Supply chain due diligence requirements for exporters in Germany soon to go into effect

Exporters with a footprint in Germany are being warned of the potential impact of new legislation that demands they take action to comply with new rules coming into force at the start of next year.

On 11th June 2021, the so-called Supply Chain Due Diligence Act (Lieferkettensorgfaltspflichtengesetz) (the “Act”) was passed by the German Federal Parliament. The Act, which will come into force on 1st January 2023, is part of a broader trend in the European Union (EU) towards establishing mandatory human rights and environmental due diligence requirements, particularly for supply chain operations.

Applicability of the Act

The Act applies to a broad range of companies doing business in Germany, including certain German companies and their U.S. subsidiaries. Specifically, from 2023, the Act applies to companies (including foreign) that have their head office, main establishment, administrative headquarters, statutory seat, or a branch office in Germany, and employ more than 3,000 employees. From 2024, the Act expands to include such companies with more than 1,000 employees. Notably, this includes temporary workers assigned for more than six months and employees dispatched to other countries, such as the United States.

Importantly, the Act is also likely to have an indirect impact on small and medium-sized enterprises (SMEs) that do not meet the employee size thresholds. Large companies will likely include new contractual terms in supply chain operations agreements with SMEs to ensure compliance with the Act. Moreover, because the Act requires that large companies’ suppliers and their sub-suppliers comply with certain requirements, regardless of whether they meet the abovementioned employee size thresholds, many SMEs are likely to impacted. Altogether, the Act is likely to have a broad extraterritorial reach outside of Germany.

Compliance Requirements Under the Act

The Act introduces several new compliance requirements across human rights and environmental issues intersecting with supply chain operations. Even for companies that already have robust compliance architectures, implementation of these new requirements will likely involve meaningful internal planning and investment.

Under the Act, companies must undertake risk management activities across a broad spectrum of identified risk areas including, but not limited to, forced labor, discrimination, and environmental damage. These activities must be supported by an internal infrastructure that, among others, defines relevant internal roles and responsibilities, establishes complaints procedures, and satisfies documentation and reporting obligations.

Companies also have obligations to prevent, minimise, and remedy any negative human rights and environmental impacts that have been identified by these risk management activities. Companies must not only monitor and act upon violations in their own operations, but also in operations of their direct suppliers, starting from the extraction of raw materials to the delivery to end customers. What is more, if a company has substantiated knowledge of possible violations of human rights or environmental standards by an indirect supplier, it must immediately conduct a risk analysis for these violations.

The Act provides for various fines and sanctions for noncompliance. Fines can amount to up to EUR 800,000 against natural persons and up to EUR 8 million against legal entities, and can be scaled upwards based on annual turnover. Upon a confirmed violation, companies may be excluded from participation in public tender opportunities in Germany for up to three years. Finally, German companies may also face claims under Section 823 of the German Civil Code (Bürgerliches Gesetzbuch – BGB) on the grounds of a breach of a duty of care and claims under foreign law, due to noncompliance with the Act.

Related EU Trends

The Act is part of an increasingly active compliance environment in the EU for human rights due diligence. In addition to Germany, the Netherlands (Dutch Child Labor Due Diligence Law), France (French Duty of Vigilance Act), Switzerland (Swiss Due Diligence Law), and Norway (Norwegian Transparency Act) have each adopted human rights due diligence laws in recent years. While these laws differ in certain respects, each represents a notable “hardening” of soft law obligations regarding human rights for both individual company activities and broader supply chain operations.

The European Commission (the “Commission”) has also recently proposed its Directive on Corporate Sustainability Due Diligence (the “Directive”). Similar to efforts on the national level, the Directive would require EU Member States to adopt legislation on human rights and environmental due diligence involving companies, their subsidiaries, and their value chains, based on employee size and annual turnover thresholds. The Commission estimates that the Directive will cover approximately 13,000 EU companies and 4,000 third-country companies. The proposal must now be presented to both the European Parliament and the Council of the EU for their respective approvals. If adopted, the Directive could come into effect as early as 2024.

What must companies do?

Responsible businesses must develop and implement a robust whistleblowing process as part of their Environmental, social and Governance (ESG) compliance. They must extend this service into their supply chain, to enable all relevant stakeholders launching reports, including own employee, employees of direct suppliers, but also those of indirect suppliers further down the supply chain.

Further, the LkSG act mandates certain specific requirements for the whistleblowing process, including, among other, publicly accessible rules of procedure, impartiality of the person entrusted with the operation, confidentiality, comprehensive (and public) information on accessibility and responsibility, and annual effectiveness review.