The European Due Diligence Duty: Promoting a Virtuous Corporate Governance Model

Civil society and non-governmental organisations (‘NGOs’) are increasingly sensitive to the effects of economic activity and production on human rights, the environment, biodiversity and climate change, while companies, concerned about their reputation and attractiveness, are more willing to question their corporate purpose (raison d’être). Some companies are keen to communicate on the efforts they are making to meet these new expectations. The vision embodied in Milton Friedman’s famous article published in the New York Times in 1970, ‘The Social Responsibility Of Business Is to Increase Its Profits’ seems to have passed. ¹ If, at the end of the ‘Trente Glorieuses’, companies took few risks for their competitiveness, their brand or their reputation by ignoring the potentially adverse impacts of their activities on their employees and local communities, such indifference is no longer conceivable today. Indeed, under the joint pressure of citizens, NGOs, the media and social networks, states have been led—including with the objective of protecting their own companies against extraterritorial sanctions for serious breaches of the principles of probity—to adopt legislation aimed at preventing corruption and reminding companies of their due diligence duties. Thus, within the European Union, banking and financial institutions in particular have been required to implement binding compliance programmes to protect them from the risk of exposure to money laundering or terrorist financing operations. As corruption is also a phenomenon likely to seriously undermine the moral, intellectual, economic, and social development of political societies, the French legislator adopted Law No 2016-1691 of 9 December 2016 on transparency, the fight against corruption and the modernisation of economic life. This text requires large French companies to take all measures to prevent and detect the commission, in France or abroad, of acts of corruption or influence peddling.

Similarly, after the tragedy of the Rana Plaza collapse in 2013, many NGOs campaigned for the law to force multinationals to better control the impact of their activities, both in France and abroad, on the environment, health, human safety, and human rights. In the scope of their jurisdiction, judges have also played a major role by contributing, through the development of case law, to better define the scope of responsibilities that companies now must assume. For example, since 2011, a significant number of judicial investigations have been opened by the ‘Crime against humanity’ unit of the Judicial Court of Paris, at the request of the public prosecutor, against companies accused of complicity in crimes against humanity or genocide. Banks are being prosecuted for allegedly financing dictatorial regimes or for selling surveillance systems to cyber intelligence companies. Although no conviction has yet been handed down against them—due to the difficulty of establishing a causal link between the supply of goods or services by the company and the crimes committed by the political regimes in question—the procedures that have been initiated are punctuated by high-profile investigations (indictments, searches, police custody, etc.), which can seriously affect the reputation of these companies and force them to seek the best means to avoid being implicated in this way in the future. Markets follow this movement of mounting pressure on economic actors. Thus, financial institutions, which are themselves being challenged by some NGOs and citizens, are increasingly requesting that companies seeking their funding include CSR principles in their strategic objectives. Furthermore, certain activist funds have set themselves the objective of ensuring the offensive defence of social and environmental rights, against shareholders for whom financial profitability remains the only concern. Thus, on 26 May 2021, the investment firm Engine No 1, whose positions in favour of the energy transition are well known and which holds only 0.02% of ExxonMobil’s capital, had two of its representatives elected to ExxonMobil’s Board of Directors, against the advice of the oil company’s management. In this operation, Engine No 1 was able to benefit from the assistance of the funds BlackRock, Vanguard and State Street which, for their part, held 20% of the capital of the US company. This event clearly shows the desire of certain investment funds, which are very involved in financing the world economy, to influence the strategy of large groups that do not sufficiently promote the ethical principles constantly mentioned in the conventions or guidelines of major international organisations (OECD, UN, World Bank, etc.) or certain NGOs.

French law has responded in part to these new concerns with the adoption of the Law of 27 March 2017 on the duty of vigilance of parent companies and instructing undertakings 

In a context where the reputation of companies has become an important aspect of their competitiveness, the efforts they make to anticipate the risks they may face are decisive elements of their development strategy and their organisation. Thus, Law No 2017-399 of 27 March 2017 on the duty of vigilance of parent companies and instructing undertakings (the ‘law on the duty of vigilance’) specified the obligations that are now incumbent on companies with regard to the consequences of their activities on human rights, health and the environment. This new legislation, developed with the active support of NGOs, has subjected large groups ² to the obligation to adopt a policy that ‘include[s] reasonable vigilance measures able to identify risks and prevent severe violations of human rights and fundamental freedoms, serious harm to human health and personal safety and environmental damage’ resulting from their activities, those of their subsidiaries or their partners (subcontractors and suppliers). ³ The French law on the duty of vigilance provides that companies failing to comply with their obligations can be challenged by any person, particularly NGOs, who can justify an interest in taking action (‘intérêt à agir’)  before French courts. The latter may not only order the company, under penalty, to comply with its obligations (creation or reinforcement of the due diligence policy) but can also oblige it to repair the damage caused by its activities to people or the environment, particularly when the performance of the company’s due diligence obligations has not been sufficiently closely monitored.

This text has undoubtedly enabled significant progress in the consideration by the public authorities of the need to promote the emergence of a new model of corporate governance. However, six years after its entry into force, the French law on the duty of vigilance has some weaknesses, as shown by the difficulties observed in its enforcement, which were also highlighted by the parliamentary report on its evaluation. ⁴ The absence of a public authority that could have facilitated the understanding and proper enforcement of the law through its control and the issuing of clear guidelines contributed to the emergence of an environment of legal uncertainty, which companies constantly point out as a risk factor for the future of their activities. This being said, courts will eventually be able to contribute, through case law, to removing the remaining legal uncertainties and ambiguities, and there are good reasons to expect that they will take into account possible developments in European law in this area.

The proposed European Directive on Corporate Sustainability Due Diligence aims to promote a more virtuous business model in Europe

The European Commission’s proposal for a directive was the result of the impetus given by the European Parliament

The current European Commission, under the impetus of a large part of European opinion, which is increasingly expressing a strong desire for environmental protection and respect for human rights, has undertaken to impose much stricter rules on companies in terms of corporate governance. In 2021, the Commission proposed the adoption of a new European directive, the Corporate Sustainability Reporting Directive. ⁵ This text, which entered into force on 5 January 2023, reforms the Non-Financial Reporting Directive of 2014 and strengthens the obligations of companies with regard to the publication of information on sustainability. Its application now extends to a much larger number of companies, including small and medium-sized listed companies. The aim of the text is to give investors and other stakeholders access to the information they need to assess investment risks related to climate change and other sustainability issues. It is also intended to create a culture of transparency within European companies on all human rights and environmental issues.

On 23 February 2023, the European Commission proposed to complement this initiative by presenting to the Council of the European Union, the representative body of the Member States, a proposal for a European directive on corporate sustainability due diligence. ⁶ This text is the result of a resolution of the European Parliament of 10 March 2021, urging the Commission to propose, as soon as possible, a text on due diligence supply chains. The proposed directive, largely inspired by French, German and Dutch laws on the subject, and the OECD’s Due Diligence Guidance for Responsible Business Conduct, is intended to require companies to (i) integrate the due diligence duties into their policies, in particular by adopting a code of conduct, (ii) identify the actual or potential adverse impacts arising from their own activities or those of their subsidiaries, and, where related to their value chains, those of their business partners (risk mapping), (iii) prevent and mitigate potential adverse impacts and stop actual adverse impacts, (iv) establish and maintain a complaints procedure relating to these impacts, (v) establish internal monitoring of the effectiveness of the due diligence system and (vi) communicate publicly on their actions in this area (Art 5).

The political compromise reached by the governments around the common position of the Council of the European Union was based on the will of the Member States to find a balance between the ambition of the Commission’s proposal and the need to provide companies with a framework offering a sufficient level of legal certainty

Many Member States, particularly the Nordic countries, considered that the European Commission’s proposal was far too clear-cut and sometimes even out of touch with economic realities. In particular, they insisted on the fact that European economic entities were subject to competition from players who were not subject to such restrictive legislation in their own jurisdictions. The text of the Council of the European Union, as established at the end of the meeting of the Permanent Representatives Committee on 30 December 2022, is therefore the result of a political compromise. Without calling into question the objectives of the initial draft, it takes into account the reservations of many Member States about the Commission’s proposal. 

The scope of the Directive

The Commission’s draft envisaged that the companies subject to the new obligations would be EU limited companies with more than 500 employees and a worldwide net turnover of more than EUR 150 million (Group 1) and EU limited companies with more than 250 employees and a worldwide net turnover of more than EUR 40 million, at least half of which is in a risk sector such as textiles, agricultural raw materials and mineral extraction (Group 2) (Art 2). Moreover, companies from third countries, active on the European market, were also to be subject to the European duty of care if they exceeded the above-mentioned thresholds, it being specified that the turnover taken into account must be achieved solely on the territory of the European Union. The Commission estimated that these thresholds, which are wider than those applicable under French law, should lead to more than 13,000 companies being required to apply the provisions of the directive.

The Council made two adjustments to these provisions, first by specifying that the thresholds had to be exceeded over two consecutive financial years, as provided for under the French law on the duty of vigilance, and, second, by proposing that the scope of companies subject to the Directive be extended only gradually. Thus, the Directive would apply for a period of three years from its entry into force to European and foreign companies with more than 1,000 employees and a worldwide net turnover of more than 300 million euros. After four years, the thresholds would then be lowered to European and foreign companies with more than 500 employees and a worldwide net turnover of at least EUR 150 million, and after five years to companies with more than 250 employees and a worldwide net turnover of at least EUR 40 million, 50% of which comes from sectors identified as high risk (Art 30).

The financial sector was not fully covered by the European Commission’s proposal, as it was already foreseen that the identification of adverse impacts should only be carried out before the service is provided to the counterparty. The majority of the Council, concerned that this measure might discourage banks from financing developing regions, chose to leave it to each Member State to decide, when transposing the Directive, whether or not to include the provision of financial services by regulated institutions within its scope. By way of derogation from the general regime, it also specified that these undertakings, if included in the scope of application at the time of transposition, would in no way be obliged to temporarily suspend or terminate the commercial relationship, even where no other measure had made it possible to correct the adverse impact (Art 7 and Art 8). 

The extent of the obligation to identify adverse impacts 

The core of the mechanism envisaged by the proposed Directive is therefore for companies to draw up a map of the ‘actual or potential adverse impacts’ on human rights and the environment resulting from their activities, those of their subsidiaries or their ‘business relationships’ (Article 6). ⁷

The Commission thus seemed to adopt a position that led companies to have to assess all their established business partners, including those in the downstream value chain. This was in response to a strong expectation on the part of NGOs, in whose view human rights and environmental abuses do not always occur at the level of suppliers or subcontractors, but also at that of customers. In order to ensure legal certainty to those subject to the obligations of the Directive, the Council chose to replace the term ‘value chain’, used by the Commission, by that of ‘chain of activities’, ‘leaving out the phase of the use of the company’s products or provision of services entirely’. ⁸ This clarification by the Council could lead to the exclusion of companies’ customers from the scope of the due diligence assessment. It limits the scope of the duty of care to upstream business partners (design, extraction, manufacture, transport, storage, supply of raw materials or products, product development) and to downstream partners as regards exclusively the distribution, transport, storage and disposal of the product (dismantling, recycling, composting or landfill) (Art 3(g)). ⁹  

The obligation of companies to mitigate and remove adverse impacts 

On the basis of the risk mapping exercise, companies will therefore have to put in place an action plan to prevent or mitigate potential adverse impacts (Art 7) and to bring actual adverse impacts to an end (Art 8) (payment of damages to affected persons, planned corrective actions with qualitative and quantitative indicators for measuring improvement, contractual assurances from partners, investments for such prevention, temporary suspension of business relations, or even permanent cessation if necessary). The Council has significantly redefined the obligations of companies in identifying, preventing and eliminating negative impacts by inserting two new provisions. The first provides that if a company could not simultaneously remedy all the adverse impacts identified, it would simply be required to prioritise them and deal only with those that are the most serious and most likely to occur (Art 6a). The second is not to require companies to terminate business relationships that enable them to obtain raw materials, goods or services that are essential to the company’s production of goods or provision of

services, if this would result in substantial prejudice to the company (Art 7.7). 

The establishment of national supervisory authorities authorized to impose sanctions

In order to guarantee the proper enforcement of the text, the proposal for a Directive requires Member States, when transposing it into their national law, to lay down ‘effective, proportionate and dissuasive’ sanctions (Art 20) imposed by national administrative supervisory authorities, which would have significant powers of investigation (Art 17 and Art 18). The creation of such authorities will enable certain Member States that do not have them, such as France, to escape from the current climate of legal uncertainty, as certain legal concepts are insufficiently defined (serious infringements, established business relationship, etc.). In the same spirit, the proposal for a Directive provides for the publication by the European Commission of guidelines, which will be important to enable a harmonised application by companies of the provisions relating to the due diligence duties. These provisions have not been substantially modified by the Council of the European Union. However, it will be recalled that in France, the Constitutional Council censured the principle of the civil fine provided for by the French law on the duty of vigilance, considering that the terms used such as ‘human rights’ and ‘fundamental freedoms’ were insufficiently clear and precise for a sanction to be imposed in the event of a breach. When transposing the Directive into national law, the possibility of administrative sanctions as provided for in the proposed Directive could be contested, and it is therefore highly desirable for future drafters of the Directive to better define these key notions. 

The scope of civil liability of companies

The Commission’s text, inspired by the French regime, provides that companies could be held liable for damages in the event of failure to fulfil their obligations to prevent the adverse effects of their activities, and this failure led to damage (Art 22). Such a provision is undoubtedly likely to encourage companies to rigorously apply the text. While the Council did not call into question the principle of liability, it clarified its scope. In particular, it excluded the possibility for national legislation to provide for punitive damages and ruled out compensation for ecological damage, which has been allowed in French law since 2016, by providing only for compensation for damage caused to natural or legal persons. It also removed the cause of exemption related to the insertion of contractual guarantees and specified, in return, that a company ‘cannot be held liable if the damage was caused only by its business partners in its chain of activities’ without the company intervening (Art 22).

 The duty of directors to ensure that the due diligence policy is put in place

The Commission’s proposal for a Directive provided that directors had a duty to implement and supervise due diligence measures and to adapt the corporate strategy to take account of the adverse impacts identified and the due diligence measures adopted, at the risk of incurring liability based on the directors’ duty of care. This provision raised transposition difficulties. Unlike UK law, French law does not enshrine a general duty on directors to act in the best interests of the company. The vast majority of Member States considered that this proposal for a Directive could not pre-empt their national competences in the field of company law. The Council has therefore deleted this provision (Art 25 and Art 26).

The Council’s common position has therefore specified the scope of the European due diligence duty, in accordance with a pragmatic approach dictated by a number of considerations: few Member States have national rules on this issue at this stage; experience in their application is still limited and the economic stakes and political expectations remain considerable. It therefore seems unlikely that the Council, in the forthcoming negotiations with the European Parliament, will agree to relinquish the balances it proposed, be it on the extent of the value chain, the policy to combat climate change or director duties. In any case, the Directive is not expected to be adopted until late 2023 or early 2024 and Member States will then have two years to transpose its provisions into national law. 

The debate on the extraterritorial application of the Corporate Sustainability Due Diligence Directive 

Member States, concerned about the distortion of competition between European and foreign businesses, have pushed for an extraterritorial application of European due diligence obligations in order to create a de facto level playing field. Thus, the proposal for a Directive provides that companies established in third countries with a turnover of at least 150 million euros in the EU will be subject to its obligations (Art 2). ¹⁰

A large number of foreign companies will thus have to apply European law, including for their activities outside the Union. Moreover, foreign companies integrated in the chain of activities of companies subject to the provisions of the Directive (subcontractors, suppliers, etc.) will have to, at least indirectly, submit to European legislation. Finally, foreign parent companies may have to bear the costs of an administrative sanction or damages where one of their European subsidiaries subject to the Directive is liable. Similarly, if the parent company is included in the chain of activities of the European subsidiary, the latter will have to undergo the same assessment as any other business partner. ¹¹

The European Union, following the example of the United States in the fight against corruption, now fully assumes the leverage of the attractiveness of its market to export its standards, including to foreign entities, and thus promote a virtuous corporate governance model, respectful of human rights and the environment, for all those who wish to access its market. ¹² Some, considering that foreign companies could choose to leave the European market rather than apply these rules, are concerned about the risk of a loss of competitiveness of the European economy in a context of strong international competition. ¹³ However, one of the EU’s strengths is that it is an important economic market for foreign companies. Living standards are among the highest in the world and consumer purchasing power among the highest. It is therefore unlikely that any company, even American or Chinese, could afford relinquishing access to the European market in order to avoid the implementation of due diligence measures. Consequently, the European Union, in its desire to promote an economic model in which the protection of human rights and the environment is guaranteed, has every interest in making full use of the attractiveness of its market to require foreign players operating on its territory to comply with the values it promotes. 

Conclusion

In contemporary Western societies, the vision of businesses as being exclusively concerned with profit is fading. Economic actors are now legitimately expected to take into account the ethical duty to protect fundamental human rights and the environment in the performance of their business operations and with regard to their business partners. Failure to do so would expose them to major risks for the sustainability of their activities. These risks can result in criminal liability, loss of market financing and the launch of public campaigns against them. The French law on the duty of vigilance has already required companies to put in place mechanisms to prevent serious violations of human rights, fundamental freedoms, human health and safety, and the environment resulting from their activities. The main weakness of this text is the absence of a supervisory authority capable of guiding companies in the implementation of their due diligence policies. Similarly, the fact that France, Germany, and the Netherlands are the only jurisdictions to impose this type of duties could create distortions of competition to the detriment of their own companies. The adoption of a European Directive is therefore necessary to create a level playing field. Although the terms of the proposed Directive are still under discussion in the trialogue, the basic principles relating to the obligation for companies to ensure risk mapping, as well as measures to prevent and eliminate the adverse impacts of their activities, all under the control of an authority capable of imposing sanctions, have now been established, in a very timely manner. In addition to the fact that the evolution of European law will provide companies with a protective framework, leading them to carry out their activities in accordance with binding ethical principles, it also responds to the demand clearly expressed by citizens that human rights and the environment be better taken into account by the major economic groups and their main business partners.

1. See Milton Friedman, ‘The Social Responsibility Of Business Is to Increase Its Profits’, New York Times, 13 September 1970: ‘[i]n a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom. […] [T]here is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.’
2. See the French Code de commerce Art L. 225-102-4-I : ‘Any company that at the end of two consecutive financial years, employs at least five thousand employees within the company and its direct and indirect subsidiaries, whose head office is located on French territory, or that has at least ten thousand employees in its service and in its direct or indirect subsidiaries, whose head office is located on French territory or abroad, must establish and implement an effective vigilance policy’ (free translation from the French original: ‘Toute société qui emploie, à la clôture de deux exercices consécutifs, au moins cinq mille salariés en son sein et dans ses filiales directes ou indirectes dont le siège social est fixé sur le territoire français, ou au moins dix mille salariés en son sein et dans ses filiales directes ou indirectes dont le siège social est fixé sur le territoire français ou à l’étranger, établit et met en œuvre de manière effective un plan de vigilance’).
3. Free translation from the French original. See the French Code de commerce Art L. 225-102-4-I: ‘Le plan comporte les mesures de vigilance raisonnable propres à identifier les risques et à prévenir les atteintes graves envers les droits humains et les libertés fondamentales, la santé et la sécurité des personnes ainsi que l’environnement, résultant des activités de la société et de celles des sociétés qu’elle contrôle au sens du II de l’article L. 233-16, directement ou indirectement, ainsi que des activités des sous-traitants ou fournisseurs avec lesquels est entretenue une relation commerciale établie, lorsque ces activités sont rattachées à cette relation.’
4. Coralie Dubost and Dominique Potier, Rapport d’information sur l’évaluation de la loi du 27 mars 2017 relative au devoir de vigilance des sociétés mères et des entreprises donneuses d’ordre, Assemblée nationale, 24 February 2022.
5. Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU, as regards corporate sustainability reporting.
6. Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937 (COM/2022/71 final) (https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A52022PC0071).
7. The notion of ‘adverse impacts’—the European equivalent of the French notion of ‘serious harm’ (atteintes graves)—has been defined by reference to an annex which lists the nature of the violations to be apprehended, as well as the reference standards in terms of human rights and the environment, which must be taken into consideration (Annex 1 of the proposal for a Directive). While the creation of such a list is to be welcomed, its particularly broad nature does not allow for a precise definition of the scope of the negative impacts to be identified. While the establishment of such a list is to be welcomed, its particularly broad nature does not allow for a precise definition of the scope of the adverse impacts that have to be identified. The Council of the European Union has decided to reduce the list in Annex 1 to cover only ‘those international instruments that were ratified by all Member States’ (ie the International Covenant on Civil and Political Rights, the International Covenant on Economic, Social and Cultural Rights, and fundamental conventions of the International Labour Organisation). The Council retained the ‘catch-all’ clause included in the Commission’s proposal (Recital 25) and expanded the list of possible environmental damage, but without including the climate risk.
8. Council of the European Union, ‘Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937 – General Approach’ (15024/1/22 REV 1), 30 November 2022, paras 18 and 19.
9. The Council clarified that these downstream assessment obligations do not apply to products subject to export controls (ie, dual-use items and weaponry).
10. The same applies to companies with a net turnover in the EU between 40 million euros and 150 million euros, provided that at least 20 million euros was generated in one or more of the high-risk sectors (textiles, agricultural raw materials and mineral extraction).
11. Ibid.
12. See Anu Bradford, ‘The European Union in a globalised world: the “Brussels effect”’ (2021) 2 Revue européenne du droit 1, 75; The Brussels Effect. How the European Union Rules the World (Oxford University Press 2020).
13. See eg Pierre-Henri Conac, ‘Sustainable Corporate Governance in the EU: Reasonable Global Ambitions?’ (2022) 3 Revue européenne du droit 2, 129.