Due diligence by companies: are we talking about the same thing?

Week of 15 March 2021

Due diligence by companies: are we talking about the same thing?

Two EU processes are currently under way that may lead to due diligence legislation. We discussed the first process, for broad corporate legislation, in our summary of the European Parliament’s approved text last week. This first process is in the hands of the Directorate General (DG) Justice. In parallel, in October 2020, the European Parliament called on the European Commission to propose mandatory due diligence laws that would request that companies show that products they sell in the EU do not drive global deforestation and violate human rights. This is a second process, and is in the hands of DG Environment. In its report on effectively legislating against EU-imported deforestation risk, forest-protection advocacy organisation Fern discusses distinct definitions of due diligence and recommends approaches to build better enforcement into the proposed EU due diligence legislation for forest risk commodities, as well as the broader due diligence legislation.

With these developments in mind (and with insights from Fern’s webinar earlier this week on due diligence-based regulation for forest risk commodities echoing in our ears), this week we are highlighting Fern’s report Enforcing Due Diligence Legislation ‘Plus.’ Although the report came out in October 2020, the insights shared are particularly relevant right now as we discuss upcoming environmental and human rights due diligence legislation.

Two different concepts of due diligence

We highlight some of the key points made here:

“One of the challenges of discussing the appropriate design of due diligence legislation and its enforcement is that two different concepts of due diligence lie behind the current debate, and they are often confused. The emergence of the two different pieces of EU legislation offers the opportunity to put both into practice.”

“Two different concepts affect the current debate: due diligence as a continuous process of improvement; and due diligence as a process that is undertaken before a decision is made, or a product is permitted to be placed on the market.”

Fern remarks that due diligence as a continuous process of improvement comes from the UNGPs and is echoed in the OECD Guidelines for Multinational Enterprises, the OECD’s Due Diligence Guidance for Responsible Business Conduct, the FAO’s Guidance for Responsible Agricultural Supply Chains, and the draft UN treaty. Fern notes that “The UN and OECD documents are written to provide guidance to enterprises. They do not in themselves consider issues of the enforcement of legislation that requires enterprises to exercise due diligence, including how enforcement agencies, or courts, can decide whether or not companies have exercised due diligence, or exercised sufficient levels of due diligence.”

Due diligence as a market obligation is “a process that must be carried out before a decision is made or an action carried out. This is common particularly in the world of finance and investment and is generally present in legislation governing the duties of financial agents. … This due diligence concept is the type that underlies … the EU Timber Regulation and the EU Conflict Minerals Regulation. In each case companies placing timber products, or four specified minerals, on the EU market, are required to exercise due diligence to avoid placing illegal timber, or conflict minerals, on the market.”

The second approach to due diligence “clearly differs from the more gradual approach” contained in the UNGPs. “Applied to forest risk commodities it would be designed to exclude products not meeting particular criteria – perhaps legality, or sustainability, or zero-deforestation – from the EU market rather than to encourage a gradual ‘cleaning up’ of supply chains. Inevitably, this carries a higher risk of companies abandoning suppliers in the countries of origin who cannot meet the criteria.”

“This is a rapidly evolving debate, and it would benefit from much greater consideration and more evidence of the impacts, positive and negative, of existing legislation. The proposals should therefore not be treated as final and may need to be modified or further developed.”

The need to improve enforceability

Fern provides recommendations for the optimum design of the EU due diligence legislation for forest risk commodities to ensure its effective enforcement, based in particular on experiences with the EU Timber Regulation (EUTR). Fern also provides separate recommendations for the broad corporate due diligence legislation. Joint recommendations for both pieces of legislation are:

    • “To be enforceable the law should be very clear on what exactly companies’ requirements are under the law. Strong procedures must be in place for monitoring and enforcing companies’ implementation of these requirements. The vaguer the legislation, the less likely it is to be effectively enforced.”
    • The “legislation should include mechanisms that allow competent authorities or other organisations in the EU to be able to gather proof of infringements. This would be easier if mechanisms which do not rely on collaboration with agencies in the countries of origin – such as import declarations – can be in place.”
    • “[C]ompanies should be required to develop a robust due diligence system. OECD guidance provides important elements of such a system, including the OECD/FAO Guidance for Responsible Agricultural Supply Chains for companies handling forest risk commodities.”
    • “[E]nsuring coherent enforcement across all EU Member States is critical.”
    • “[P]enalties imposed for infringements must be dissuasive, possibly by linking penalties to the size of the company.”
    • “[T]he legislation should apply to all companies throughout the supply chain, although care should be given to create a system that is workable for small companies. Certification should not serve as proof of compliance with the legislation.”
“There is a risk that companies may avoid liability for the harm they cause simply by adopting due diligence plans while failing to take action to implement them effectively. Hence, any legislation should establish liability for companies in whose supply chains damage occurs.”
“The inclusion of a reporting requirement in both pieces of due diligence legislation would be an important means of improving transparency and assisting compliance; where possible it should build on or replace systems already put in place for other reporting requirements rather than simply add more obligations on top. Reporting is however only ever a tool, not an end in itself. To be an effective tool, it should not be seen as a static instrument but as a process of continuous improvement, e.g. by first calling attention to unsustainable production practices; then supporting supply chain actors in making more sustainable decisions; then ensuring that those same actors are held to account, and are not falling behind in delivering on their commitments; then providing updated information to inform renewed efforts to improve practices; and so on.”