A Basic syllabus of corporate responsibility regulation – PART 3: Corporate responsibility legislation challenges traditional contracting models

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The due diligence obligation in corporate sustainability and responsibility legislation applies in practice to every company, although only certain larger companies are directly within the scope. In order to meet their reporting and due diligence obligations, these larger companies need to have a clear understanding of the different operators in their own activity and value chains. This requires dialogue and information sharing between companies on issues such as greenhouse gas emissions, identified or potential risks to the environment or human rights, measures to prevent or mitigate them and compensation for any damage caused. This blog uses two practical examples to analyse elements of corporate responsibility legislation that are challenging companies to think and act in new ways.

The first example relates to the exchange and use of information between companies. To simplify and generalise, information sharing between companies has traditionally been very limited and is often preceded by a non-disclosure agreement. Even under a non-disclosure agreement information is shared in a limited way and its use and disclosure is very strictly regulated by such agreements. At the EU level and under domestic competition law, the exchange of information between competitors is limited in order to avoid distortions of competition. Therefore, the exchange of information between competitors is even more limited than described above.

However, the exchange of information required by the corporate responsibility legislation challenges this traditional model, as easy access to reliable data from operators at different stages of the chain of activities is essential for regulatory compliance. It must be possible to pass on and use data relevant to corporate responsibility for reporting purposes that has been obtained for the various operators in the activity or value chain. Information can also be requested from indirect business partners and, to facilitate access and disclosure, it would be desirable that the obligation to disclose necessary information for corporate responsibility compliance purposes is included in all the contracts between companies operating at different levels of the chain of activities. Competition legislation and data protection aspects should still be considered in the exchange of information between companies, for example when contemplating on sharing audit reports.

Access to the necessary information and data is essential for a company subject to the due diligence obligation under the CS3D or the CSRD to fulfil its obligations. For small and medium-sized enterprises, the ability to timely deliver reliable data on their own operations is essential when they are a part of large corporation’s chain of activities, and to be able to provide the necessary information in a timely manner, the smaller enterprise must have the necessary information ready and available when the request is made.

A good example of this is the gathering of data on one’s own emissions. Many smaller companies may naturally think that there is no need to start looking into this yet – let’s wait and see if this situation arises. If the company is operating in the chain of activities of a large corporation, the issue of greenhouse gas emissions is going to come up. To be able to provide information on greenhouse gas emissions, you first need to collect data on a very large scale on your own operations and then use the data to do the actual emissions calculation. If outsourced, the emissions calculation will, at best, take several weeks but it often requires several months. Failure to provide data when requested by the reporting party is at the very least a reputational damage and in the worst case even a breach of contract. Participation in public procurement can also be hampered if the necessary data is not available, as it takes a considerable amount of time to collect, analyse and process the necessary data into a suitable format.

Another example of how the traditional way of thinking is challenged by the corporate sustainability legislation relates to the application of the CS3D in case it appears that a contracting party is not complying with the contract. In general, if a contracting party commits a breach of contract, for example by failing to comply with a contractual obligation, the infringed party may, in addition to claiming damages, terminate the contract under certain conditions. Similarly, the termination of the contract and of the business relationship may have been involved, for example, if it became apparent that the other party was using child labour in the manufacture of products and there were no longer any grounds for continuing the cooperation.

However, the CS3D requires that even if a direct or indirect contractual party in the chain of activities causes an adverse human rights or environmental effect, the business relationship must not be immediately terminated. The first step is to stop the effect or minimise its extent, and only then should it be assessed whether to refrain from entering into new business relationships or extending the existing ones. Termination of the business relationship is the last resort and, even then, the company must assess whether the harm caused by the termination is greater than the harm caused by continuing the business relationship. For example, in a child labour situation, termination of the contract may result in even worse working conditions for the children concerned, and therefore it may not be possible to terminate the contract, and instead the situation must be resolved by other means.

The due diligence obligation in the CS3D therefore requires a company to assess what kind of harmful environmental or human rights effects are at hand and to take this into account in preventing, mitigating, removing and minimising the harmful effects.

The CS3D also provides for the obtaining of so-called contractual assurances from direct and indirect business partners against potential or occurred harmful effects. Under these contractual assurances, the counterparty undertakes to comply with the company’s code of conduct and, where necessary, with the company’s preventive or remedial action plan. It is also essential that compliance with these requirements can be verified. The European Commission intends to publish model contractual clauses for the contractual assurances referred to herein, but there are no specific details yet on the schedule of the publication.

The increasing legalisation of corporate responsibility and sustainability questions is changing the way companies interact with each other and the way they conclude contracts. It requires each operator to be aware of its own environmental and human rights effects, to take them seriously, and to take genuinely effective action to prevent or eliminate harmful effects – because even if a smaller enterprise is not directly covered by the binding legislation, pressure from larger companies will gradually change the way smaller enterprises operate.

 

Read the part 1: The content of the CS3D in brief

Read the part 2: Why should we care about corporate responsibility?

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