Preparing for CS3D

published on 2 April 2024 | reading time approx. 4 minutes

The Corporate Sustainability Due Diligence Directive (CSDDD or CS3D) reached a qualified majority on Friday, March 15, 2024, in the Permanent Representatives Committee of the Council (COREPER, composed of EU Ambassadors). Thus, the draft legislation finally cleared the crucial hurdle of necessary approval from EU member states. Previously, Germany’s surprising announcement to abstain from voting in the EU Council seemed to endanger the entire legislative project. Only through a significant dilution of the original political agreement between Parliament and Council from December 2023, the Belgian Presidency managed to garner support from 17 EU member states for a new compromise proposal in the past week – on the third attempt.

What does the new compromise text of the European Supply Chain Act entail, and what are its implications for German companies?

Changes compared to the original legislative proposal »
What does the new compromise proposal mean for German companies? »
Conclusion and outlook »

Changes compared to the original legislative proposal

On February 23, 2022, the European Commission presented a proposal for a directive on corporate due diligence in the field of sustainability to the European Parliament and the EU Council. The CS3D introduces harmonized and binding rules across Europe, obliging companies operating in the EU to embed human rights and environmental due diligence in their value chains. During the latest so-called trilogue negotiations between the EU legislators (EU Council, EU Parliament, and EU Commission), member states and Parliament reached a provisional political agreement in December 2023. The legislative draft based on this agreement was originally scheduled for adoption in the COREPER on February 28, 2024, which was considered a mere formality. However, only after a renegotiated compromise proposal had been tabled by the Belgian Presidency, blockage by member states was overcome. The new compromise text significantly weakens the original political agreement between the EU Council and the EU Parliament in several respects.

Limited Scope of application

The number of companies falling within the scope of the directive has been further restricted. Under the new compromise proposal, only large companies with more than 1000 employees and an annual net turnover of over 450 million euros will fall under the EU Supply Chain Law. The original compromise between Parliament and Council proposed that the law would apply to companies with 500 employees and an annual net turnover of 150 million euros. At the very beginning of the negotiations, Parliament had demanded a threshold of 250 employees. Additionally, the concept of risk sectors has been removed in the current compromise proposal.

Previously, the draft law proposed a lower threshold (250 employees and 40 million euros in annual net turnover) for companies operating in a risk sector. However, the new compromise includes a review clause, allowing for a lower threshold for companies in risk sectors to be reintroduced at a later date.

Phased application

The new proposal provides for generous transitional periods, allowing companies more time to prepare for the implementation of their due diligence obligations. The directive applies:

after three years to companies with at least 5,000 employees and an annual turnover of at least 1.5 billion euros (expectedly in 2027);
after four years to companies with at least 3,000 employees and an annual turnover of at least 900 million euros (expectedly in 2028);
after five years to companies with at least 1,000 employees and an annual turnover of 450 million euros (expectedly in 2029).

Definition of the Value Chain

The original political compromise between the Council and Parliament defined the value chain as “chain of activities” and included some parts of the downstream value chain. With the new compromise, the downstream value chain has been further limited since references to the disposal and recycling of products have been removed. Furthermore, due diligence obligations regarding the downstream supply chain are now limited to direct business partners acting for or on behalf of the company (elimination of due diligence obligations regarding downstream indirect business relationships). The due diligence obligations under CS3D now primarily concern the company's own operations (including subsidiaries), direct and indirect suppliers, as well as the storage, transportation and distribution of the product (if this is done directly on behalf of the obliged company).

Climate transition plans

While the new compromise text includes the 1.5°C target set out in the Paris Climate Agreement and the assets protected by CS3D still include environmental protection, the obligation for companies above a certain threshold to promote climate transition plans with financial incentives for management has been removed.

Civil Liability

The obligation for Member States to provide appropriate conditions for civil liability has been adjusted, giving Member States more flexibility in the application of the provision. Companies shall only be liable for damages resulting from intentional or negligent failure to take preventive or remedial measures. Companies are not liable for damages caused by business partners. The definition of causation lies within member states law. The burden of proof stays with the plaintiff. Furthermore, civil liability is now only possible for proven damages a company caused to a natural or legal person. So even if causes can be brought by NGOs and trade unions, they can only be brought on behalf of victims. Thus, access to justice is limited to persons versus causes (no cases on behalf of the environment possible).

Financial Sector

The financial sector remains largely exempted.

What does the new compromise proposal mean for German companies?

With the new compromise proposal, less will change for German companies than originally anticipated, as the European law in its current version (in most cases) will only apply to companies that already fall under the scope of the German Supply Chain Due Diligence Act.

Since CS3D additionally provides for a minimum annual turnover in addition to the number of employees, and its scope is limited to certain types of companies, some companies currently obligated under the German Act may even fall out of the scope of supply chain due diligence obligations.

The narrowed definition of the downstream value chain in the new compromise proposal means that the due diligence obligations of the European directive will only extend very limitedly into the downstream value chain. Here, too, the new compromise aligns with the German law.

However, under the German Supply Chain Act, companies are currently focusing on their direct supply chain, as the law limits the substantive scope of due diligence obligations to Tier 1 suppliers. In practice, this has led to a compliance-oriented approach focusing on creating full transparency of all direct suppliers. In contrast, CS3D covers the entire upstream supply chain and emphasizes at the same time the need for companies to address the key risks that are directly related to their own products or services. Since the most salient potential negative impacts of companies often lie in the deeper supply chain, the EU directive is expected to be more demanding and less bureaucratic at the same time. This risk-based focus intents to offer companies the opportunity to establish leaner but more efficient due diligence processes by scoping their real impacts instead of analyzing all direct suppliers during their risk assessment.

It should also be emphasized that unlike the German Act, the new compromise proposal introduces the possibility for holding companies to be exempted from their due diligence obligations (upon application) if their activity is limited exclusively to holding shares and a subsidiary in the EU implements the due diligence obligations.

Furthermore, the EU-wide regulation is likely to represent an advantage for German companies in that it carries more weight in partner countries, allowing companies to have a greater leverage when working together with foreign suppliers towards improving human rights and environmental standards in global supply chains. In addition, with the EU-wide regulation entering into force, companies can expect an EU-wide development of best practices as well as EU-funded support for small supplier businesses that need to cooperate in applying the due diligence obligations and are therefore indirectly touched by the law.

Finally, both the new compromise proposal and the past version of CS3D provide that companies subject to CS3D and Corporate Sustainability Reporting Directive (CSRD) only have to report under CSRD. The CSRD report will have to include how the due diligence obligations have been implemented according to CS3D. This avoids a double reporting obligation. An adaptation of ESRS standards to incorporate requirements of CS3D is therefore expected.

Conclusion and Outlook

German companies are well positioned to meet the new requirements of CS3D as the new compromise found in Council is now closer to the German Supply Chain Act. However, new areas of law, particularly regarding potential adverse impacts of companies on climate and the environment will still be covered by CS3D. Moreover, even if downstream obligations have been further limited by the new compromise text, CS3D contains a wider definition of the supply chain than the current German law. In particular, the due diligence obligations will cover the entire upstream value chain. At the same time, the EU directive sets a clear focus on potential salient impacts of companies, including those in the deeper supply chain. This requires companies to adopt a less compliance-focused and more impact-oriented approach in their due diligence processes. Thus, affected companies are well advised to start preparing for the new law.

The current compromise text was adopted by the Parliament's Legal Affairs Committee on March 20, 2024 with 20 votes in favor, 4 against, and no abstentions. It still needs to be adopted by the plenary of the EU Parliament and formally by the EU Council. The vote in the EU Parliament is scheduled for April 24, 2024. No more changes on the content of the law are expected. After adoption by Parliament and Council, the directive will enter into force 20 days after publication in the Official Journal of the European Union. After entry into force, Member States have two years to transpose the requirements into national law. It is not yet foreseeable when Germany will enact the implementing law within this two-year period and thus adapt the German Act to the new EU requirements.