German Supply Chain Law requires companies to adopt due diligence procedures

Approved on July 16, 2021, Germany’s Supply Chain Law establishes due diligence obligations and ESG standards for companies in order to prevent human rights violations in supply chains.

German companies will have to implement standards for compliance and risk management, and also demonstrate that human rights are fully respected throughout their supply chains, including by suppliers in foreign countries (including Brazil). The legislation will gradually take effect as of January 1, 2023.

The law – known in German as Gezetz über die unternehmerischen Sorgfaltspflichten zur Vermeidung von Menschenrechtsverletzungen in Lieferketten (or colloquially, as Lieferkettensorgfaltspflichtengesetz or LkSG) – is the first law in Germany to establish compliance obligations for foreign suppliers. Despite the existence of international regulations on the matter, Germany’s Parliament was of the view that the previous voluntary commitments were insufficient. Therefore, the new provisions set specific requirements, with substantial fines in the event companies fail to comply.

Sustainability due diligence

In February 2022, the European Commission proposed a specific corporate sustainability due-diligence directive, which would make companies liable for environmental damages and human rights violations in their international supply chains. Although the European Parliament has yet to approve it, the directive already suggests a trend toward further regulations of this type.

Certain European countries have also been implementing similar legislation in recent years. France’s Corporate Duty of Vigilance Law (Law No. 2017-399 of March 27, 2017) determines that international companies operating in France must monitor their entire production process. In other words, companies must observe the applicable legal provisions from the point of raw material production through to input supply and the sale of products to end consumers.

In a similar fashion to the LkSG, the French law determines that parent companies in France with over five thousand employees over two consecutive years must set mechanisms to identify risks and prevent violations of human rights, individual liberty, and the right to healthcare, security, and an ecologically balanced environment. These measures apply to damages stemming from activities conducted by either parent companies (main activity) or the companies they directly or indirectly control (Article L. 233-16, Item II), or damages from activities conducted by subcontractors/suppliers they have a business relationship with.

According to the law, French companies operating in Brazil with over ten thousand employees (between the parent company and direct and indirect subsidiaries) must implement a Surveillance Code, which their subsidiaries and controlled companies must comply with in order to avoid being held liable in France.

Furthermore, there is a trend toward filing lawsuits in European countries regarding damages that occur in other countries – including Brazil. In some of these cases, claimants seek to have companies with head offices in Europe charged by European courts, although observing the legislation in the jurisdiction where the damages took place. As such, subsidiaries that allegedly cause damages while operating in Brazil could face lawsuits based on Brazilian legislation in European courts.

Innovative aspects

The main innovation the LkSG introduces is the need for companies to demonstrate no human rights were violated throughout their production chain (both within their own facilities and those of their immediate suppliers), with specific protocols and sanctions in the event of non-compliance. Despite less strict standards for indirect suppliers (such as those supplying raw materials), risk analyses must be conducted in the event of complaints or indications of non-compliance.

German companies may require their suppliers to set corrective measures should they become aware of any rights violations (for instance, via complaints). Although the penalties the legislation provides for are only directed at German companies, foreign suppliers may be subject to commercial penalties – including contractual fines – if they fail to comply with the applicable provisions. The failure to resolve any issues regarding non-compliance may lead to the termination of commercial relations.

Key measures in the legislation

The LkSG also sets out other key measures, including the requirement for companies to implement an internal risk management system, risk analyses, and preventive and corrective measures (as necessary) – both in regard to their own and their suppliers’ production chains. Moreover, companies must disclose annual compliance reports on their websites for a minimum of seven years. Companies must prove that they have implemented adequate internal procedures to handle complaints and inform the general public about the negative impacts of their business on human rights.

The main objective of the legislation is to prevent human rights violations, correct substandard practices, and end illegal practices by ensuring commercial relations are terminated with companies who fail or refuse to comply with the standards. The LkSG is mainly focused on preventing the following illegal practices:

• Child labor;
• Slave labor and practices similar to slave labor;
• Non-compliance with labor standards;
• Violation of freedom of association;
• Discrimination, including unequal treatment based on race, gender, nationality, social origin, age, health, or religious beliefs; and
• Violations of environmental obligations.

Fines

Fines of up to five million Euros may apply in the event that companies fail to comply with the legal provisions, whether due to a lack of mechanisms for monitoring risks or a refusal to comply. The failure to adopt preventive measures when potential risks are identified may lead to fines of up to eight million Euros. For large companies with annual revenue above 400 million Euros, other violations may lead to fines up to 2% of their annual revenue. Moreover, companies that have been fined amounts above 175,000 Euros will be barred from participating in public tenders for three years.

The new provisions have been met with concern by some German companies, especially in regard to the extent of their indirect civil liability for social and environmental damages third parties in the production chain cause in other countries. After many discussions, a new provision was added to the final version of the approved legislation to address this specific question (Section 3, Paragraph 3), which expressly determines that the breach of legal obligations does not entail civil liability. However, the pre-existing liability provisions in the German legislation have been maintained. It is necessary to await the German courts’ interpretation of the new legislation in regard to the extent of the civil liabilities.

LkSG impacts in Brazil

In 2022, it is extremely important for companies to make any necessary adjustments in their production chain to conform to both Brazilian social and environmental regulations and the LkSG’s requirements, which become effective as of January 1, 2023. This not only applies to subsidiaries of German companies operating in Brazil but also to Brazilian companies providing goods or services to companies headquartered in Germany.

As such, companies must prepare specific compliance manuals, analyze and control social and environmental risks, disclose information and annual reports on ESG standards, and ensure adequate reporting channels for both social and environmental risks and human rights violations. Companies must also conduct employee training and adopt due diligence measures to identify and prevent social and environmental risks in their production chains. Those who fail to take these measures face serious liability risks, both in Brazil and Germany.

For further information on Germany’s Supply Chain Law, please contact Mattos Filho’s ESG practice area.

* With the collaboration of Isabella Senedez de Andrade.

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