Upcoming supply chain due diligence obligations for companies exporting to or doing business with Germany or the European Union

“Production and sale of goods under whatever conditions (or: under the cheapest conditions)” is no more- it will be replaced with “production and sale without a negative impact on the environment and by observing employees universal rights in the light of social market economic principles.”

This new law constitutes a worldwide unique set of legal rules and is a first of its kind step towards better working conditions for exploited labor forces as well as better environmental protection outside the borders of the EU.

The Lieferkettensorgfaltspflichtengesetz (LkSG), referred to as Lieferkettengesetz in short, which in English can be called the German Supply Chain Due Diligence Law (LkSG or the “Law”) will enter into force as of January 1st, 2023. The EU quickly has followed suit and completed a draft Directive on the same topic.

Although the referred Law has been passed by the German Federal Parliament, the Bundestag, it will have consequences for businesses exporting their products and services to Germany from anywhere in the world.

The purpose of the Law is to develop a worldwide liability for German companies aiming to ensure their observation of human rights and environmental matters while doing international business with an increasing speed and volume.

Objectives of the EU Directive

The objectives of the mentioned EU Directive are particularly as follows:

·?????improve corporate governance practices to better integrate risk management and mitigation processes of human rights and environmental risks and impacts, including those stemming from value chains, into corporate strategies;

·?????avoid fragmentation of due diligence requirements in the single market and create legal certainty for businesses and stakeholders as regards expected behavior and liability;

·?????increase corporate accountability for adverse impacts, and ensure coherence for companies regarding obligations under existing and proposed EU initiatives on responsible business conduct;

·?????improve access to remedies for those affected by adverse human rights and environmental impacts of corporate behavior;

·?????being a horizontal instrument focussing on business processes, applying also to the value chain, this Directive will complement other measures in force or proposed, which directly address some specific sustainability challenges or apply in some specific sectors, mostly within the Union.

Under its Article 3 paragraph (1), the Law explains how the due diligence would be interpreted within the context of this Law. Accordingly, the due diligence liability is related to human rights and environmental matters as indicated under the Law in order to prevent any human rights violations or to hinder any environmental risks within the supply chains of the companies, to mitigate the same or to terminate any such kinds of violations or risks.

The due diligence liability is also not defined under the EU Directive (2019/1937/EU). However, liabilities with respect to human rights and ecology determined under Article 5 to 11 of the draft EU Directive can be interpreted within the scope of the due diligence liability in the sense of this Directive (2019/1937/EU). Under Article 3 of the draft EU Directive with the heading “Definitions”, circumstances that may lead to due diligence liability are described as adverse environmental impact, adverse human rights impact, and severe harmful impacts.

Scope of the German Supply Chain Due Diligence Law

The scope of the due diligence is described under Article 3 paragraph (1) of the German Supply Chain Due Diligence Law:

·?????Ensuring a risk management system.

·?????Setting up an internal authority matrix.

·?????Contemplating regular risk analysis.

·?????Preparation of fundamental principles declaration.

·?????Taking preventive measures available to the respective areas among the own company activities and direct suppliers.

·?????Taking constructive measures.

·?????Building up an effective whistleblowing and complaint system.

·?????Implementation of due diligence liability with respect to risks emerging from intermediate suppliers.

·?????Documentation and reporting.

·?????Amendments in and additions to the contracts.

On the other hand, in the draft EU Directive, the same list is constituted based on acts of wrongdoings. Thus, the draft EU Directive implies acts like “do not harm!”, “do not cause a harmful impact” and “do not violate international conventions!”.

Which companies are affected?

Which companies are included within the scope of the Law is explicitly stipulated under Article 1 of the same Law. Accordingly, regardless of their types/ forms, this Law (LkSG) shall apply to companies fulfilling the following criteria jointly:

1. Having a domestic (in Germany) headquarters, head office, management center or business center registered in its articles of association;?
2. Companies have employed, as a rule, at least 3.000 employees domestically (in Germany) including those employees having transferred abroad.

Notwithstanding paragraph (1) above, this Law (LkSG), shall also be applicable to companies, regardless of whatever legal form, with a domestic branch according to Article 13d of the German Commerce Law (HGB) and companies having employed at least 3000 employees domestically. The minimum number of employees shall decrease to the threshold of 1000 as of January 2024.

While calculating the number of employees of companies that have recruited employees temporarily, such employees shall be taken into consideration if the duration of their employment contracts would exceed 6 months.

In affiliations [Article 15 of AktG (the German Stock Law)] while calculating the number of employees recruited by the mother company, the number of employees recruited by all companies included within the same group (paragraph 1 sentence 1 number 2) and those employees of companies resident domestically (in Germany) shall be taken into consideration.

Comparison with the draft EU Directive in terms of applicability

The draft EU Directive binds more companies, decreases the thresholds, adds a revenue threshold, and also includes companies resident not only within the boundaries of the EU but also those foreign entities that are trading with EU countries.?In other words, the EU Directive is stricter than the current German law and will affect even more businesses!

Accordingly, Article 2 of the draft EU Directive (in the subsequent two paragraphs shall be referred as “Directive”);

1.????This Directive shall apply to companies that are formed in accordance with the legislation of a Member State and which fulfill one of the following conditions:

(a)??the company had more than 500 employees on average and had a net worldwide turnover of more than EUR 150 million in the last financial year for which annual financial statements have been prepared;

(b)?the company did not reach the thresholds under point (a), but had more than 250 employees on average and had a net worldwide turnover of more than EUR 40 million in the last financial year for which annual financial statements have been prepared, provided that at least 50% of this net turnover was generated in one or more of the following sectors: (i) the manufacture of textiles, leather and related products (including footwear), and the wholesale trade of textiles, clothing and footwear; (ii) agriculture, forestry, fisheries (including aquaculture), the manufacture of food products, and the wholesale trade of agricultural raw materials, live animals, wood, food, and beverages; (iii) the extraction of mineral resources regardless from where they are extracted (including crude petroleum, natural gas, coal, lignite, metals and metal ores, as well as all other, non-metallic minerals and quarry products), the manufacture of basic metal products, other non-metallic mineral products and fabricated metal products (except machinery and equipment), and the wholesale trade of mineral resources, basic and intermediate mineral products (including metals and metal ores, construction materials, fuels, chemicals and other intermediate products).

2.????This Directive shall also apply to companies which are formed in accordance with the legislation of a third country, and fulfil one of the following conditions: (a) generated a net turnover of more than EUR 150 million in the Union in the financial year preceding the last financial year; (b) generated a net turnover of more than EUR 40 million but not more than EUR 150 million in the Union in the financial year preceding the last financial year, provided that at least 50% of its net worldwide turnover was generated in one or more of the sectors listed in paragraph 1, point (b).

Note: While calculating these thresholds within the draft EU Directive, part-time employees shall be considered within the calculation with respect to full-time employees. The number of temporary employees shall be taken into consideration as they were regular employees.

Audit by German Companies

Whether the companies included within the supply chain have fulfilled their obligations shall be audited by the importing German companies. The Law comprises direct suppliers and indirect or intermediate suppliers within the mentioned audit.

Any direct supplier is a contracting party of which supply is required for the delivery of goods or services in order to maintain the manufacturing of goods instructed by the business owner or to provide the relevant services of the latter and to benefit from such services.

Indirect or intermediate suppliers are companies that are non-direct suppliers but their involvement is required within the manufacturing chain in order to maintain the production of the related company’s products or provision of services and to benefit from such services. In this sense, it should be acknowledged that suppliers included within every instance of the manufacturing and sale process along with their sub-suppliers shall be deemed to be included within the mentioned process with respect to the obligations and audits indicated as follows.

Due diligence obligations for foreign (non-German or non-EU) companies falling under the above-mentioned definition of the supplier:

·?????Ensuring a risk management system (Article 4 paragraph 1).

·?????Setting up an internal authority matrix (Article 4 paragraph 3).

·?????Contemplating regular risk analysis (Article 5).

·?????Preparation of fundamental principles declaration (Article 6 paragraph 2).

·?????Taking preventive measures available to the respective areas among the own company activities (Article 6 paragraph 1 and 3) and direct suppliers (Article 6 paragraph 4).

·?????Taking constructive measures (Article 7 paragraph 1 to 3).

·?????Building up an effective whistleblowing and complaint system (Article 8).

·?????Implementation of due diligence liability with respect to risks emerging from intermediate suppliers (Article 9).

·?????Documentation (Article 10 paragraph 1) and reporting (Article 10 paragraph 2).

What foreign companies exporting to Germany (or EU) need to do now:

1. Each company is required to prepare its own strategies for complying with the due diligence liability stipulated by the draft EU Directive and the German Supply Chain Due Diligence Law.
2. The risk analysis for compliance with the due diligence liability should be performed by an independent company.
3. Deficiencies determined in risk analysis should be completed as soon as possible.
4. Accessible and understandable whistleblowing and complaint system for employees (including their own and intermediate supplier employees) should be set up.
5. The above-mentioned system should be independent of the company as much as possible and settlement venues should be sought by the damaged.
6. Frequent internal controls should be conducted.
7. A relationship on a C-level should be maintained with the auditors and independent whistleblowing and complaint systems.
8. The compliance with the German Supply Chain Due Diligence Law and the draft EU Directive with the due diligence obligations by their own suppliers and their sub-suppliers should be ensured.
9. Conditions for a recourse system should be established.
10. Revision of the supply and other relevant contracts including compliance provisions with respect to the Law and the EU Directive has to be conducted.
11. Since the protection of personal data is also essentially important for compliance purposes, actions already taken for protecting such data need to be reviewed.?
12. Information of employees and training thereof on a C-level is recommended.
13. Sanctions in the event of any violation of their own contracts with their suppliers should be determined.
14. The supply chain has to necessarily work with skilled and eligible consultants being experts in such areas of compliance.
15. Required preparations need to be completed for the assignment of an appropriate representative stipulated by the draft EU Directive.

Combining extensive cross-border and local expertise, our law firm is the leading firm in Turkey & beyond offering consultancy and auditing services for businesses affected by the new Law and upcoming Directive. We are also professionally qualified to provide training with respect to this topic.

Authors: Prof. Dr. iur. Mehmet K?ksal (Partner)

Translation: Didem Ataün (Senior Associate), Sven K?ksal (Consultant)

We are soon publishing more comprehensive guides, presentations, and informative articles on this topic on our website (mainly in Turkish, translated to German and English soon after). Stay tuned for more!