Human rights and the environment create new liabilities

Sustainability issues are at the top of the corporate agenda for companies of all sizes and are a priority for their insurance partners, too. New EU rules expected to come into force in the coming few years are set to increase the responsibility on companies to ensure they and their suppliers are acting in a sustainable and responsible manner and open up a new range of liabilities and exposures that previously did not exist.

In recent months, stakeholders, shareholders, employees and regulatory bodies have been placing ever greater scrutiny on the environmental, social and governance (ESG) performance of companies they interact with, invest in, work for and buy from.

Environmental and climate concerns are a particular priority for risk professionals and insurers, with bio­diversity loss, climate action failure and extreme weather ranked as the three most potentially severe risks for the coming decade by the World Economic Forum’s Risk Report.

At the international level, firms are working to achieve the UN’s sustain­ability goals, reduce their carbon footprint in line with net-zero targets and report on ESG commitments – both financial and non-financial – among other efforts. In Europe, certain governments have begun to introduce requirements to monitor ESG performance and now the EU is stepping up its oversight of companies’ corporate sustainability due diligence.

Last week the European parliament’s legal affairs committee voted to approve the draft EU Corporate Sustainability Due Diligence Directive (CSDDD), paving the way for lawmakers to negotiate the final shape of the directive.

The CSDDD will introduce a mandatory human rights and environmental due diligence framework, which will impose due diligence obligations on a company’s own operations, its subsidiaries and its value chain – both direct and indirect.

Scope of the directive

While some EU member states already have laws and regulations that touch upon this area (the Modern Slavery Act in the UK, for example, and the recently enacted German Supply Chain Act) the CSDDD will have a wider scope and introduce corporate sustainability due diligence requirements throughout the supply chain for companies based in the EU and those that derive a certain proportion of their turnover from the EU.

The CSDDD initially will apply to all EU companies with more than 500 employees and more than €150m in annual turnover. Two years after introduction, it will be extended to apply to EU companies with 250 employees and annual turnover of €40m or more that operate in so-called “high-impact” sectors, which include textiles, agriculture and the extraction of wholesale minerals.

Crucially, the CSDDD also will apply to non-EU (third country-based) companies that have annual EU turnover of €150m and companies operating in “high-impact” sectors that derive €40m in turnover from the EU. Overall, the CSDDD is expected to apply to about 13,000 EU-based companies and some 4,000 based outside the EU.

The directive will require directors to take into account the human rights, climate change and environmental consequences of decisions they take when acting in the best interests of their company

The directive will impose a number of requirements on companies. First, they will need to undertake specific steps to prevent potential adverse impacts of their own operations and in their value chain. Those impacts might include pollution or biodiversity loss or exploitation of workers or child labour, for example.

Second, they will need to identify potential adverse impacts and put in place steps to prevent, end or mitigate them. Next, they will have to consult stakeholders to develop and implement a prevention action plan and put in place timelines for action and indicators to measure improvement.

Finally, companies will need to seek contractual assurances from business partners they will comply with the company’s code of conduct and action plan and seek assurances from partners they have measures to verify compliance.

Liability and insurance impact

The CSDDD represents a step change in terms of exposures stemming from corporate sustainability and opens up a new set of liabilities for companies and their directors and officers that did not previously exist.

As well as introducing fines for non-compliance, the CSDDD will create a liability for companies to ensure actors in their value chain are compliant too and it also will require directors and officers of companies to assume responsibility for ensuring corporate sustainability due diligence is part of their strategy and planning.

Article 8 of the CSDDD will require firms to neutralise or minimise any adverse impacts that occur by paying financial compensation to victims of environmental damage or human rights violations and require them to develop a corrective action plan.

Under the directive, EU member states will be required to create a civil liability regime for failure to comply with due diligence processes where adverse impacts that should have been identified, prevented, mitigated or stopped led to damage. These civil liability regimes will have the power to impose sanctions on companies that fail to comply, including turnover-based fines.

The CSDDD also introduces duties for the directors of EU companies that fall under its scope. Those duties will include setting up and overseeing the implementation of due diligence processes and ensuring corporate sustainability due diligence is integrated into the company’s strategy.

Importantly, the directive will require directors to take into account the human rights, climate change and environmental consequences of decisions they take when acting in the best interests of their company.

It also will open the door to claims against firms whose suppliers or partners in the value chain breach corporate sustainability due diligence codes.

Historically, it has been rare for plaintiffs to successfully bring cases against companies whose suppliers have failed to comply with safety regulations resulting in damage and harm, for example. But under the CSDDD there is a clear obligation for companies to ensure due diligence is observed both up and down the supply chain. This obligation is largely without precedent and the directive, therefore, effectively creates liabilities where none may previously have existed. This will have an impact on general liability and directors’ and officers’ liability, among other lines.

It is also worth bearing in mind the CSDDD will cover financial services firms, meaning not only will insurers need to examine coverage for clients but their own operations and supply chains will also fall under the scope of the due diligence requirements.

Getting ready for CSDDD

The directive will introduce a new layer of scrutiny across the entire value chain and, as such, it is vital companies start their preparations now. Knowing the supply chain has always been important, but the CSDDD will impose more explicit requirements on companies to ensure the third parties with which they interact are complying with due diligence processes. This means they must ensure suppliers are effectively and regularly screened.

The CSDDD also places a clear obligation on boards to set up and integrate sustainability due diligence into strategy and processes. Senior management teams need to ensure processes are in place – and robust – well ahead of 2030. This might mean, for example, creating internal responsibilities and delegating those effectively.

The directive aligns with the current trend of EU lawmakers to focus on sustainability and protection of consumers. As with other legislation insurers and their clients currently are readying themselves for, such as EU collective redress and non-financial disclosure requirements, the CSDDD puts the onus on firms to act in a responsible way or face consequences.

The CSDDD will now go to a full European parliament vote, expected by June 1. After that lawmakers will continue negotiations with member atates on the final shape of the directive, with a deal expected by the end of the year. Once the directive has been agreed, member states will have two years to transpose it into national law.

In the meantime, firms likely to fall under the CSDDD’s remit and their insurance partners will begin readying themselves for this new set of corporate sustainability due diligence requirements and the new set of liabilities and exposures it will bring.

Henning Schaloske is a partner at Clyde & Co