Clifford Chance

The Legal Affairs Committee of the European Parliament has agreed a draft text likely to resemble the final negotiating position of Parliament following a plenary vote scheduled for 1 June 2023.

On 25 April 2023, the Legal Affairs Committee ("JURI") of the European Parliament ("Parliament") passed a vote on its agreed draft of the proposed Corporate Sustainability Due Diligence Directive ("CS3D").

JURI is headed by Lara Wolters, Rapporteur for the Parliament in the CS3D negotiations. The text agreed on 25 April 2023 is likely to be indicative of the Parliament's final negotiating position, currently pencilled in for 1 June 2023. It therefore gives companies an early signal of the remaining points of contention to be negotiated in the trilogue discussions between the Parliament, the Council of the EU ("Council") and the European Commission ("Commission") that will take place in the coming months before landing on the final text of the CS3D.

JURI text proposes changes to the Commission's proposal, published on 23 February 2022 (see our blog and briefing) as well as key differences to the approach propounded by the Council in its agreed negotiating text (see our post on the Council's draft). The state of play is considered below.

Clarity on some key issues?

Which companies would the CS3D apply to?

The scope of application of the CS3D proposed by JURI 's text extends beyond both the Commission's and the Council's respective proposals.

JURI proposes that companies (references to a "company" include any entity that may be in-scope of the CS3D in its various draft forms) with more than 250 employees and an annual turnover of EUR 40 million are caught; and that companies from non-EU countries will be in-scope if their turnover in the EU totals at least EUR 40 million and they have a global turnover of EUR 150 million. In effect, JURI's proposal scraps the lower thresholds applicable only to companies in "high-impact sectors" by widening the net to all companies which meet the above turnover threshold.

JURI's text also introduces additional parent company criteria, capturing large companies which might otherwise be outside the scope of the CS3D due to their turnover. Parent companies which do not reach the required thresholds on their own, but which (with their subsidiaries) have 500 employees and over EUR 150 million in annual global turnover (with at least EUR 40 million generated in the EU for non-EU companies), would be in scope of the CS3D.

Where along a company's value chain would CS3D apply?

This question has dominated discussions since the Commission first published its proposal for full life cycle "value chain" due diligence of a company (i.e. including end use by consumers).

The Council adopted a more restrictive approach by doing away with a duty to conduct human rights and environmental due diligence ("HREDD") across a company's entire value chain. Instead, the Council's proposed text focuses on a more limited "chain of activities", defined primarily by reference to supply chain activities (both upstream and downstream), but excluding the element of downstream value chains that would cover the use of the company's products by consumers.

The initial CS3D proposal limited due diligence for a company to conducting due diligence on its own operations, subsidiaries and business partners in an "established business relationship" in its value chain. The Council's proposal abandoned the term "established business relationship" and included "business partner", because of the broader impact and scope of that term. Nevertheless, the Council's proposal placed more emphasis on a risk-based approach by companies and prioritization of severe adverse impacts in the company's "chain of activities".

Like the Council, JURI has abandoned the Commission's "established business relationship" concept. However, going further than the Council, JURI's call for "value chain" due diligence (excluding waste management of the product by individual consumers) means that obligations which require due diligence on the use of a company's products by its consumers are back on the menu.

What human rights and environmental ("HREDD") due diligence obligations will companies have?

JURI has largely adopted the basic elements of the HREDD obligations proposed by the Commission, as amended by the Council's proposal. However, JURI has added clarifications to the text.

JURI's amendments seek to further align the elements of due diligence required under the CS3D with the human rights due diligence principles and processes that businesses are expected to implement in accordance with the UN Guiding Principles on Business and Human Rights (“UNGP”), and as also applied to human rights and across other areas of responsible business conduct (including in relation to the environment) by the OECD Guidelines for Multinational Enterprises and related guidance.

Though mentioned in the Commission and Council's draft recitals and reflected in elements of the due diligence provisions and associated definitions, JURI has more clearly drawn from these soft law standards and guidelines in several significant respects. For example, companies must identify the adverse impacts that they have either "caused" or "contributed to", and also those to which they are "directly linked", broadening the impacts which need to be identified. These terms are given definitions that seek to align with the terms as employed in the UNGP and the OECD Guidelines.

Other additions require Member States to place further obligations on companies operating in specific contexts with higher risks associated with adverse environmental and human rights impacts. For example, when operating in areas in a state of armed conflict, post conflict situations, occupied or annexed areas, or areas with weak governance (such as in failed states), Member States must ensure that companies conduct "heightened" due diligence and respect international humanitarian law. Specific obligations are also placed on Member States to regulate financial investors' due diligence with respect to investee companies. Member States must put forward legislation that institutional investors and asset managers are obliged to take appropriate measures to ensure that investee companies bring adverse impacts to an end.

How ambitious are the proposals on climate change, and the environment more generally?

JURI has sought to be more prescriptive than either the Commission or the Council concerning requirements on in-scope companies to develop and publish plans in relation to climate change and the transition to net zero. JURI's proposal would more closely align the required plans to the reporting provisions on climate transition plans set out in the recently adopted Corporate Sustainability Reporting Directive ("CSRD") , while going even further.

For example, JURI's proposal would require that a Transition Plan is not only adopted, but also implemented, a point that was left unclear in the Commission and Council positions. The Plan must also be aligned not only with international targets to achieve net zero by 2050, but also with the EU’s Climate Target Plan to cut greenhouse gas emissions by at least 55% by 2030.

Among stakeholder criticisms of the initial Commission proposal was that climate change was not included as part of the general due diligence duty under the CS3D. JURI has sought to redress this by bringing breaches of international and EU climate change obligations within the due diligence duty, as part of a broadening of the environmental scope of the Directive.

Has the scope of possible civil liability been expanded?

JURI's draft text widens the scope of potential civil liability to include strict liability for adverse impacts arising as a result of a company's failure to comply with the CS3D but has not extended such strict liability to breaches by a company's subsidiaries.

Could directors of companies be liable under CS3D?

Directors' liability is likely to provide a key battleground between the Parliament and the Council.

JURI is proposing to stick with the original wording of the Commission's proposal imposing duties on directors of in-scope companies to take into account the consequences of their decisions for human rights, climate change and the environment. This means that failure to comply with this duty would incur the same potential personal liabilities for directors as other breaches of directors' duties under each Member States' laws.

For companies with over 1,000 employees, JURI is pushing for policies to be in place ensuring that directors' variable remuneration is linked to the climate transition plan, and for those policies to be approved at companies' AGMs.

Conversely, the Council's proposal dropped the provision imposing duties on directors of in-scope companies as well as the proposal to link directors' remuneration to setting "Climate Plans", favouring the view that directors' remuneration is a matter for the company and its shareholders.

What financial sanctions might companies face from Member State supervisory authorities?

The Commission proposed to leave the question of specific financial sanctions to Member States, requiring that the penalties imposed by Member States be "effective, dissuasive and proportionate". The Council agreed. JURI's proposal builds on the Commission's suggestion that sanctions be based on a company's net turnover by imposing an upper limit of 5% of a company’s global net turnover but also proposes that Member States have the option to reverse the burden of proof in relation to alleged breaches to which the penalties might apply. JURI's clarification would provide some harmonisation over the maximum level of pecuniary sanctions across the various Member States.

Would the CS3D apply to financial services?

The inclusion of financial services within the categories of entities required to conduct HREDD has also been a significant bone of contention.

Last year, there were calls for clarity on the definition of "financial services" and how the HREDD obligations would apply to certain investment managers, financial transactions and activities – such as derivatives transactions, and transactions entered into purely for hedging purposes or as a result of algorithmic trading. The Council's approach was to give Member States the option to include financial services within the scope of their laws implementing the Directive, or not.

JURI's text exempts financial services companies if they already conduct similar due diligence checks in other contexts under EU law. JURI proposes to limit the types of financial service providers required to comply with the CS3D, expressly exempting certain services providers form its scope (including pension institutions, alternative investment funds, UCITS and credit rating agencies).

By contrast, the Council's proposal leaves it to each Member State to decide whether to include financial services within the definition of "chain of activities", and thus, the entities on which in-scope companies may be required to conduct HREDD, when transposing the CS3D into national law.

When would the CS3D apply to in-scope entities?

JURI proposes that smaller companies be given more time to implement the new rules, compared to the Commission's proposal.

* Member States will be given two years to transpose the CS3D into Member State law once it enters into force, but companies will be required to comply within the timeframes above.

**in net annual global turnover.

***Companies in this category may comply after five years where they explain their reasons for delaying to the relevant supervisory authority.

What next?

As mentioned above, attention now turns to the Parliament's vote on 1 June 2023. Over the coming weeks, it is likely that interested parties and factions in Parliament will continue to make further public statements in an attempt to influence that crucial vote. Once the text is adopted, current information suggests that the Parliament is keen to start the trilogue proceedings with the Council and Commission before the Parliament's summer break.