POSITION PAPER 23 May 2022
Since many years, Directors’ Institute Finland (DIF) promotes sustainability and today, approximately one third of our events and materials are related to sustainability. Even our annual seminar this spring focused on sustainability in supply chains.
We are seeing a significant change in the business sector: sustainability is a core strategic issue for companies. In our members’ survey this spring, the results were that the topic gaining the most additional weight on board agendas is sustainability. Furthermore, our survey also shows that sustainability criteria are becoming more common in executive remuneration, including long-term-incentives. We find that the proposal is based on aging information of corporate action while we are living in a quickly changing world. Also, corporate governance codes are a quicker and a more flexible tool to promote sustainability in governance.
Furthermore, the current Russian war should be taken into account in the continuing preparatory work. Difficulties and disruptions are to be expected and companies should not be punished because of the consequences possibly forced on them by the war.
While strongly promoting sustainability, DIF emphasizes the necessity of clarity, proportionality as well as the subsidiarity principle. Unfortunately, the proposal falls short in these respects. The current text emphasizes liabilities, complaints, and sanctions. This may prove to be counterproductive: mitigating climate change will require immense investments from the private sector, and this may not happen in Europe if European legislation is unclear, unpredictable, and punitive. Companies should be encouraged to put their efforts and resources on their continued improvement in sustainability rather than focusing on checklists and excessive bureaucracy to avoid sanctions.
Adopt a risk-based approach
A risk-based approach would be more productive as prioritization based on salient risks is a proven concept in conducting due diligence. It seems to us that a smaller company (within the scope to the proposal) with minimal emissions or other negative impact, could be severely sanctioned for not completing the bureaucratic duties of the proposal whereas a major emitter – even on global scale – of greenhouse gases could continue its operations without sanctions if it fulfills the requirements of the proposal regarding e.g. planning and sanction channels. To better achieve the goals of the proposal, a risk-based approach should be adopted and applied to all companies regardless of size.
The current text of the proposed directive may lead to major discrepancies in different Member States due to the unclear nature of many parts of the text. Also, we find that the proposal is overlapping with other EU regulatory work such as the Corporate Sustainability Reporting Directive.
DIF also stresses the importance of proper impact assessment. We find it necessary to assess thoroughly the impacts of the proposal on companies, including SMEs, as well as EU Member States’ national economies, taking into account the proposed bureaucratic requirements as well as changes in supply chains.
Public tenders missing
We are disappointed that public tenders were deleted from the directive at the final stages. We find the requirement to use sustainability criteria in public tenders in all EU countries an efficient tool to increase sustainability among all actors, not just focusing on companies. Sustainability should be a common goal, and not regulated with emphasis of corporate sanctions.
Incorporating international conventions into a directive
The proposal designs due diligence obligations for companies by incorporating a long list of international environmental and human rights conventions. DIF does not find this legislative technique suitable for corporate law. The guidelines of the international conventions are ambiguous in their wording and do not always contain unambiguous rules that are directly transposable. It is of utmost importance that EU regulation is clear and comprehensible. Incorporating international conventions into hard law and complaint channels and sanctions would open the scene for excessive legal disputes. Any regulation to be derived from the international conventions must be sufficiently unambiguous and express precisely the obligations imposed on companies. This is not accomplished in the proposal.
SMEs situation
Also, we are worried of the indirect impact of the new rules on SMEs. Although SMEs are not directly under the scope of the proposal, they are so indirectly, e.g. due to the proposed contractual cascading (art 7). The heavy requirements regarding supply chains in the proposal would inevitably lead to fewer companies being able to participate in supply chains. Even for larger companies it would be too onerous and expensive to monitor all current supply chain participants’ suitability and operations.
Validity of contracts
The proposed obligation to terminate a contract when potential adverse impacts could not be prevented or mitigated or when actual adverse impacts could not be brought to an end goes against fundamental principles of honoring existing contracts, pacta sund servanda, and against prohibition against retroactive legislation. It would disproportionately disrupt the existing business of companies, undermining the overall market stability. It should therefore be removed.
Improve clarity in definitions – Supply chain instead of value chain
DIF suggest the term supply chain to be used in the directive instead of value chain. Even the international conventions referred to in the proposal use the term supply chain. The meaning of value chain is too vague and may lead to unintended consequences, frivolous litigation, in particular. We don’t understand how to build a complaints channel throughout the whole global value chain as stipulated in the proposal.
Furthermore, we wonder why customers seem to be fully missing from the proposal. Also, we find the concept of established business relationships to require more precise wording.
EU companies cannot alone stipulate and monitor the global chains. The proposal may lead to some companies and even countries to lose their positions in global supply chains. This may lead to geopolitical implications. The European Union should work relentlessly on the global arena to achieve at least the largest countries to include sustainability on their agenda.
Complexity of the financial market
Mandatory due diligence in the provision of financial services should be limited to clients that are not themselves regulated financial undertakings. The wide range, large number and complexity of business relationships within the financial sector would make it disproportionately burdensome to apply the directive, for example, in the interbank market and in securities clearing and settlement. The value added would also be limited, as regulated financial undertakings are, by definition, established in the EU and already subject to harmonized regulation and supervision, including that of ESG risks.
What constitutes a client in the financial sector supply chain should be more clearly defined. The proposal does not provide a definition for a client, and therefore it is not clear if other forms of legal persons than companies, as defined in article 3 (a), are in the scope of mandatory due diligence. We understand that it is not in the spirit of the proposal that small and medium-sized entities, such as limited liability housing companies and not-for-profit foundations and associations, would be in the scope of mandatory due diligence.
In addition, the definition of what types of financial services are included in the scope of the directive should be more clearly defined. We are of the view that mandatory due diligence should not apply to the provision of statutory services.
Remuneration
The proposed art 15 (3) regarding directors’ remuneration is very unclear. As said before, remuneration is undergoing a major change and we are seeing and will see increasing emphasis on sustainability criteria in remuneration schemes. Remuneration is already handled in Shareholders Rights Directive II and consequently any additional regulation would be best suited to be given in corporate governance codes. Even without a legislative obligation, it will be material for companies to consider the physical and transition risks of climate change and prepare for the transition toward a low carbon society and adapt their business models and strategies accordingly.
Civil liability (art 22) unclear
The proposed article is unclear and incomplete. The proposed provisions on civil liability would run the risk of unduly interfering with the established principles of national civil law, undermining its consistency, risking the insurability of legal risks of companies, and should be left out of the directive. The proposed article on civil liability creates a new type of legal framework for liability for damages. The proposal deviates from the requirements of negligence and sufficient causation.
The proposed article disregards the concept of a limited liability company, especially if liability can be caused by other participants of the supply chain. The “failed to comply” standard, as proposed, leaves open the possibility that mere negligence in failing to identify an adverse impact would trigger liability. Given the challenges in the current proposed directive not limiting the scope of due diligence requirements (i.e., no risk-based discretion), along with the full ”value chain” approach (which could result in large entities having several thousand suppliers in scope), it would be essential to apply a heightened negligence standard.
The proposed legal obligation to pay damages to affected groups does not meet the requirement of adequate predictability as it is not based on any objective criteria, especially with respect to the amount. Additionally, there is no centralized body to co-ordinate multiple payment of damages by various companies to the same affected group, which is likely to result in difficult and costly disputes, often in third countries. It should also be noted that financial compensation is not and should not be the only form of remedy when neutralizing adverse impacts.
Duty of Care (art 25 and 26) needs to be deleted
Corporate law is primarily national law. The definition of director’s duty of care has not been harmonized at EU level, and Member States have different legal traditions, and it is not a realistic target to harmonize the concept of duty of care in the different Member States. We also note that a proper and comprehensive impact assessment of the proposal has not been made.
The proposed art 25 overlaps national legislation. The content of the proposed article is so unclear that it is not understood even by company law experts. The proposal may lead to unexpected consequences, including difficulty to recruit board members to companies especially in some challenging sectors where best possible directors are needed to lead companies through the multitude of crises we are currently, and in the future, facing.
The directive aims at increased stakeholder participation. Such an unclear article may lead to excessive and frivolous litigation and needs to be deleted from the proposal. Furthermore, it needs to be noted that the prerequisites of business operations are stipulated in specific legislation, such as labour law and environmental regulations. Despite that we do agree that companies overall need to consider the consequences of their decisions on sustainability matters, and we see that they are increasingly doing exactly that, we do not see any added value in the unclear and unfinished proposal.
Regarding art 26 we also wonder if there is a confusion between the management of the company and the board of directors.
Frivolous litigation
As mentioned before, the proposal contains unclear texts and on the other hand, stresses liabilities, complaints channels and sanctions. We foresee a major risk of frivolous litigation if such ambiguous texts are adopted as legislation.
The directive should allow for the use of existing complaints procedures, such as those established under Directive 2019/1937 and the National Contact Points for Responsible Business Conduct under the OECD Guidelines for Multinational Enterprises. It is not in line with the UNGPs that the only option for a company would be to establish the complaints procedure on its own, and it will create a heavy administrative burden on companies. In addition, it should be clarified that relevant stakeholders do not need to be identified in advance as it would be unnecessary and disproportionately burdensome for companies.
Furthermore, we find it very important that only relevant stakeholders are included in the scope of the directive. Currently the wording implies that just about any person or organization may deem itself to be stakeholder granted to use the procedures included in the proposal.
Supervisory powers should be predictable and proportionate
The power to require remedial action as proposed in the directive does not meet the general requirement for predictability, as it could be interpreted as to allow the supervisory authorities rather unlimited discretion. The authorities could e.g. decide the detailed measures to neutralize or minimize adverse impacts and the exact amount of damages to be paid to affected stakeholders. The responsibility to choose appropriate measures should remain within the company.
Moreover, the proposed powers should not interfere with the powers of judicial courts as laid down in national law, in order to ensure a consistent application of the overall legal framework of a Member State.