The German Supply Chain Act: additional compliance measures required?

Although Austrian and other non-German companies are not subject to the LkSG, they may form part of the supply chains of German companies bound by due diligence obligations under it. In a parallel step in February 2022, the European Commission adopted a proposal for a Directive on corporate sustainability due diligence, which the European Council confirmed in principle in December 2022. Thus, another layer of compliance obligations for companies seems to be emerging.

The German Supply Chain Act

The LkSG applies to all companies with their head office, main branch or statutory seat in Germany. As of 2024, the scope will be extended to German companies with more than 1,000 employees. In essence, the LkSG obliges in-scope companies to evaluate potential violations of human and environmental rights in their supply chain, to implement a compliance management system along with regular risk analyses, to draw up prevention and mitigation measures, to publish a policy statement, to set up a complaint system and to document compliance measures.

In general, German companies are obliged to implement thorough diligence standards to their own operations and vis-à-vis their direct suppliers. As regards indirect suppliers, an investigation is only foreseen on an ad hoc basis if there are certain suspicions.

Impact of the LkSG on non-German companies

The mere fact that the LkSG applies to German in-scope companies does not mean that non-German companies remain unaffected. As part of the due diligence processes of German companies, non-German entities must be prepared to provide their German customers with information on their supply chains. In some cases, they may also be obliged to actively minimise risks through contractually agreed codes of conduct.

Therefore, non-German companies are well advised to take a closer look at their supply chains and the risks they pose. It is prudent for non-German companies within German supply chains to implement appropriate compliance measures. In this regard, a regular exchange – especially with direct suppliers – will be crucial, since processes can be coordinated, divided up and implemented more efficiently.

Draft EU Supply Chain Directive

The European Commission's draft Directive on corporate sustainability due diligence aims to foster sustainable and responsible corporate behaviour throughout global value chains. The new due diligence rules, as currently set out in the draft Directive, would apply to the following companies:

• Group 1: all EU companies of substantial size and economic power (with 500+ employees and EUR 150m+ in net turnover worldwide);
• Group 2: other EU companies operating in defined high-impact sectors, which do not meet both Group 1 thresholds, but have more than 250 employees and a net turnover of EUR 40m+ worldwide, with at least EUR 20m of this being in a critical (resource-intensive) sector;
• Group 3: non-EU companies active in the EU with a turnover threshold aligned with Groups 1 and 2, generated in the EU.

In addition to human and environmental rights, the draft Directive places great emphasis on climate protection and biodiversity. The due diligence obligations shall apply not only to companies in their own area of business and to their direct suppliers (cf. the term "supply chain" in the LkSG), but also along the so-called "activity chain", better known as the value chain. The activity chain therefore also includes downstream business activities. Violations of due diligence obligations shall be subject to fines and are based on the company's turnover. Even though this is currently still a draft document, clear trends can be derived from it that will lead companies to expand their compliance efforts.

What compliance measures should be considered?

Non-German companies can already initiate measures now. First and foremost, they should increase the awareness of employees in purchasing and sales about human rights and environmental protection issues. Companies should analyse the basic structure of their business, the procurement and sales structure as well as business relationships. It is sensible to define the abstract risks in the company as a first step and to subsequently weigh and prioritise the concrete risks (probability of occurrence, severity, possibility of influence, etc.).

A crucial question is to what extent the (future) newly imposed obligations can already be integrated into existing compliance management systems ("CMS"). From today's perspective, there is no reason why the upcoming obligations should not be integrated into the existing systems. However, integration into a group-wide CMS covering various countries may be impractical. In particular, until harmonised rules within the EU are in force, companies will have to examine what is more efficient: subjecting all group companies to a general CMS including the requirements of the LkSG or implementing a new CMS only regarding supply chain responsibility.

Finally, human rights and environmental protection should be the subject of a code of conduct to be observed by all employees. Despite all the additional burdens, supply chain compliance can also bring commercial benefits, such as better reputation and the associated advantages in hiring and employee motivation.

authors: Christoph Haid, Johannes Frank