Addressees of the German Act on Corporate Due Diligence Obligations in Supply Chains should note some new developments, including the first complaints filed under the act, guidance on small- and mid-sized enterprises as suppliers of obligated large companies, and updates on EU-level legislation.
Companies’ responsibility to respect human rights and certain environmental and social standards in global supply chains has legally been regulated in Germany, for the first time, through the new Act on Corporate Due Diligence Obligations in Supply Chains (Lieferkettensorgfaltspflichtengesetz, or LkSG) (the Act). For companies that are addressees of the Act, their responsibility no longer ends at their own factory gate but rather applies along the entire supply chain.
The Act lays out specific obligations in this respect for large companies: it requires companies with a location in Germany that exceed the relevant employee threshold there (currently 3,000 employees in Germany, which on January 1, 2024 will be lowered to 1,000 employees) to establish an appropriate and effective risk-management system that is integrated into all relevant business processes and identifies, prevents, minimizes, or eliminates human rights or environmental risks.
The Act obliges companies within its scope to observe human rights and environmental standards and obligations in their supply chains in an appropriate manner. The obligations that companies must fulfill vary depending on their scope of influence, in particular with regard to (1) their own business field, (2) the actions of contractual partners (direct suppliers), and (3) the actions of other (indirect) suppliers.
Since its enactment on January 1, 2023, the Act has applied to companies that (1) have their central administration, principal place of business, administrative headquarters, statutory seat, or branch office in Germany, and (2) have 3,000 or more employees in Germany. Consequently, the Act also applies to German subsidiaries and branch offices of foreign companies provided the employee threshold is met.
A nonprofit women’s rights association, a human rights organization, and a union of workers from the clothing industry have recently lodged a complaint under the Act against multinational corporations with the German Federal Office for Economic Affairs and Export Control (Bundesamt für Wirtschaft und Ausfuhrkontrolle, or BAFA). In June 2023, an international human rights organization lodged another complaint against other multinational corporations. These are the first cases of their kind since the Act came into force in January 2023.
It is now up to BAFA to consider those complaints. Should BAFA find actual violations of the obligations under the Act, the affected companies may face severe fines. However, BAFA will need to observe the principle of proportionality. While it does not seem likely that BAFA will impose fines in the upper area of the fine range (described below) in the first complaint under the Act, this may change in the future in the case of repeated willful violations of the obligations under the Act. Since further complaints are to be expected, companies will need to carefully prepare and ensure that they comply with current and future regulations.
Against this background, the below answers to frequently asked questions provide an overview of the obligations under the Act.
How Does the Act Define a Supply Chain?
The supply chain within the meaning of the Act includes all steps in Germany and abroad that are necessary for the manufacture of products and provision of services offered by any company, from the extraction of the raw materials to the delivery to the end customer, and includes
What Specific Obligations Does the Act Provide for?
The obligations set out in the Act relate to
What Human Rights and Environmental Concerns Does the Act Protect Specifically?
The Act refers to international conventions in which human rights are enshrined and defines typical supply chain risks that need to be considered. These include the prohibition of child labor, protection against slavery and forced labor, freedom from discrimination, protection against unlawful taking of land, occupational health and safety and related health hazards, prohibition of withholding an adequate living wage, the right to form trade unions and workers’ representations, the prohibition of causing any harmful soil change or water pollution, and protection against torture.
Furthermore, certain environment-related risks are addressed, for example, in case they may lead to human rights violations (e.g., poisoned water). The Act also contains rules on banning substances that are dangerous to humans and the environment.
Moreover, the Act focuses on certain environment-related obligations that are mandatory for companies taken from three international conventions: the Minamata Convention on Mercury, the Stockholm Convention on Persistent Organic Pollutants, and the Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and Their Disposal.
Are There Fines for a Violation?
If a company fails to comply with its obligations under the Act, it faces fines of up to €8 million or up to 2% of its annual sales. Moreover, a company that violates the Act may be excluded from being awarded public contracts for up to three years.
How Is a Company’s Supply Chain Management Monitored?
The competent authority is BAFA, which has far-reaching enforcement powers. For instance, BAFA may enter business premises, request information, and inspect documents as well as demand that companies take concrete action to fulfil their obligations and enforce this by imposing financial penalties.
The Act is relevant not only to companies within its scope, but also to companies that may be indirectly affected. Small- and medium-sized enterprises (SMEs) that do not meet the employment thresholds of the Act may still be indirectly affected by the requirements of the Act if providing services or products to another company that is itself subject to the Act’s obligations. The SME is then considered a direct supplier of the obligated company under the Act.
The obligated company must include direct suppliers with respect to which it suspects a risk in its risk analysis and, as the case may be, in preventive and remedial measures and the implementation of its complaints management.
BAFA recently published guidance (in German) on supply chain collaboration between obligated companies and their suppliers (LkSG: Neue Informationen zur Zusammenarbeit in der Lieferkette, dated June 29, 2023, with accompanying documents) in support of SMEs that have supply relationships with addresses of the Act.
Collaborations Between Obligated Companies and SME Suppliers
The starting point of the BAFA guidance is the agency’s assessment that “obligated companies partially make (too) far-reaching claims towards their suppliers.” BAFA’s guidance is meant to indicate what obligated companies may legitimately request from their suppliers under the Act. Further, BAFA’s guidance contains recommendations for a constructive collaboration between obligated companies and their suppliers.
BAFA stresses that while obligated companies will in many cases depend on collaboration with their suppliers to fulfil their own statutory diligence obligations, obligated companies must not transfer their obligations under the Act to suppliers. Companies outside the scope of the Act are not required to fulfil the statutory diligence requirements: “[c]ollaboration does not mean an extension of the scope of the Act.”
BAFA’s guidance stresses that the Act does not oblige SMEs to conduct their own risk analysis in relation to their supply chain, determine for themselves which prevention and remediation measures they should implement, establish their own complaint procedure, or submit reports to BAFA or cooperate in doing so.
BAFA’s guidance notes that although the Act is not directly aimed at SMEs, it does require that obligated companies cooperate with SMEs as their suppliers to fulfill the obligations under the Act, and that to assess the effectiveness of a diligence measure obligated companies should consider the capabilities of their suppliers, including SMEs.
What a supplier is able to achieve depends particularly on its resources, size, sector, and position in the supply and value chain as well as specific local conditions. According to BAFA, measures taken by an obligated company that are clearly too demanding for a supplier to implement are generally ineffective and therefore inappropriate.
While there is currently no legislation on supply chains at the EU level, on February 23, 2022 the EU Commission presented its legislative proposal for a directive on sustainable corporate governance, including mandatory obligations concerning global supply chains. The European Parliament adopted its negotiating position regarding the directive on June 1, 2023.
The next stage of the EU legislation process—negotiations on the final text of the directive between the Council, the EU Parliament, and the EU Commission—can therefore now officially begin.
The outcome of the legislative process remains to be seen. Based on the Commission’s proposal for the directive, the future EU regulation could go beyond the Act’s regulation, possibly introducing, for example, civil liability of affected companies and a higher upper limit of fines for violations.
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