German Supply Chain Act: Due Diligence obligations for German and also Brazilian business partners

published on 20 March 2023 | reading time approx. 6 minutes

The new German Supply Chain Due Diligence Act (German: Lieferkettensorgfaltspflichtengesetz, short: “LkSG”), imposes extensive new obligations on companies with regard to human rights along the supply chain. The LkSG has been in force since January 1, 2023. In the following we will highlight the main points of the new law and also briefly address implications for Brazilian suppliers as well.

German Supply Chain Act

1. Personal scope of application

The LkSG applies directly to all German companies, regardless of their legal form, headquarters, principal place of business or registered office. The relevant thresholds are based exclusively on the number of employees:

From January 1, 2023: Companies with at least 3,000 employees; and
From January 1, 2024: Companies with at least 1,000 employees.

Please note that the LkSG also applies to German subsidiaries of Brazilian companies, if the subsidiary exceeds the above-mentioned thresholds and has its registered office in Germany.

2. Coverage

The Due Diligence obligations of the companies basically cover the entire supply chain – from the raw material to the finished sales product, which means:

In addition to its own business operations, the business relationships and production methods of its direct suppliers must also be considered.
In the case of indirect suppliers, a company must take action if there are actual indications that a violation of a human rights or environmental obligation is possible.

The requirements placed on companies are graduated, in particular according to their ability to influence the perpetrator of the human rights violation and the different stages in the supply chain.

3. Duty of care

Internationally fundamental human rights standards are to be protected by the LkSG. If environmental risks lead to human rights violations (e.g. through poisoned water), air and water pollution as well as the use of chemicals and pesticides or illegal deforestation are also included.

4. Due Diligence obligations

According to Section 3 of the LkSG, companies are required to conduct appropriate human rights and environmental Due Diligence in their supply chain with the aim of preventing or minimizing human rights or environmental risks; or ending the violation of human rights or environmental obligations.

The Due Diligence obligations include:

Section 4 (1) LkSG – Risk Management: The company must establish an appropriate and effective risk management system which must be embedded in all relevant business processes through appropriate measures.
Section 4 (3) LkSG – Human Rights Officer: The company must define who within the company is responsible for monitoring the risk management. The management shall regularly, at least once a year, inform itself about the work of the responsible person.
Section 5 LkSG – Risk analysis: The company shall conduct an appropriate risk analysis to identify the human rights and environmental risks in its own business operations and those of its direct suppliers. The risk analysis must be carried out once a year as well as on an ad hoc basis if the company must expect a significantly changed or expanded risk situation in the supply chain, for example due to the introduction of new products, projects or a new business field.
Section 6 LkSG – Preventive measures: If a company identifies a risk as part of a risk analysis in accordance with Section 5, it shall immediately take appropriate preventive measures within the company's own business area and vis-à-vis direct suppliers.
Section 7 LkSG – Remedial action: If the company discovers that the violation of a human rights-related or an environmental obligation has already occurred or is imminent in its own business area or at a direct supplier, it shall immediately take appropriate remedial action to prevent or end this violation or to minimize the extent of the violation.
Section 8 LkSG – Complaints procedure: The company must ensure that an appropriate internal complaints procedure is in place. The complaints procedure enables persons to point out human rights and environmental risks as well as violation of duty that have arisen as a result of the economic actions of a company in its own business area or of a direct supplier. Section 9 LkSG provides for Due Diligence measures with regard to indirect suppliers.
Section 10 (1) LkSG – Documentation: The fulfillment of the Due Diligence obligations pursuant to Section 3 LkSG shall be documented on an ongoing basis within the company. The documentation shall be kept for at least seven years from its creation.
Section 10 (2) LkSG – Reporting measures: The company shall prepare an annual report on the fulfillment of its Due Diligence obligations in the previous financial year and make it publicly available free of charge on the company's website for a period of seven years.

5. External control and sanctions

The LkSG provides for external inspection of fulfillment of the Due Diligence obligations by the Federal Office of Economics and Export Control (German: Bundesamt für Wirtschaft und Ausfuhrkontrolle, short: “BAFA”):

Accordingly, inspections of companies based on the annual reporting procedure are carried out.
Fines are possible for violations of the law. Companies can also be excluded from public procurement for up to three years in the event of serious violations.

European Corporate Sustainability Due Diligence Directive

In the same direction as the German LkSG, the European Commission presented on February 23, 2022 a draft proposal of the European Corporate Sustainability Due Diligence Directive (“CSDDD”).

The Directive lays down rules on obligations for companies regarding actual and potential human rights adverse impacts and environmental adverse impacts, with respect to their own operations, the operations of their subsidiaries, and the value chain operations carried out by entities with whom the company has an established business relationship and on liability for violations of the obligations mentioned above.

1. Status

On November 7, 2022, the rapporteur of the European Parliament's Committee on Legal Affairs, Lara Wolters, published a Draft Report which in some cases included significant tightening compared to the Commission's proposal.

Less than a month after the publication of Lara Wolters' draft report, on December 1, 2022 the European Council formally adopted its negotiating position (“General Approach”) on the CSDDD.

As soon as the European Parliament has also given its position (which is expected to happen by spring of this year), the so-called trilogue negotiations will be initiated. In 2024, the EU supply chain legislation could already be in place.

Depending on the implementation deadline agreed upon, the member states would then have 2 or 3 years to enact corresponding national supply chain laws or adapt existing laws.

2. Differences with the LkSG

The scope of application of the CSDDD goes significantly beyond that of the LkSG and requires, among other things, that the entire supply chain be covered, as well as users and disposers of products, not just direct suppliers as in the LkSG. The CSDDD is also to apply to companies with 500 or more employees (or 250 or more in high-risk sectors) and not just 1,000. The new EU regulation will possibly include civil liability for companies, allowing affected parties to sue for damages in European courts. Furthermore, the EU is also working on an expansion of Due Diligence requirements.

Suppliers and Business Partners

The new LkSG creates an urgent need for action for the obligated companies. They must implement the above-mentioned requirements in their compliance systems or make corresponding internal adjustments to ensure compliance with human rights in their supply chains.

However, the LkSG does not only entail Due Diligence obligations for companies covered by the scope. Even if only indirectly, small and medium-sized enterprises must also comply with the requirements of the LkSG. They are also bound by the Due Diligence obligations as potential suppliers or business partners of directly affected companies, since the mainly affected companies must audit their entire supply chain (and this precisely includes suppliers). In the future, particular attention will be given to suppliers from high impact industries such as food, textile and agriculture, which is why local Brazilian suppliers in particular should also address the requirements of the law to ensure their future business relationship with the large German companies. These suppliers and business partners of affected German companies will have to fill out questionnaires or expert reports from their principals in which they must assure that they do not work with any companies that violate human rights.

We have assembled an international and interdisciplinary team of experts to support companies subject to the LkSG worldwide (at the parent company and international subsidiaries) in implementing the requirements, and also to conduct selective risk-based audits of suppliers.

On the other hand, we also support the suppliers themselves in their voluntary review of compliance with the law (from a German and Brazilian legal perspective).

Source: Newsletter Recht & Steuern, Deutsch-Brasilianische Industrie- und Handelskammer