What Is the EU Corporate Sustainability Due Diligence Directive?
The Corporate Sustainability Due Diligence Directive (CS3D) is a pivotal European Union directive that mandates human rights and environmental due diligence for in-scope EU and non-EU companies. The directive requires in-scope companies to conduct due diligence across their entire “chains of activities” globally to ensure compliance with human rights and sustainability standards.
Additionally, in-scope companies must develop and annually update a transition plan for climate change mitigation, to ensure the compatibility of their business model and strategy with both the transition to a sustainable economy and the limiting of global warming to 1.5 degrees Celsius in line with the Paris Agreement.
This alert sets out some of the key issues that companies must consider under the CS3D. For more on the international legislative background to the CS3D, see our September 19, 2024, client alert, “UK Modern Slavery Act: The Future of Transparency in Supply Chains.”
What Are the Parameters of the CS3D?
Scope
The CS3D applies to:
- EU companies (i.e., companies established under the laws of a member state) that have more than 1,000 employees on average and a net worldwide turnover of more than €450 million.
- Non-EU companies that have a net worldwide turnover of more than €450 million in the EU.
- Non-EU and EU franchises with a net global turnover of more than €80 million and more than €22.5 million in royalties in the EU.
Companies that do not reach the thresholds above, but are the ultimate parent companies of a group that reached those thresholds in the last financial year for which consolidated annual financial statements have been or should have been adopted, are also in scope of the CS3D.
Companies must meet the relevant thresholds for two consecutive financial years to be in scope of the CS3D.
To provide greater clarity to non-EU companies as to whether they are subject to the CS3D, the European Network of Supervisory Authorities will publish an indicative list of companies.
There is an exemption under the CS3D for ultimate parent companies1 (i) whose main activity is holding shares and (ii) that do not engage in management, operational or financial decisions affecting the group or their subsidiaries.
Such parent companies may be exempt from CS3D, provided they:
- Apply for the exemption to the relevant national supervisory authority and the application is granted (following confirmation that the conditions are met).
- Nominate an EU subsidiary to fulfil the obligations of the parent company under the CS3D on behalf of the ultimate parent company. This designated subsidiary must be endowed with all necessary means and authority to fulfil the obligations of the ultimate parent company under the CS3D.
Even if it is granted this exemption, the ultimate parent company will remain jointly liable with the designated subsidiary for a failure to comply with CS3D.
The CS3D applies to financial sector companies such as credit institutions, investment firms, insurance undertakings and financial holding companies, provided that they meet the thresholds discussed above. However, the CS3D is not applicable to alternative investment funds or undertakings for collective investment in transferable securities.
Timeline for Compliance
EU companies have three to five years from 25 July 2024 to comply with CS3D, depending on their turnover and number of employees as follows:
- More than 5,000 employees and more than €1,500 million net worldwide turnover: three years (2027).
- More than 3,000 employees and more than €900 million net worldwide turnover: four years (2028).
- More than 1,000 employees and more than €450 million net worldwide turnover: five years (2029).
Non-EU companies similarly have deadlines running from 25 July 2024 as follows:
- More than €1,500 million turnover in the EU: three years (2027).
- more than €900 million turnover in the EU: four years (2028).
- more than €450 million turnover in the EU: five years (2029).
Franchises have five years — until 25 July 2029 — to comply.
Obligations Under the CS3D
Due Diligence
The due diligence obligation applies to the activities of companies in scope and to their subsidiaries. The obligation extends across companies’ worldwide “chains of activities,” which are defined to comprise the operations of:
- Upstream business partners, related to the production of goods or the provision of services by the company.
- Downstream business partners, related only to the distribution, transport and storage of the company’s product for or on behalf of the company, and excludes dual-use and military goods.
Further, EU legislators are set to consider the need for further sustainability due diligence requirements for regulated financial undertakings within the next two years. This follows from the compromise position that was reached in the final text of the CS3D, which provides that for regulated financial undertakings, only the upstream but not the downstream part of their chains of activities are covered.
To this end, the European Commission is required to submit a report to the European Parliament and European Council on the necessity of providing additional sustainability due diligence requirements tailored to regulated financial undertakings. The report should be published “at the earliest possible opportunity” after 25 July 2024 but no later than 26 July 2026.
If appropriate, the report is to be accompanied by a legislative proposal.
In order to fulfil the human rights and environmental due diligence obligations, companies will be required to:
- Integrate due diligence into their policies and risk management systems.
- Identify and assess actual or potential adverse impacts on human rights and the environment across their chains of activities.
- Prioritise those impacts based on their severity and likelihood.
- Prevent and mitigate potential adverse impacts.
- Provide remediation for actual adverse impacts, e.g., by providing financial compensation to affected persons.
- Engage meaningfully with stakeholders.
- Establish and maintain a notification mechanism and a complaints procedure.
- Monitor the effectiveness of their due diligence policy and measures.
- Publicly communicate on due diligence.
Adverse human rights impacts include abuses recognised by international human rights instruments, such as relating to the right to life, liberty and security, as well as employment rights (including prohibitions on child and forced labour) and environmental rights (including prohibitions on environmental degradation).
Adverse environmental impacts, based on international environmental instruments, include obligations to minimise impacts on biodiversity, handle waste lawfully and prevent marine pollution.
If both the parent company and subsidiary fall under the CS3D, the parent can fulfil most of the subsidiary’s obligations to ensure compliance. The subsidiary must integrate the parent’s due diligence policy, prevent and remediate adverse impacts, and engage with stakeholders.
If only the parent is in scope, it must cover its subsidiaries’ operations. If only the subsidiary is in scope, it must cover the parent’s operations to the extent that they are a part of its “chains of activities.”
Importantly, companies will be required to publish an annual statement on their websites with details of how they have discharged their obligations under the CS3D. The content requirements associated with such statements will be detailed by the European Commission in delegated legislation by 31 March 2027.
Companies already reporting under the Corporate Sustainability Reporting Directive (CSRD) are exempt from this requirement. These reporting requirements under CS3D will only come into force in relation to:
- Financial years starting on or after 1 January 2028 for companies that must comply from 26 July 2027.
- For financial years starting on or after 1 January 2029 for all other in-scope companies.
Climate Transition Plans
Companies must adopt, implement and annually update a climate change mitigation transition plan that aims to ensure that the business model and strategy of the company are compatible with the transition to a sustainable economy and with limiting global warming to 1.5 degrees Celsius per the Paris Agreement, as well as with the objective of achieving climate neutrality.
Member state supervisory authorities will oversee the adoption and implementation of transition plans. The following must be included:
- Time-bound climate targets for 2030 and every five years up to 2050, including absolute emission reduction targets for Scope 1, 2 and 3 greenhouse gas emissions.
- Decarbonisation strategies and key actions, including product/service changes and new technologies.
- Investment and funding details supporting the plan.
- Roles of administrative, management and supervisory bodies.
- Progress towards emission reduction targets.
Plans will need to be updated every 12 months, and they must reflect the progress the company has made towards achieving the targets set out in the transition plan.
Companies that report a transition plan for climate change mitigation under the CSRD are deemed to fulfil this requirement, and subsidiaries covered by a parent company plan are also deemed compliant.
Enforcement and Penalties
Member states’ supervisory authorities will be tasked with the enforcement of the CS3D.
For EU companies, the relevant supervisory authority will be that of the member state in which the company has its registered office.
For non-EU companies, the relevant supervisory authority will be where the non-EU company has its branch. In cases of no or multiple branches, the member state in which it generates the highest net turnover in the EU will be the relevant supervisory authority.
Non-EU companies will also be responsible for designating a natural or legal person resident or established in one of the member states where it operates to act as its authorised representative. That representative will be responsible for notifying the supervisory authority that the company meets the relevant threshold such that it is in scope of the CS3D.
Supervisory authorities can impose penalties up to a maximum threshold that must be at least 5% of the company’s net worldwide turnover. If the company fails to pay the penalty, the CS3D gives “name and shame” powers to the supervisory authorities of member states.
Additionally, supervisory authorities will at least have the power to order companies to:
- End infringements by performing or ceasing to perform an action or conduct.
- Adopt interim measures in the event of an imminent risk of severe or irreparable harm.
- Provide remediation proportionate to the infringement and necessary to bring it to an end.
Civil Liability
Under the CS3D, companies may face civil liability in national courts if they fail to comply with their obligations to prevent or mitigate adverse impacts, causing damage to the protected legal interests of a legal or natural person. Companies will be jointly and severally liable for damages caused with a subsidiary or business partner, but not for damage caused solely by a business partner.
The CS3D sets a limitation period of at least five years from when the infringement ceased and the claimant became aware (or should have reasonably been aware) of it.
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1 “Ultimate parent company” is defined in Art 3(1)(r) as “a parent company that controls, either directly or indirectly in accordance with the criteria set out in Article 22(1) to (5) of Directive 2013/34/EU [EU Accounting Directive], one or more subsidiaries and is not controlled by another company.”
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.