eur-lex.europa.eu/eli/reg/2019/2088/oj

[8]https://eur-lex.europa.eu/eli/reg/2020/852/oj

[9]https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32022L2464

[10]https://finance.ec.europa.eu/capital-markets-union-and-financial-markets/company-reporting-and-auditing/company-reporting/corporate-sustainability-reporting_en

[11]https://www.consilium.europa.eu/en/press/press-releases/2023/12/14/corporate-sustainability-due-diligence-council-and-parliament-strike-deal-to-protect-environment-and-human-rights/

[12]https://digitallibrary.un.org/record/720245?v=pdf