Blog: Compliance requirements due to the German Supply Chain Due Diligence Act

In April 2013, an outcry went through the media when over 1,000 people lost their lives in a building collapse of a textile factory in India. The affected workers had previously discovered cracks in the building but were forced to continue working. The question of who was to blame and who was responsible was in the air. Was it the supervisors who forced the workers to continue working despite the known defects in the building? Weren't the international fashion chains, which have their products manufactured as cheaply as possible, also partly to blame? Isn’t also the consumer to blame, for whom textiles cannot be cheap enough?

This tragedy of the loss of so many lives in the workplace was the impetus for a discussion about responsibility. Suddenly there was a worldwide discussion about fair working conditions in the textile industry. Even if this was not the birth of the German Supply Chain Due Diligence Act (LkSG), it at least accelerated efforts in this direction.

Six months after the disaster, there was an agreement called the "Rana Plaza Arrangement", whereby relatives received compensation. The companies initially refused, and it was not until October 2015 that the compensation was paid to those affected. Another change triggered by this event was the “Accord on Fire and Building Safety in Bangladesh”. This stands for better protection and more safety in the textile factories in order to eliminate violations there. At the end of 2013, the minimum wage for textile workers was finally raised.^[i]

What is covered by the Supply Chain Act?

In general, companies are aware of the risks of their operations in an international context. Nevertheless, they are often accused of producing cheaply abroad, for example, without taking care of the risks that arise for people and the environment. This is precisely where the LkSG comes into the picture. In the future, companies will bear responsibility for the violation of human and environmental rights along the supply chain.

The Supply Chain Act, which was passed on 11 June 2021, is intended to ensure that companies pay attention to human rights and the environment from the extraction of raw materials to the end customer. This applies both at home and abroad and is intended to prevent child labour, forced labour, discrimination and inadequate safety standards in the supply chain. Better working conditions should minimise the risk of occupational accidents and other health risks.

The term supply chain is broadly defined. According to section 2 V of the LkSG, this covers all products and services, in particular all steps at home and abroad that are necessary to manufacture the products and provide the services. In addition to its direct applicability, the indirect spillover effect of the LkSG should also be taken into account.

When must the contents of the new Supply Chain Act be implemented?

The LkSG will come into force on 1 January 2023. However, companies already have to adapt their risk management in accordance with the new legal requirement now. The Supply Chain Act obliges all companies to comply with a clear proportionate and reasonable legal framework to fulfil human rights due diligence obligations. The requirements are based on the due diligence standard.

Is my company affected by the LkSG?

The LkSG applies to all companies under German or foreign law, regardless of their legal form, if they have their main administrative or statutory seat or their headquarter in Germany.

In addition, companies that have a branch office in Germany pursuant to section 13 d of the HGB (German Trade Law) are also covered. German subsidiaries can also fall within the scope of the LkSG.

A further prerequisite is that the companies must have at least 3,000 employees, which also includes any employees sent abroad. In the case of parent companies, the number of employees of all companies belonging to the group must be included. The number of employees must also include temporary workers who have been working for the company for at least six months.

As of 1 January 2024, this threshold will drop from 3,000 to 1,000 employees.

Furthermore, in the summer of 2024, it is to be decided whether the scope of the LkSG will be extended even further, so that companies with less than 1,000 employees will also be obliged by the LkSG.

Experts suspect that companies that are not obliged parties under the LkSG will be at least indirectly affected. Companies working with them could contractually oblige them so that they too must comply with the due diligence requirements of the Supply Chain Act. Furthermore, supplying companies are indirectly affected by the LkSG.

What happens if I do not comply or comply too late with the new legal requirements?

If the LkSG is violated, fines of up to € 800,000 may be imposed for intentional and negligent violations. For companies with a turnover of more than € 400 million, the fine can be increased to up to two percent of the global turnover. Under section 22 of the LkSG, companies can even be excluded from public procurement for a period of up to three years if a fine of € 175,000 or more is imposed. A damaged image associated with a violation of the law could indirectly lead to further financial damage.

However, according to section 3 III of the LkSG, a civil liability of the company due to violations of due diligence obligations regarding the protection of human rights as well as the protection of the environment is excluded. Consequently, there is also no personal liability of the managing directors in the case of violations of the LkSG.

What are my obligations as a company?

The due diligence resulting from the LkSG can be divided as follows:

own actions in one's own business area according to section 2 V no. 1, VI of the LkSG,
the actions of a contractual partner,
the actions of a direct supplier according to section 2 V no. 2, VII of the LkSG and
the actions of an indirect supplier according to section 2 V no. 3, VIII of the LkSG.

This means that responsibility no longer ends exclusively within the company itself, but - as the name of the law suggests - extends beyond it: along the supply chain.

The Supply Chain Act contains a final catalogue of eleven internationally recognised human rights conventions. From the legal rights protected there, behavioural requirements or prohibitions for corporate action are derived in order to prevent a violation of protected legal positions. These include the prohibition of child labour, slavery and forced labour, the disregard of occupational health and safety, the withholding of an adequate wage, the disregard of the right to form trade unions or employee representatives, the denial of access to food and water as well as the unlawful deprivation of land and livelihoods.

In section 3 of the LkSG, the law only mentions the companies' obligation to make efforts. Therefore, there is neither a duty to succeed nor a warranty liability. Furthermore, all due diligence obligations are subject to an appropriateness proviso, which gives companies discretion and room for manoeuvre. A gradation of the duty results from the company’s existing possibilities of influence. As a result, according to section 3 III of the LkSG, companies cannot be held liable under civil law for a violation of the due diligence imposed on them. Thus, there is also no personal liability of the managing directors.

Even if companies have to observe human rights and environmental concerns, nothing impossible can be demanded of them. Due diligence obligations can be fulfilled even if the entire supply chain cannot be traced, or preventive or remedial measures cannot be taken in case these actions are practically or legally impossible.

Even though the LkSG has been criticised particularly by business associations because, according to them, it would harm competitiveness, for example, the topic of sustainability is not entirely new in the legal landscape. Since 2017, there has been an obligation under the CSR RUG (CSR Directive Implementation Act) to disclose certain sustainability aspects such as environmental and social concerns, employee concerns, respect for human rights and the fight against corruption.

What compliance measures must be taken?

Based on the LkSG, companies and business managers are obliged to set up a compliance system to observe human rights and environmental due diligence obligations:

Establishment of a corresponding risk management system
Establishment of an internal responsible person or a representative
Issuing a corresponding policy statement
Implementation of a (direct/indirect event-based) supplier due diligence process
Conducting regular/continuous risk analyses
Focusing on risk-based and corrective actions
Definition of preventive measures within the own business unit(s) and direct suppliers
Establishment of a complaints procedure ("whistleblowing system")
Documentation and reporting

The law stipulates in section 4 I of the LkSG that risk management must be established to identify, prevent, end or at least minimise risks and violations of human and environmental rights along their supply chains. The law indicates which preventive measures, obligations for complaint procedures and reporting are required for this. In addition, clear responsibilities must be established within the company to monitor the risk management system. A person responsible for risk management must be appointed within the company. According to section 5 of the LkSG, an appropriate risk analysis must be carried out to determine human rights and environmental risks.

At least once a year as well as on an ad hoc basis in the event of a significantly changed or expanded risk situation, the company must check its own business area and its direct suppliers whether there is a violation of human rights or environmental concerns. In the case of indirect suppliers, the obligation to conduct a risk analysis only exists if the company has sound knowledge of possible violations.

According to section 6 I and V of the LkSG, if companies identify a risk, they must immediately take appropriate preventive measures and review them annually and on an ad hoc basis. If the company then detects violations, it must take corrective measures. The last resort may also be the termination of the business relationship with the supplier.^[ii]

Section 8 of the LkSG obliges companies to set up an appropriate internal complaints procedure. This is intended to enable individual persons to point out possible human rights or environmental risks and violations in the company's own business sector or at a direct supplier.

Pursuant to section 10 I of the LkSG, compliance with due diligence obligations shall be documented accordingly and kept for seven years. In addition, according to section 10 II to IV of the LkSG, there is an obligation to prepare an annual report on the fulfilment of due diligence obligations in the previous business year and to publish it on the company website no later than four months after the end of the business year. Furthermore, the management levels shall issue a policy statement for the human rights strategy of the company.

Environmental, Social, Governance (ESG)

The examination of ESG aspects plays a central role in the discussion of how companies position themselves in a way that is compliant with the LkSG. Against the background of a sustainable supply chain, the topics of environment, social (includes aspects such as safety, health of employees, labour rights, etc.) as well as corporate governance (includes topics such as corruption, etc.) must be taken into account. A rating of business partners for the entire spectrum of ESG areas should be included in the risk analysis in order to meet the requirements of legal due diligence.

Other regulations besides the LkSG

In addition to the German LkSG, there are other regulations that are to be taken into account in the international context:

EU Supply Chain Act: Since February 2020, there has been a draft for an EU Supply Chain Act. This goes much further than the German LkSG. The draft law is aimed at EU companies and companies operating in the EU with 500 or more employees and a turnover of more than € 150 million. According to the draft directive, the threshold is already 250 employees and € 40 million turnover in sectors that pose a risk to people and the environment.

The new EU regulation includes civil liability for companies. Affected parties can sue for damages in European courts. However, companies can be exempted from liability if they have set up a compliance management system that defends them. Even though it is only a draft at the moment, it makes sense to also orientate oneself on the EU regulations in the context of the implementation of the German LkSG in order to avoid having to make further costly improvements later on.

Bribery and corruption prevention: Within supply chain compliance, aspects of bribery and corruption prevention, which fall under governance in the ESG check, should also be taken into account. The fact that a large number of companies operate globally, foreign laws with extraterritorial application may also have to be taken into account.

US Foreign Corrupt Practice Act (FCPA): Originally, the FCPA only applied in the United States. It is considered the mother of all anti-corruption laws. In 1998, the FCPA was expanded to the effect that foreign companies and individuals could also be covered by the FCPA. A de facto effect has only been recorded since 2004 through increased implementation. This development has led to an enormous sensitivity to compliance issues worldwide and has set standards for the establishment of compliance management systems.

It consists of two parts:

Anti-bribery rules: These prohibit giving or promising benefits to non-US public officials with corrupt intent to gain a business advantage.
Accounting and internal control rules: These require proper accounting and data custody as well as internal control systems to ensure the proper use of company funds.

The FCPA has also encouraged other countries, such as Canada and the UK, to enact similar laws with extraterritorial application.

UK Bribery Act (UKBA): The law applies to all companies doing business in Great Britain and Northern Ireland. Neither the act of corruption nor the act intended by the bribery have to take place in the UK. As a result, any business with a foreign connection to the UK can be covered by this law.

German companies can be held accountable for corrupt behaviour anywhere in the world, even if the act of corruption is not related to an activity in the UK. It is sufficient that affected companies carry out business activities in the UK. However, the fact that shares of the company are traded on the London Stock Exchange or that subsidiaries are registered in the UK is not sufficient.

United Nations Global Compact (UNGC): The United Nations Global Compact has developed ten principles^[iii] in the areas of human rights, labour standards, environmental protection and anti-corruption, which can be applied not only within one's own company but to the entire value chain. The UN Global Compact and the UN Global Compact Network Germany (UN GCD) call on companies to align their strategies with these ten principles. Even though it is a non-binding recommendation, the UNGC is the world's largest initiative for corporate sustainability (also known as corporate social responsibility) with 13,000 company participants and other stakeholders in over 170 countries. The guide "Sustainability in the Supply Chain^[iv]" can be consulted by companies to help them establish and develop sustainable supply chain management. However, the UNGC looks at the relationship with upstream suppliers and does not focus on relationships with distributors, end customers or product disposal. The United Nations Global Compact Office will look more closely at actors downstream in the value chain in the future.^[v]

United Nations Office on Drugs and Crime (UNODC): The United Nations Office on Drugs and Crime offers a web-based anti-corruption portal called TRACK^[vi] (Tools and Resources for Anti-Corruption Knowledge). “The UNCAC Legal Library is a comprehensive database of anti-corruption and asset recovery legislation and jurisprudence from over 175 States, systematized in accordance with the requirements of the Convention. The legal library, which will be regularly updated, identifies laws that have been successfully used to recover assets as well as barriers to asset recovery caused by inadequate or incompatible legal frameworks. This practical and user-friendly resource will aid countries as they design and improve their legal frameworks so that they are more conducive to the recovery of stolen assets.”^[vii]

The database provides a unique overview of UNCAC articles and the corresponding provisions of national law. Searches can be limited to a specific country, UNCAC chapter and UNCAC article. Clicking on a country name opens a page with links to detailed information on domestic anti-corruption authorities and the full text of UNCAC-related laws. Here, too, companies can seek out targeted assistance and relevant information for their compliance.

Who checks compliance with the LkSG?

The Federal Office of Economics and Export Control checks compliance with the Act. It checks company reports and investigates complaints submitted.

An authority is provided with effective enforcement tools to monitor companies' supply chain management. The responsible authority, the Federal Office of Economics and Export Control, has far-reaching control powers. It can, for example, enter business premises, demand information and inspect documents, as well as request companies to take concrete action to fulfil their obligations and enforce this by imposing penalty payments.

Conclusion

The entry into force of the Supply Chain Due Diligence Act entails numerous legal obligations for companies. Not to be disregarded are the legal regulations from other countries, which must also be taken into account due to their extraterritorial effect. In addition, an ESG check is recommended.

Companies obliged under the LkSG must comply with a clear, proportionate and reasonable legal framework for due diligence. The requirements are based on the due diligence standard.

In addition to effective risk management, compliance with these legal obligations also requires more extensive duties and the implementation of various mechanisms that require a certain lead time. These cannot be named in general terms but must be clearly identified individually for each company.

In the download provided, you can make your own initial assessment of the type and scope of the legal obligations imposed by the LkSG that may affect your company. The following overview shows you which steps have to be taken to comply with the Supply Chain Act. If you have any further questions, please do not hesitate to contact us.

LkSG Steps to comply