Key Elements of the Corporate Sustainability Due Diligence Directive
On April 24, 2024, after lengthy negotiations, the European Parliament adopted the final text of Directive 2024/1760/EU (“Corporate Sustainability Due Diligence Directive” or “CSDDD”), published in the Official Journal of the EU on July 5, 2024.
The CSDDD imposes new obligations on companies within its scope to prevent and mitigate negative impacts on human rights and the environment.
These obligations concern actual and potential human rights violations and negative environmental impacts caused by:
- the company’s own operations;
- the operations of their subsidiaries;
- operations along the value chain, both upstream (production of goods, provision of services) and downstream (distribution, transport, and storage of products).
Companies within the scope of the CSDDD will need to integrate due diligence on human rights risks and potential environmental damage using a risk-based approach. This means that when it is not feasible to address all identified negative impacts simultaneously, companies must prioritize their actions based on the severity and likelihood of those impacts.
To comply with this obligation, companies must develop a due diligence policy, draft a code of conduct (to be also applied to subsidiaries and business partners), and provide a description of the process and implementation of the due diligence policy, including measures to verify its effective application.
Article 22 of the CSDDD also requires companies to develop and implement transition plans to reduce greenhouse gas emissions, ensuring that their business model and strategy are compatible with the objective of limiting global warming to 1.5°C, as mandated by the Paris Agreement. The transition plan is the tool through which the European Union aims to integrate ESG factors into companies’ risk management plans, facilitating the economic transition to more sustainable business models.
For an overview of the main regulatory obligations imposed by the CSDDD and an analysis of the companies within its scope, refer to the contribution “Directive 2024/1760/EU (CSDDD): How the Rules for Entrepreneurs Are Changing,” published on July 6, 2024.
Innovative Aspects of the CSDDD Compared to Other EU ESG Regulations
The Corporate Sustainability Due Diligence Directive marks a significant shift in the EU regulatory framework on corporate responsibility. This directive stands out from previous ones, such as the Corporate Sustainability Reporting Directive (CSRD), by introducing a more interventionist approach.
While previous regulations primarily relied on transparency obligations, trusting markets to steer consumer and investor choices toward companies with better sustainability performance, the CSDDD imposes substantial obligations on companies, requiring proactive management of environmental and social impacts throughout the entire value chain.
This paradigm shift represents a crucial transition: from a model based on disclosure and market incentives to a system that demands concrete and measurable commitments from companies. The CSDDD not only promotes transparency but also requires companies to implement effective due diligence processes, adopt preventive and corrective measures, and take responsibility for the impacts of their activities.
In summary, the CSDDD reflects the growing awareness that addressing global challenges related to sustainability and human rights requires active and responsible involvement from the private sector. It is no longer just about reporting but embracing substantial changes in business practices, integrating sustainability principles into business models and operational strategies.
Impacts of the CSDDD on the Selection of Business Partners
The CSDDD introduces new obligations for companies in selecting and managing business partners to prevent, mitigate, or eliminate negative impacts on human rights and the environment along the entire value chain.
According to Articles 10 and 11 of the CSDDD, companies must adopt specific prevention plans and require appropriate contractual guarantees from their suppliers and partners.
However, if these measures prove ineffective, the CSDDD requires companies to refrain from entering into commercial relationships with entities involved in negative impacts. For existing relationships, temporary suspension is provided, followed by permanent termination in the absence of improvements.
This provision could lead to a significant increase in legal disputes related to potential abuses or differing interpretations of the provisions.
For instance, in the context of activating corrective measures under the CSDDD, disputes could arise regarding the failure to grant a grace period for implementing corrective measures or evaluating the effectiveness of preventive measures adopted. These situations could create significant legal uncertainties, as the parties involved might apply different interpretations to compliance requirements and timelines for implementing corrective measures. Clarifying these aspects will be crucial to avoid conflicts and ensure proper application of the CSDDD.
Furthermore, it cannot be excluded that some companies might exploit this provision to prematurely terminate commercial relationships, using compliance with the CSDDD as a pretext.
Conversely, if a company decides to continue a commercial relationship despite the prohibition imposed by the CSDDD, it could be held liable for damages caused by failure to comply with due diligence obligations, opening the door to potential legal disputes.
Civil Liability Regime
Article 29 of the CSDDD introduces a civil liability regime that arises under four conditions:
- violation of the due diligence obligations set forth in Articles 10 and 11 of the CSDDD
- the presence of actual damage
- a causal link between the violation of obligations and the damage
- the element of fault or intent.
It is crucial to note that a company cannot be held liable under Article 29 if the damage is caused solely by its business partner, without prejudice to the possibility of contesting the company’s failure to conduct adequate due diligence activities. Depending on how the provision is interpreted, the liability of companies for activities occurring along their value chain could be more or less extensive.
Regarding prescription terms, each Member State may define a term as long as it is not less than 5 years.
The liability regime outlined by the CSDDD has notable similarities to Article 2043 of the Italian Civil Code on non-contractual liability. The similarities are found in the requirements to establish liability, the prescription term, and the exclusion of liability for acts entirely attributable to third parties.
A significant aspect of the CSDDD is the possibility for the injured party to authorize a union or a non-governmental organization for human rights or the environment to take actions to assert the rights of the injured party. This provision is based on the assumption that such entities are better equipped to handle complex cases of this nature and to mobilize the economic resources necessary to support large-scale legal actions. This recognition represents an important step toward greater involvement of civil society in promoting corporate responsibility and protecting human rights and the environment.
Implementation Challenges
The effectiveness of the Corporate Sustainability Due Diligence Directive remains uncertain at this stage and will depend on its practical implementation and various factors, such as the definition of “value chain,” the exercise of rights by injured private parties, and the effectiveness of public oversight mechanisms.
Defining the boundaries of a value chain and, consequently, the scope of due diligence is not a simple task, especially regarding relationships with business partners indirectly involved in production processes, with whom there are no direct commercial agreements.
Another critical aspect concerns the risk of merely formal compliance, without a real substantive commitment to the objectives of European regulations on sustainability and corporate responsibility.
Furthermore, there is a real risk of strategic corporate reorganizations aimed at circumventing regulatory obligations, such as outsourcing the most polluting operations to suppliers; a risk that the EU legislator has sought to mitigate by extending due diligence obligations to subsidiaries and the value chain.
The CSDDD could also lead to the relocation of production activities to countries with less stringent regulations or lower compliance costs. If the measures required to ensure compliance with the directive are perceived as excessively burdensome and the level of enforcement by suppliers located in other parts of the world is lower, production relocation outside the EU could occur, leading to increased sourcing costs.
The CSDDD partially addresses this risk by extending obligations to third-country companies with significant activities in the EU and encouraging coordination among national supervisory authorities in their oversight practices to ensure uniform application.
It is crucial that coordination among national supervisory authorities in their oversight practices and strategies for implementing the CSDDD ensures a level playing field while preserving the competitiveness of European companies.
Economic Effects
Another significant aspect concerns the costs companies will incur to establish effective sustainability due diligence procedures and continuously monitor their application.
The extent of these costs will vary based on several factors, including the maturity level of existing processes to make the business more sustainable and the availability of personnel with specific ESG expertise within the company. In the absence of such internal expertise, companies will need to turn to external consultants, excluding the possibility of delegating these activities to inexperienced entities, given the economic and reputational risks associated with inadequate or incorrect compliance with CSDDD obligations.
According to a survey conducted by Istat, almost 60% of large Italian companies are already integrating ESG sustainability considerations into their corporate strategy. Some small and medium-sized enterprises have also started to reduce the environmental and social impact of their production processes, often in response to stakeholder demands or recognizing the potential of this change and seeking to leverage the competitive advantages of a proactive approach.
Common initiatives include investments in renewable energy production, purchasing electric or hybrid vehicles, and measures to reduce energy consumption and improve the energy efficiency of buildings. These efforts not only demonstrate a commitment to sustainability but can also translate into economic and reputational benefits for the involved companies.
In fact, the CSDDD also brings positive economic effects and corporate value creation. Improvements in internal processes could lead to better economic performance, employees might feel more satisfied working for companies committed to sustainable growth, with greater security and better working conditions. Moreover, the pressure to adopt more advanced management systems can lead to significant organizational improvements. Consumers, in turn, might be more inclined to purchase products and services from responsible companies, and credit conditions could also be more favorable for these companies.
Conclusions
The CSDDD represents a fundamental step towards integrating sustainability into European business practices. While its implementation presents significant challenges, the CSDDD also offers opportunities for companies to improve their governance, environmental, and social processes.
The economic impact of the directive could be twofold: on one hand, companies will face initial costs to implement due diligence procedures; on the other hand, these same measures can translate into competitive
