The German government has adopted draft law to ensure corporate compliance with human rights in the supply chain.

By Paul A. Davies, Michael D. Green, Joachim Grittmann, Stefan Bartz, and Alexander Wilhelm

On 3 March 2021, the German government adopted the draft Corporate Due Diligence in Supply Chains Act (Gesetz über die unternehmerischen Sorgfaltspflichten in Lieferketten), which is intended to oblige large German companies to better fulfil their responsibilities in the supply chain with regard to internationally recognized human rights by implementing core elements of human rights due diligence.

The draft law will now be introduced in the legislative procedure and is expected to be passed this summer. If passed, the new law will enter into force in January 2023.

Application Scope

The draft law applies to companies that have at least 3,000 employees and are headquartered or have a main branch in Germany. This threshold will be lowered to 1,000 employees in January 2024. These numbers include the employees of all companies belonging to the German company group, even if the group companies are domiciled abroad. Smaller companies will be effected indirectly since the draft law obliges the companies in scope to ensure human rights and environmental protection by their suppliers, e.g. by contractual obligations.

Analysis and Reduction of ESG-Related Risks

The draft law obliges German companies to comply with an appropriate level of due diligence with regard to human rights and environmental protection throughout their supply chains. The annex to the draft law lists 13 international conventions for the protection of human rights, the environment, and human health. These conventions determine the meaning of the terms “human rights” and “environmental protection”, and therefore clarify the scope of the risks addressed by the draft law. Based on these conventions, the draft law lists examples of violations of rights that German companies must monitor and prevent, including: (i) child labour; (ii) the failure to comply with occupational safety measures or the principle of free association and non-discrimination against employees; (iii) the contamination of soil, water, or air as well as excessive water consumption; and (iv) the manufacture of products containing mercury.

Obligation to Act

The draft law obliges German companies to make their best efforts to prevent violations of human rights in their own business operations and in the supply chain. However, there is no obligation according to which these measures also have to be successful, i.e., actually help to remedy human rights abuses or environmental violations. The companies in scope of the draft law are obliged to fundamentally expand their risk assessment and management. The key feature of the enhanced risk management is a comprehensive risk analysis, which must be carried out once a year as well as on an ad hoc basis if the company expects that risks in its supply chain have significantly changed or expanded (e.g., upon the introduction of new products or the entrance into new markets). When preparing the risk analysis, companies are required to examine the risk of human rights or environmental violations within their supply chains and not just within their internal operations.

Legal Uncertainty Regarding Level of Appropriateness

Based on the results of the risk analysis, the draft law requires companies to implement “appropriate” remedial or preventive measures. The appropriate level of the measures is subject to relatively broad reservations, including, amongst others: (i) the type and scope of the specific business activity, (ii) the company’s ability to influence the direct perpetrator of the violations, and (iii) the contribution of the company to the causation of the human rights or environmental risk. Due to the lack of specified criteria, it remains to be seen how the authorities and the courts will determine the appropriateness of the measures.

Potential Impact on the Entire Supply Chain

Under the draft law, the risk analysis and the obligation to implement preventive measures must not only refer to the company’s own business activities, but also to the activities of its direct suppliers. Preventive measures within the supply chain may include the contractual commitment to comply with human rights and environmental standards and implementation of control mechanisms such as regular supplier audits. However, if the company obtains substantial knowledge of a possible violation of human rights or environmental requirements by an indirect supplier, the risk analysis and the concept of mitigation measures must immediately be extended to such indirect supplier.

Further Obligations

Companies affected by the draft law will need to adopt a general policy on their human rights strategy and appoint a human rights officer to monitor the risk management. In addition, companies must prepare an annual report on their fulfilment of due diligence obligations. The report must explain in a comprehensible manner: (i) which risks the company has identified, (ii) what the company has done in order to fulfil its obligation, (iii) how the company assesses the impact and effectiveness of the preventive measures, and (iv) what conclusions it draws for the future. The report must be made publicly available for a period of seven years starting from no later than four months after the end of the financial year. The draft law also requires companies to implement a complaints procedure that allows individuals both inside and outside of the company to anonymously report human rights and environmental risks or violations. The latter obligation is interconnected with a recently published German draft law on whistleblower systems implementing Directive (EU) 2019/1937 on the protection of persons who report breaches of Union law (the so-called EU Whistleblower Protection Directive). Companies will be required to ensure that their whistleblower system meets the obligations of both laws.

Enforcement and Penalties

The German Federal Office for Economic Affairs and Export Control (Bundesamt für Wirtschaft und Ausfuhrkontrolle – BAFA) will be responsible for monitoring and enforcing compliance with the draft law’s due diligence obligations. The BAFA can start the proceedings ex officio on the basis of its own investigations or following an external complaint backed up by substantial evidence. Violation of the due diligence obligations can lead to significant administrative fines.

Although the draft law does not provide for a direct civil liability of German companies, it may well lead to increased civil prosecution of human rights violations due to the reporting obligations imposed on companies and higher public awareness of the relevant issues the draft law is trying to address. For companies with annual group turnover of more than €400 million, the fines may be as high as 2% of the average annual global turnover. Companies with an annual turnover of less than €400 million still face fines of up to €800,000 depending on the type of violation. In addition, a violation of the due diligence obligations can lead to an exclusion from participation in public tenders for up to three years.

Upcoming Legislative Proposal in the EU

It seems Germany will not remain alone on the fight against human rights and environmental violations. At the beginning of 2020, the European Commission announced that the European Union plans to develop a legislative proposal by 2021 that will require businesses to carry out due diligence in relation to the potential human rights and environmental impacts of their own operations as well as those of their supply chains. In February 2021, a public consultation on the EU initiative was closed. The draft proposal for a European Directive is expected in the second quarter of 2021. Germany’s draft law is to be adapted to future EU legislation with the aim of preventing competitive disadvantages for German companies.