Introduction
The European Union (EU) has been intensifying its efforts to promote corporate sustainability, particularly through regulatory measures. One of the most significant developments in this domain is the EU Corporate Sustainability Due Diligence Directive (EU-CSDDD), aimed at ensuring that companies operating within the EU uphold human rights and environmental standards throughout their supply chains. This Directive mandates that companies take proactive steps to prevent, mitigate, and remedy adverse impacts on human rights and the environment, making it essential for businesses to reassess their contractual practices to ensure compliance.
Regulatory Context
The EU-CSDDD is part of the EU’s broader strategy to enforce sustainable and responsible business conduct across all industries. The Directive applies to EU companies with more than 1,000 employees and a turnover of more than EUR 450 million, as well as non-EU companies with significant operations in the EU, defined as having a turnover of more than EUR 450 million, regardless of the number of employees.
Smaller companies in high-impact sectors are also covered, with adjusted thresholds. The Directive establishes a legal framework for due diligence obligations, requiring companies to identify, assess, prevent, and mitigate potential and actual adverse impacts on human rights and the environment in their operations, subsidiaries, and value chains.
The Directive mandates companies to integrate due diligence into their corporate policies, establish complaint mechanisms, and publish due diligence statements. Non-compliance may result in penalties, civil liability, and reputational damage, making it crucial for companies to adapt their contracts to meet these new requirements.
Key Contractual Considerations
The importance of contracting has shifted significantly, as supply contracts now go beyond merely ensuring quality and delivery stability to also prioritise sustainability, human rights, and environmental impact, reflecting the evolving legal and ethical obligations under the EU Corporate Sustainability Due Diligence Directive.
To comply with the EU-CSDDD, businesses need to scrutinise and revise their contracts, particularly those with suppliers, partners, and other stakeholders. The following are key contractual aspects companies should address:
- Scope of Application
Clearly state the scope over which applicability of the Directive extends into the contract: specify what kind of business activities, entities, or subsidiaries the Directive would have control over and what it would not cover to avoid any misunderstandings and disputes.
- Due Diligence Clauses
Contracts should include specific clauses that require all parties to conduct due diligence on human rights and environmental impacts. These clauses should outline the scope of due diligence, including the identification, assessment, and mitigation of risks. To achieve this, contracts can mandate regular audits, require supply chain transparency, and demand the implementation of corrective actions where necessary.
- Sustainability Obligations
Explicit sustainability obligations should be embedded into contracts. These obligations could include adherence to recognised international standards, such as the UN Guiding Principles on Business and Human Rights or the OECD Guidelines for Multinational Enterprises. Contracts should specify the expectations for environmental performance, such as reducing carbon emissions or ensuring sustainable sourcing of materials.
- Monitoring and Reporting Requirements
Contracts should require continuous monitoring and regular reporting of compliance with sustainability obligations. This could include setting up key performance indicators (KPIs) related to sustainability goals and requiring all parties to provide periodic reports on their progress. Companies should ensure that contracts grant them the right to conduct audit and inspect their partners’ operations to verify compliance.
- Training and Capacity Building
Contracts can also include provisions for training and capacity-building initiatives to help partners and suppliers meet the Directive’s requirements. This could involve providing resources or organising workshops on sustainability practices, ensuring that all parties are well-equipped to comply with the due diligence obligations.
- Collaboration and Continuous Improvement
Contracts should encourage a collaborative approach to sustainability, fostering continuous improvement rather than merely penalising non-compliance. This could involve setting up joint working groups or partnerships aimed at addressing complex sustainability challenges and enhancing the overall resilience of the supply chain.
- Remediation and Termination Provisions
Contracts should include clear remediation procedures for addressing identified breaches of sustainability obligations. These provisions should outline the steps to be taken in case of non-compliance, such as corrective action plans or the suspension of business relationships. Additionally, contracts should include termination rights in cases of severe or repeated non-compliance with sustainability requirements.
- Liability and Indemnification Clauses
Companies should consider including liability and indemnification clauses that clearly define the allocation of risks, specifying which party is responsible for addressing particular risks. These clauses should protect both parties from potential legal and financial liabilities arising from breaches of sustainability or human rights obligations. These clauses can help protect the company from penalties or damages resulting from a partner’s non-compliance with the Directive’s requirements.
- Dispute Resolution Mechanism
Contracts should include specific dispute resolution mechanisms, such as mediation or arbitration, when disagreements or conflicts arise with respect to any sustainability obligation. These methods provide for a structured way of resolving disputes, avoiding expensive litigation and ensuring timely resolution of conflicts that may result from the implementation of the Directive.
- Force Majeure Clauses
Contracts should include force majeure clauses that deal with unforeseen circumstances, more commonly known as “acts of God,” such as natural disasters, wars, pandemics, or government actions that may impact compliance with the sustainability obligations. These clauses provide clarity on what responsibilities the parties have in such extraordinary circumstances and reduce the risks resulting from such unforeseen events that may affect the implementation of sustainability initiatives.
- Periodic Review and Amendment Clauses
Include provisions for the periodic review of contractual obligations to adapt to evolving legal requirements and best practices in sustainability.
Timeline and Legislative Implementation
The EUCSDDD was proposed by the European Commission in February 2022, and adopted in April 2024. Now the Directive will need to be transposed into national law by each EU Member State, typically within two years. This means that businesses operating in the EU should expect the Directive to take full effect by 2026. During this period, companies should actively engage with the legislative developments in each Member State, as the specific implementation may vary, potentially affecting the exact legal requirements.
Conclusion
The EU Corporate Sustainability Due Diligence Directive represents a significant shift towards mandatory sustainability and human rights obligations for companies operating within the EU. To navigate this new regulatory landscape, businesses must proactively adjust their contractual practices, embedding comprehensive due diligence and sustainability obligations into their agreements. By doing so, they not only ensure compliance but also contribute to more sustainable and responsible business practices across their value chains.
As the Directive progresses through the legislative process, companies must stay informed about national implementations and be prepared to adapt their strategies accordingly. Ensuring that contracts reflect these new obligations will be key to mitigating risks and fostering long-term sustainability in business operations.