The German Act on Corporate Due Diligence Obligations in Supply Chains
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The LkSG obliges companies to ensure that human rights violations (e.g. child and forced labour, slavery, violations of occupational safety and health obligations applicable under the law of employment, restrictions on the freedom of association), but also certain environment-related risks (in particular prohibition to cause environmental pollution, use of certain chemicals – POPs, mercury – as well as the import and export of hazardous waste) are identified and avoided in their own business area and along their supply chains.
The regulations of the Act initially predominantly apply to large domestic entities, irrespective of their legal form, with at least 3,000 employees in Germany, which have their statutory seat, central administration, principal place of business, administrative headquarters or (in case of foreign companies) domestic branch office in Germany. From 1 January 2024 onwards, this threshold will drop to 1,000 employees and thus significantly expand the group of affected entities.
The "supply chain", as defined by the Act, begins with the extraction of raw materials and extends to delivery to the end customer. The responsibility of the companies essentially refers to their own business area and direct suppliers. However, this scope can be extended if misconduct and grievances within the supply chain of indirect suppliers become apparent. If this is the case, companies are also obliged to take remedial actions. As a result, the LkSG also has a direct impact on companies that remain below the above-mentioned number of employees. This is the case where companies are part of the supply chain of entities directly falling within the scope of the Act and are obliged by them to comply with the applicable human rights and environment-related requirements. Even indirect suppliers can be affected, because direct suppliers must in turn adequately address the expectations of the companies within scope vis-à-vis their own suppliers and service providers (e.g. through clauses that pass on due diligence obligations).
The LkSG obliges companies within scope to comply appropriately with the human and environment-related requirements in supply chains. Companies within the scope of the Act must demonstrate they have implemented the following due diligence obligations:
- A risk management system
- Appropriate internal responsibilities (e.g. appoint a human rights officer)
- Regular performance of risk analyses
- Issuance of a policy statement
- Preventative measures in their own business area as well as vis-à-vis direct suppliers (e.g. through a whistleblower hotline/information system)
- Taking remedial action in the event of identified violations
- A complaints procedure
- Documentation and reporting
In particular, companies should prepare for the following requirements:
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Risk management and analysis: The establishment of an appropriate and effective risk management system requires, among other things, the definition of responsibility for the monitoring of the risk management. This can be done inter alia by appointing a human rights officer. The management must regularly (at least once a year) seek information about the work of the human rights officer(s). Companies must identify, weigh and prioritise the risks in their supply chain (primarily in their own business area and with their direct suppliers) as part of the risk analysis. The risk analysis must be carried out once a year and on an ad hoc basis (e.g., if a violation becomes known, or if new business areas or products are introduced). If they identify human rights risks in the course of conducting risk analyses in their business area or with direct suppliers, appropriate counteractive measures must be taken immediately.
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Prevention: Businesses are required to adopt a policy statement on their human rights strategy and to embed appropriate preventive measures in their own business operations and vis-à-vis their direct suppliers. In their own business operations, these should include in particular the implementation of the defined human rights strategy, the development and implementation of appropriate procurement strategies and purchasing practices, training and risk-based control measures. With regard to direct suppliers, human rights and environmental-related expectations should be taken into account in the selection process. In addition to the implementation of contractual control mechanisms, contractual assurances should be obtained so that direct suppliers comply with the required specifications and address them appropriately.
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Remedial action: If the company determines that a violation of a protected legal position or an environmental obligation has already occurred or is imminent in its own business area or at a direct supplier, it must immediately take appropriate remedial action. However, a termination of the business relationship with the direct supplier is only required in exceptional cases, such as in case of very serious violations of the protected legal positions and provided that the implementation of the measures developed in the concept do not remedy the situation, or no other less severe means are available to the company or the increase of its ability to exert influence has no prospect of success.
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Complaint mechanisms: In order to identify human rights violations as early as possible, internal complaint procedures must be introduced or participation in external complaint mechanisms must be provided for.
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Reporting obligation and documentation: Companies within direct scope of the Act have to provide an annual report publicly available online - no later than four months after the end of the business year - on the actual or potential adverse impacts of their business activities on human and environment-related rights and submit it to the Federal Office of Economics and Export Control (BAFA). These reporting obligations are also accompanied by documentation and publication obligations.
Compliance with due diligence obligations is monitored by the Federal Office of Economics and Export Control (Bundesamt für Wirtschaft und Ausfuhrkontrolle - BAFA). To this end, the Federal Office of Economics and Export Control is equipped with effective enforcement instruments and extensive monitoring authority to oversee companies' supply chain management. If companies fail to comply with their due diligence obligations, they face fines of up to 8 million euros or up to 2 percent of their annual turnover (the turnover-based fine framework only applies to companies with more than 400 million euros in annual turnover). Similarly, companies that violate the act can be excluded from public tender procedures for up to three years if a fine of a certain minimum amount is imposed.
The LkSG does not establish (additional) civil liability for the conduct of third parties in the supply chain. However, the act has introduced a new form of litigation. Affected parties can authorise domestic trade unions and NGOs to conduct civil proceedings as litigants in cases of a violation of paramount legal positions.
In February 2022, the European Commission presented a long-discussed draft directive on corporate due diligence in the supply chain. The draft goes much further than the LkSG and, in addition to extended protected rights, also provides for the civil law liability of companies. The due diligence obligations and requirements also extend to the entire (upstream and downstream) supply chain. Moreover, the circle of addressees is expanded compared to the LkSG: According to the current draft, companies with 500 or more employees and a minimum turnover of EUR 150 million are covered, as well as companies with 250 or more employees and a minimum turnover of EUR 40 million if they are active in particularly high-risk sectors. However, the legislative process will still take some time which means that implementation into German law is not expected before 2025.
Our lawyers support you in the legal structuring of your supply chains, including international procurement and distribution structures. Learn more now: Advice on the Supply Chain Due Diligence Act