Corporate Sustainability Due Diligence in Practice, part 3

The importance of companies’ behaviour in the climate transition and to achieve a sustainable development has led to increasing requirements on corporate responsibility and an ongoing shift towards more binding rules in the sustainability field. In accordance with a proposed new EU directive, requirements will be imposed on companies to implement due diligence processes in relation to sustainability. The main features of the proposal have been explained here. In this article series, Cederquist’s specialists on Corporate Sustainability explain which due diligence measures should be taken according to the proposed directive and existing international standards in the field.

In the two first parts of this article series, which can be read here and here, we described how due diligence should be integrated in the policies and management system of the company and the subsequent fundamental step in the due diligence process regarding identification of potential and actual adverse impacts.

In the following, we will explain in more detail how companies, in accordance with the proposed directive and the OECD Due Diligence Guidance for Responsible Business Conduct, should prevent potential adverse impacts and minimize or make actual adverse impacts come to an end. In this context, it should be noted that the OECD Guidance includes more fields of responsible business conduct than the proposed directive. For illustrative purposes, we have still included examples from the Guidance in the following.

The proposed requirement of management of potential and actual adverse impacts

When a company has identified the actual and potential adverse impacts for human rights and the environment with respect to its own operations, the operations of its subsidiaries and the value chain operations carried out by entities with whom the company has an established business relationship, these adverse impacts must be dealt with in an adequate way. In the proposed directive, the obligations on companies’ management regarding potential respective actual adverse impacts are divided into separate provisions for clarity. However, essentially the same type of measures should be taken in both cases.

Companies are primarily obliged to prevent adverse impacts from occurring by taking appropriate preventive measures. Examples of preventive measures are removing hazards in the workplace to prevent accidents or participating in initiatives in high-risk countries where local entities are educated in anti-corruption matters and government agencies’ capacity to monitor and prosecute bribery are strengthened to contribute to the preventing of bribery taking place in the future.

When it comes to ongoing actual adverse impacts, appropriate measures shall in first hand be taken to make them come to an end.

Insofar as it is not possible to prevent or to make an actual adverse impact to come to an end, neither at all nor immediately, companies should instead mitigate the adverse impact in an appropriate way. Measures in this category, which accordingly aim at mitigating the extent of the ongoing adverse impacts, are for example installation of purification systems resulting in decreased levels of emissions which can limit the impact on water pollution, as well as reporting by the company to government agencies and collaboration in investigations and prosecutions which can limit the adverse impacts of already committed acts of bribery.

The requirements on management in accordance with the above applies both in relation to adverse impacts that the company indeed has identified, and those which the company should have identified (i.e. if the requirements in the previous step of the due diligence process were met). Consequently, a company cannot escape its obligations, and by extension its responsibilities, by claiming that it did not discover a certain potential or actual adverse impact and thus was not obligated to act on it.

Companies shall take “appropriate measures” to manage adverse impacts

The assessment of what constitutes “appropriate measures” in different situations has been accounted for in our previous article regarding the identification of potential and actual adverse impacts, which can be read here. Here, it should be noted that the most important obligations set out in the proposed directive are obligations of means and not of result, which means that they do not entail any requirement on guarantees that adverse impacts under no circumstances will occur or that they always will be possible to prevent. It is however expected that companies are able to stop adverse impacts which occur in their own operations or those of their subsidiaries.

To provide companies with legal clarity and certainty, the measures that companies may be required to take in their management of adverse effects are listed in the proposal. In accordance with the underlying international standards in the field, all the measures set out have in common that that they must be designed with respect to the interests of those who are (or can be) affected negatively.

Neutralizing adverse impacts

Companies are obliged to neutralize or minimize the extent of actual adverse impacts that have occurred by taking measures which are proportionate to the significance of the adverse impacts and to the contribution of the company’s conduct thereto in each case. Different approaches are taken depending on whether the company has caused or contributed to a negative effect, or if the negative effect is directly linked to the company’s operations, products or services. It is also implied in the concept “appropriate measures” that the company’s obligations, as well as its ability to act, are more far-reaching as regards impacts that the company itself or its subsidiaries has caused or when the company to a large extent has contributed to the effect. The company’s influence is in general greater in relation to partners with whom it has a direct business connection and decreases correspondingly the further away you get from the company in the value chain.

In the proposed directive, it is set out that neutralisation of adverse impacts can be achieved, inter alia, by paying damages or economic compensation to affected individuals or societies. This is connected to the proposed provision on civil liability, which will however not be discussed in detail in this article.

Implementing preventive or corrective action plans

If necessary due to the complexity of the preventive or corrective measures, the company shall create and follow an action plan for the implementation. Such measures can for example be those who are difficult to implement due to operational, contractual or legal reasons.

The plan shall be created in consultation with concerned parties and contain reasonable and clear time limits, as well as qualitative and quantitative objectives for follow-up. The company should also make sure that there is a clear division of responsibilities for respective measure, and that the company’s legal department and other senior decision-makers are involved from start.

Contractual assurances from direct or indirect business partners

The objective should be that the company’s direct business partners shall undertake to follow the company’s code of conduct and any existing action plans, inter alia by obtaining corresponding contractual assurancesfrom their partners to the extent their operations are included in the company’s value chain.

If the measures taken by a company in accordance with the above don’t have the intended effect, another possibility is that the company seeks to obtain contractual assurancesregarding compliance with the company’s code of conduct or any existing action plans from a partner in its value chain with whom it has an indirect business relationship.

In a situation where a company has obtained contractual assurances,the company must also take appropriate measures to verify compliance therewith. According to the proposal, companies shall for this purpose for example be able to refer to appropriate industry initiatives or independent third-party verification. If it is a small or medium sized company that has given a contractual assurance, the terms that are used in this regard must be fair, reasonable and non-discriminatory, and the company obtaining the assurances must stand the costs for any independent third-party verification itself.

Necessary investments

To make sure that actual and potential adverse impacts are prevented, stopped and mitigated in a comprehensive way it can be necessary for companies to make investments for this purpose, for example in management or production processes or infrastructure.

Support to small or medium sized companies

Many small and medium sized companies lack the organizational and financial resources that are required to comply with companies’ codes of conducts or action plans. To contribute to the implementation, companies may thus need to offer targeted and proportionate support to those smaller companies with whom they have an established business relationship, for example by direct financing, low-interest loans, guarantees of continued sourcing, and assistance in securing financing, as well as technical guidance in terms of training, management systems upgrading and collaboration with other companies.

Collaboration with direct and indirect business partners

In particular in situations where no other measures are deemed appropriate or efficient, companies may need to cooperate with their direct and indirect business partners to increase their ability to make adverse impacts come to an end. When it comes to adverse impacts which occur where the company has an indirect business relationship, it might also be necessary to cooperate with other companies with better ability to implement the necessary measures.

In case of collaborations, the parties always need take into account other EU legislation, such as competition law.

Industry initiatives and similar systems as tools

As mentioned above in relation to verification of compliance with contractual assurances, industry initiatives can in some cases be used as a tool in the due diligence process. In the preamble to the proposal, it is highlighted that industry cooperation, industry schemes and multi-stakeholder initiatives can contribute to the further improvement of the conditions to identify, mitigate and prevent adverse impacts. To the extent that such systems are deemed appropriate by the company, it should therefore be possible to rely on such systems in order to support the implementation of the company’s due diligence obligations.

According to the proposed directive, the European Commission and the member states shall facilitate the distribution of information about such systems or initiatives and their result, and can also mutually issue guidelines for the assessment of their appropriateness.

Termination of business relationships as a last-resort action

To ensure that the measures taken in accordance with the directive are efficient, it is emphasized in the proposal that companies should as far as possible prioritize collaboration with business relationships in the value chain above discontinuation, since the latter risks worsening those adverse impacts. A typical example of this is cases where child labour is found to occur. This is also in line with the obligations on corporate behaviour in the OECD Guidance, which also contains further concrete recommendations in this area.

If a company still doesn’t succeed in preventing, ceasing or to an adequate extent mitigating potential or actual adverse impacts by taking the measures described above, the company shall however refrain from entering into new or extending existing relations with the partner which the effect has either occurred in connection to or within its value chain. If there are reasonable expectations of the potential or actual adverse impacts being prevented, put to an end or mitigated, the company shall temporarily suspend the business relationships while taking such measures. If the potential or actual adverse impacts are severe, the business relationships shall instead be terminated as regards the operations in question.

Temporary suspension and termination of business relationships in accordance with the above shall only take place if permitted by the legislation applicable on the parties’ business relationship. According to the directive, all member states shall ensure that there is an opportunity to terminate the business relationship in contracts that are regulated by their legislation.

Furthermore, a particular exception applies to regulated financial entities, which will not be obliged to terminate contracts concerning the providing of credit, loan or other financial services on the conditions set out above, if it can reasonably be expected to cause severe harm to the party receiving the service.

Continuous risk analysis and improvement

As regards the entire due diligence process, it is essential that the steps included therein are performed in parallel and that the process is dynamic. This means that the company continuously shall take into account experiences, evaluate the measures’ efficiency and carry out those measures that are needed for improvement. For example, the occurrence of adverse impacts which the company did not predict can give rise to a need of an updated risk analysis, completions or adjustments of the company policies and management process, targeted educational measures, as well as allocating responsibility at the right level within different parts of the organisation and the initiating of cross-operational collaboration. The company may also need to initiate renewed or deepened dialogues with stakeholders focusing on the relevant risks or adverse impacts, to better understand and come to terms with them.

As for adverse impacts that occur in the value chain, companies should consider the need for further measures to strengthen the ability to influence the behaviour of businesses with which the company has a direct or indirect business relationship, which beyond commitments on compliance with the company policies or code of conduct also can contain other contractual mechanisms such as various incitements and use of company market power, and a joint power of influence through industry initiatives and collaboration with government agencies.