Navigation and service

Act on Corporate Due Diligence in Supply Chains

Women in Ethiopia harvesting tea leaves.
Source:  iStock

On 3 March 2021, Germany’s Federal Cabinet approved draft legislation on corporate due diligence in supply chains. This represents the first time that the responsibility of German companies to respect human rights in global supply chains has been given a legal foundation. On 11 June 2021, the German Bundestag adopted the legislation, which was followed by the authorisation of the German Bundesrat on 25 June 2021. On 22 July 2021, the act was published in the Federal Law Gazette. Find here the legal text in English translation. This translation is a service of the Federal Ministry of Labour and Social Affairs.

We have also summarised the most important questions about the Supply Chain Act for you:

In December 2016, the Federal Government adopted the National Action Plan for Business and Human Rights (NAP) in order, together with enterprises, to help improve the human rights situation worldwide and to give globalisation a social dimension in keeping with the Agenda 2030 for Sustainable Development. The NAP is based on the United Nations Guiding Principles on Business and Human Rights. In addition to state protection and judicial and extrajudicial remedies, corporate responsibility lies at the centre of the plan. In its Action Plan, the Federal Government has set out its expectation that all enterprises based in Germany comply with the core elements of human rights due diligence obligations in a manner commensurate with their size, their industry sector and their position in the supply and value chain, and respect human rights along their supply and value chains.

However, a business survey conducted by the Federal Government in 2020 (NAP monitoring) showed that less than one fifth of German-based enterprises with more than 500 employees sufficiently met their due diligence obligations along their supply chains. This shows that a voluntary commitment does not suffice. In the coalition agreement, the Federal Government agreed to take legislative action at a national level in this case and, at the same time, to work towards binding rules at a European level. On 22 July 2021, the Act on Corporate Due Diligence Obligations in Supply Chains (Lieferkettensorgfaltspflichtengesetz, LkSG) was promulgated in the Federal Law Gazette.

The supply chain within the meaning of the Act refers to all products and services of an enterprise. It includes all steps in Germany and abroad that are necessary to produce the products and provide the services, starting from the extraction of the raw materials to the delivery to the end customer and includes

  1. the actions of an enterprise in its own business area,
  2. the actions of a direct supplier and
  3. the actions of an indirect supplier

It also includes the use of necessary services, such as the transport or temporary storage of goods.

The Act places the enterprises covered by the scope of application under an obligation to exercise due regard for human rights and environment-related due diligence obligations in their supply chains. The obligations placed on an enterprise are graded according to its ability to exert influence, specifically in relation to

  • its own business area,
  • the actions of a contractual partner,
  • and the actions of other (indirect) suppliers.

The Act will apply from 2023 to enterprises that have their central administration, principal place of business, administrative headquarters, statutory seat or branch office as well as 3,000 employees in Germany; from 2024 it also applies to enterprises with 1,000 or more employees in Germany.
That said, the Act is also important for enterprises that do not fall within the direct scope of application. This is because they may be indirectly affected, for example as suppliers of an enterprise that is subject to the Act. However, enterprises outside the scope of application are not the addressees of administrative fines or legal obligations.

In addition to the company itself, the own business area also includes affiliated enterprises in Germany and abroad. This applies provided that the parent company exercises a decisive influence on the group company. It must be possible to exert influence in accordance with the governing law that applies in each case. Whether a decisive influence exists is determined by taking all aspects involving economic, personnel-related, organisational and legal ties between the subsidiary and the parent company into account. Indications are, for example, a significant majority shareholding in the subsidiary, a group-wide compliance system, responsibility for the control of core processes in the subsidiary, similar business areas or employees with roles in both the parent and the subsidiary.

Yes, in addition to its own business area, the business relations and production methods of its direct suppliers must also be taken into account. If an enterprise has actual indications that suggest that a violation of a human rights or an environment-related obligation at indirect suppliers may be possible, it must also take action there as warranted.

The principle of reasonableness applies: enterprises are only required to do what is possible in view of their individual context, such as their size, type of business activity or proximity to the supplier. Enterprises are not required, for example, to address all identified human rights challenges at the same time, but to focus on the main risks first. If, despite all (reasonable) efforts, a human rights violation does occur in the supply chain, the enterprise cannot be held liable.

The Act on Corporate Due Diligence Obligations in Supply Chains lists the international conventions in which human rights are enshrined and defines typical supply chain risks that need to be considered when fulfilling due diligence obligations. These include the prohibition of child labour, protection against slavery and forced labour, freedom from discrimination, protection against unlawful land confiscation, occupational safety and health and related health hazards, the prohibition of withholding an adequate wage, the right to form trade unions or workers’ representative bodies, the prohibition of causing harmful soil or water contamination and protection against torture.

Certain environmental risks are also taken into account: on the one hand, if they lead to human rights violations (e.g. poisoned water) and, on the other, where a ban on substances that are dangerous to human beings and the environment is concerned. The Act takes up certain environment-related obligations from three international conventions that enterprises must comply with: the Minamata Convention on Mercury, the Stockholm Convention on Persistent Organic Pollutants and the Basel Convention on Transboundary Movements of Hazardous Wastes and their Disposal. The supervisory authority also imposes sanctions for violations of environment-related obligations.

Undertakings must exercise due regard for human rights and environment-related due diligence obligations in their supply chain. In order to comply with the due diligence obligations, enterprises must establish an appropriate risk management system. To do so, it is necessary to define responsibilities within the enterprise to monitor compliance with due diligence obligations, for example by appointing a human rights officer.

As a first step, it is essential to seek to clarify and understand one’s own supply chain and to conduct a risk analysis. This means that enterprises must first identify those parts of their own business area as well as at their direct suppliers that pose particularly significant human rights and environment-related risks. With regard to indirect suppliers, a risk analysis must be carried out if an enterprise has actual indications that suggest that a violation of a human rights-related or an environment-related obligation may be possible (substantiated knowledge). In addition to its own findings, actual indications may include reports on the poor human rights situation in the production region, the fact that a supplier belongs to a sector with particular human rights or environment-related risks, or information received from the relevant authority.

If risks are identified, appropriate preventive measures must be taken. This includes, for example, agreeing appropriate contractual human rights clauses with the direct supplier and providing training. In particular, enterprises must implement procurement strategies and purchase practices that prevent or minimise identified human rights and environment-related risks. In addition, checks must be carried out as to whether the contractual partner adequately addresses identified risks along its supply chain. If the risk of a human rights violation at an undertaking’s own location or in the supply chain has been identified, appropriate measures must be taken to end or minimise it. This applies even more so if the human rights violation has already occurred.

If the enterprise has actual indications of a possible violation of a human rights-related or an environment-related obligation at an indirect supplier – i.e. lower down the supply chain – it must take appropriate preventive measures vis-à-vis the party responsible. This includes, for example, the implementation of control measures, support in the prevention and avoidance of a risk, or the implementation of sector-specific or cross-sector initiatives to which the enterprise is a party. If a violation is imminent or has already occurred, a concept must be created and implemented to prevent, end or minimise it.

In addition, enterprises must either establish an internal complaints procedure or participate in a corresponding external complaints procedure that allows those directly affected as well as those who are aware of potential or actual violations to point out risks and violations.

Enterprises must submit an annual report to the competent authority on how they are meeting their due diligence obligations.

The implementation of the Act is monitored by the Federal Office for Economic Affairs and Export Control (Bundesamt für Wirtschaft und Ausfuhrkontrolle, BAFA)

Enterprises must submit their report on the fulfilment of their due diligence obligations to BAFA no later than four months after the end of the financial year; they will then be checked by BAFA.

BAFA also carries out risk-based checks on enterprises. It can summon individuals, enter business premises and inspect and review documents, prescribe specific actions to remedy any shortcomings. Furthermore, the authority can impose financial penalties and administrative fines.

Enterprises must submit an annual report on the implementation of due diligence obligations to the Federal Office of Economics and Export Control and publish it online.

The report must provide clear informationn on

  • whether and which human rights and environment-related risks the enterprise has identified,
  • what the enterprise has done to fulfil its due diligence obligations,
  • how the enterprise assesses the impact and effectiveness of the measures,
  • what conclusions it draws from the assessment for future measures.

The report must be made publicly available online no later than four months after the end of the financial year and must be kept available for seven years. Due consideration is to be given to the protection of business and trade secrets.

An electronic reporting format is being worked on to minimise the burden on enterprises.

Financial penalties in administrative enforcement proceedings and administrative fines may be imposed to enforce compliance with the Act. If enterprises fail to comply with their obligations to carry out a risk analysis, to establish a complaints procedure, to take preventive measures and to effectively stop any known human rights violations, they face administrative fines of up to 8 million euros or up to 2% of annual turnover. The fines system based on turnover applies only to enterprises with an annual turnover of more than 400 million euros.

Similarly, enterprises that violate the Act can be excluded from the award of public contracts for up to three years if an administrative fine of a certain minimum amount is imposed (threshold depending on the severity of the violation: EUR 175,000 or EUR 1,500,000, EUR 2,000,000 EUR, 0.35% of annual turnover). To this end, the Federal Office for Economic Affairs and Export Control will be equipped with effective enforcement measures and broad control powers to monitor the supply chain management of the enterprises.

No, there is no liability for the conduct of third parties in the supply chain.

The Act itself does not change the existing legal bases for liability. However, employees abroad can already sue for damages in German courts if they feel that their rights have been violated by a German enterprise. However, the law of the country in which the damage occurred applies in such cases.

A new aspect introduced by the Act is the fact that those affected will in future be able to authorise domestic trade unions and non-governmental organisations (NGOs) to act as litigants in civil cases in their own capacity. Special capacity to sue is a procedural tool. It applies when there is a possible violation of legal positions of paramount importance pursuant to section 2 (1) of the Act, for example life and limb. In the respective proceedings, the law of the place where the damage occurred continues to apply, i.e. usually foreign law.

As part of the National Action Plan, the Federal Government has put in place extensive support for enterprises regarding the implementation of the due diligence obligations. This includes initial advice provided by the Business & Human Rights Helpdesk, which has been in existence since 2017, or the establishment of support networks abroad around the embassies of the Federal Foreign Office. Another key means of support are the sector dialogues on the implementation of the National Action Plan, which are moderated by the Federal Ministry of Labour. Among other things, detailed instructions for the implementation of individual due diligence obligations are developed as part of these dialogues, which increase confidence to take action especially in industry sectors with special human rights challenges.

A good overview of the support offered by the Federal Government for the implementation of corporate due diligence obligations as well as by other actors, and detailed information on the implementation of due diligence obligations can be found on the Federal Government’s information portal at https://www.csr-in-deutschland.de/EN/Home/home.html.

Going forward, the Federal Office for Economic Affairs and Export Control (BAFA), which is responsible for enforcing and monitoring the Act, will also publish cross-sector and sector-specific information and assistance on compliance with the Act.

The EU Commission is planning to introduce European legislation on sustainable corporate governance later this year, which will also include mandatory due diligence obligations in global value chains. EU-wide legislation will, on the one hand, increase the effectiveness of the protection of human rights while, on the other, creating uniform competitive conditions in the internal market.

In principle, enterprises that do not fall within the scope of the Act shall also implement due diligence obligations. The UN Guiding Principles on Business and Human Rights are addressed to all enterprises. The National Action Plan on Business and Human Rights (NAP), which lays down corresponding expectations for all enterprises based in Germany, has already been in force since 2016.

In addition, if enterprises outside the scope of the Act are direct suppliers of enterprises covered by the Act, they may additionally be required to meet due diligence obligations as part of their contractual relationship (which may, for example, include provisions laying down human rights-related expectations).

By their nature, the obligations under the Act cannot simply be passed on to suppliers. This applies, for example, to reporting obligations vis-à-vis the authorities and the general public. Nor does a supplier outside the scope of application of the Act have to fear control measures or sanctions by BAFA. In addition, enterprises that are subject to the Act remain responsible for keeping an eye on their supply chains and for fulfilling the obligations of carrying out a risk analysis and taking preventive and remedial measures.

The principle of “enablement before withdrawal” is explicitly enshrined in the Act. Enterprises are encouraged not to withdraw from regions with weak standards, but to work locally with their suppliers or within the industry to minimise risks. This gives them legal certainty, especially when dealing with suppliers who do not yet adequately address human rights risks.

Even in the case of serious human rights violations, a termination of the business relationship is only warranted if the following factors apply:

  • serious violation or breach
  • attempts to mitigate the risk fail within the time specified
  • no other milder means are available
  • there is no prospect of increasing influence

The mere fact that a country has not ratified the international conventions referred to in the Act does not require a termination of the business relationship.

The first report under the LkSG has to be submitted to the competent authority no later than four months after the end of the financial year ending in the calendar year 2023 (for enterprises with more than 3,000 employees) and 2024 (for enterprises with more than 1,000 employees). The reporting period only starts from 1 January 2023 (or 1 January 2024).

The first risk analysis must be carried out – from the entry into force of the Act (2023 and 2024 respectively) – as part of an appropriate and effective risk management system. The analysis must be carried out once a year, including during the first financial year, and on a case-by-case basis. Case-by-case analyses must be carried out, for example, if an enterprise is expected to face a significantly altered or significantly expanded risk situation in the supply chain. Information obtained on the basis of information obtained in the complaints procedure must be taken into account. If appropriate, several analyses may also be required in the first financial year.

The date on which the first risk analysis must be completed depends on the individual case as it depends on the individual circumstances prevailing in the enterprise and its risk management. If an enterprise identifies risks within the meaning of the LkSG in the course of this risk analysis, it must immediately take appropriate preventive measures, in particular a policy statement pursuant to section 6 (2) of the LkSG.

The EU’s leg­isla­tive pro­pos­al

A globalised economy requires a European strategy in the form of an action plan to effectively protect human rights in the supply chains of EU companies. The Federal Ministry of Labour and Social Affairs promoted the issue during Germany’s Presidency of the Council of the European Union in 2020; a concrete legislative proposal from the EU Commission is to follow in 2021.