Mandatory sustainability due diligence is key to a sustainable future

By Beate Sjåfjell and Jukka Mähönen, 19 February 2021

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Beate Sjåfjell is Professor at the Faculty of Law, University of Oslo, and Adjunct Professor at the Faculty of Economics and Management, The Norwegian University of Science and Technology (NTNU)

The European Commission has concluded its consultation on Sustainable Corporate Governance. Our input is clear: we need an EU company law reform with mandatory and research-based sustainability due diligence at the core, covering all European business undertakings.

Mitigating the business and financial risks of unsustainability

Jukka Mähönen is Professor at the Faculty of Law, University of Oslo, and Professor of Cooperative Law at the Faculty of Law, University of Helsinki.

Much attention has been given to the call for mandatory human rights due diligence, which recently has been expanded to a call for human rights and environmental due diligence. However, a broader approach is needed, drawing on a research-based concept of sustainable value creation within planetary boundaries. Climate change, which the Financial Stability Board’s Task Force on Climate-Related Financial Disclosure have done much to raise awareness about, is just one of the identified planetary boundaries. Biodiversity loss, natural resource use and the release of novel entities are examples of other environmental categories that should be included in assessments of financial and business risks. Risks concerning social aspects should be encompassed, including human rights violations, lack of decent work, corruption and tax evasion. All of these bring with them business and financial risks.

Mandatory sustainability due diligence is crucial for business itself, to mitigate these risks. A systematic analysis of the risks of unsustainability should indeed be the core of the due diligence duties.  

The extreme legal uncertainty of the rising trend of lawsuits

One key factor amongst the risks of unsustainability already being realised is the liability risk. The international trend of lawsuits against companies and states for environmental and human rights harms are indications of the growing lack of acceptance of status quo.  The lawsuits are brought by states, individuals, non-governmental organisations and other businesses against corporations, including parent corporations, for environmental or social harm allegedly caused by their subsidiaries, and against lead corporations for negative environmental or social impacts in their global value chains.  While many cases are rejected for procedural reasons, often based on underdeveloped international private law rules, and many lost, some are won. The sheer multitude of cases makes them a risk to be reckoned with.

Mitigating the risks of unsustainability, including the extreme legal uncertainty about potential lawsuits for harms across the global value chains, is a crucial benefit of mandatory sustainability due diligence.  The response from business, inter alia reported on in the study on due diligence undertaken for the European Commission (L. Smit et al., 2020), shows business support for legislative reforms that can give business a level playing field in the transition to sustainability. 

Raising the bar: beyond legal compliance

The due diligence duty should be defined as sustainability due diligence, encompassing all environmental, social and governance aspects of sustainable value creation within planetary boundaries. These should be defined drawing on international and EU law, on interdisciplinary sustainability research, and on widely accepted due diligence guidance, notably the UN Guiding Principles for Business and Human Rights and in the OECD Due Diligence Guidance for Responsible Business.

Identifying issues for sustainability due diligence includes of course also compliance with applicable regulatory frameworks on human rights, workers’ rights, indigenous people’s rights, health and environment, and governance issues such as anti-corruption and taxation. However, legal compliance is not enough. The standards for due diligence should be set higher, encompassing the global impacts of the business activities and promoting sustainable value creation within planetary boundaries. In its Communication on the EU Green Deal, the Commission writes appropriately: ‘As the world’s largest single market, the EU can set standards that apply across global value chains’. Mandatory sustainability due diligence is crucial to achieve this, striking an appropriate balance between being principles-based enough to allow for individual assessments across various types of undertakings and sectors and across time, while being firm and specific enough on the environmental, social and governance issues that must be encompassed in the due diligence.

Member State initiatives inspire – but EU action is necessary

Individual initiatives by national legislators can be inspiring examples and also stimulate a coherent EU action, and initiatives such as the French vigilance law are for that reason laudable. However, national initiatives also bring with them challenges including questions of scope and of legal certainty for businesses with cross-border operations and activities, and may lead to a regulatory competition between EU Member States, to the detriment of their businesses.

Today business is met with a  plethora of various requirements through a fragmented picture of some sector-based EU requirements, some requirements (usually thematic) in national legislation in the various countries in which they operate or are registered, and through influential international guidance such as the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises. This leaves business with a difficult task in figuring out the various requirements and expectations. Harmonisation on EU level would bring legal certainty and the benefits of simplification and clarity.

Providing legal certainty through clear mandatory due diligence rules

EU rules should set out how the results of the due diligence are to be followed up. As a minimum, identified lack of legal compliance should be rectified immediately. For other identified sustainability impacts and risks, an ambitious continuous improvement process should be drawn up under the leadership of the board. The ambitious continuous improvement plan should include qualitative and quantitative Key Performance Indicators where appropriate. EU rules should also provide for external verification that the due diligence process is undertaken in accordance with the rules, and annual reporting on this should be audited. Together this would provide a good basis for legal certainty for the board that it is following this up as it should and a level playing field in the sense that it would know that other undertakings would be subject to the same rules.

Further, such a process would provide legal certainty for the undertaking as concerns its sustainability impacts, mitigating effectively the risks of unsustainability. As Lise Smit and Claire Bright point out in their 2020 paper ‘The concept of a “safe harbour” and mandatory human rights due diligence’, it is important that due diligence does not act as a safe harbour, i.e. that affected parties cannot file a lawsuit against the undertaking or its board, nor must it devolve into a box-ticking exercise. However, compliance with a thoughtfully formulated mandatory sustainability due diligence regime as suggested here, would serve as a defence for the undertaking and its board. This will increase the legal certainty for European business, while providing better access to justice for affected workers and communities.

Giving the competitive advantage to sustainability-oriented business

Currently, sustainability-oriented businesses have to compete with businesses that do not take the various requirements seriously, creating a highly uneven playing field. A level playing field for sustainability-oriented businesses would give them the competitive advantage and promote the development of sustainable business models with all its positive impacts for European society and economy, with knock-on effects for third countries. Mandatory sustainability due diligence for small and medium-sized enterprises (SMEs) would provide this legal certainty also for them. Conversely, excluding undertakings under a certain threshold would mean taking opportunities away from SMEs, which constitute a significant part of the European economy. 

Securing a sustainable future for all

The European Commission has through its EU Green Deal signalled an unprecedented broad and ambitious approach towards transitioning to a sustainable future. Mandatory sustainability due diligence as a duty for corporate boards is key to achieving the relevance and reliability of information from businesses. Relevant and reliable information is currently the missing link in the EU’s Sustainable Finance initiative. Providing such information will give sustainability-oriented investors and investees the level playing that they are asking for. Integrating sustainability into corporate governance in this way also provides a better basis for Sustainable Public Procurement, and resonates with and strengthens the EU’s Circular Economy initiative. It is high time to put into place such a crucial piece of the jigsaw puzzle of sustainability.

This blog post is based on the Oslo Company Law Group’s submission to the European Commission’s consultation on Sustainable Corporate Governance, which in turn draws on the SMART Project results, notably its reform proposals for EU company law and corporate governance.

Tags: Business and global value chains, Reform proposals, Sustainability
Published Feb. 19, 2021 3:53 PM - Last modified Sep. 5, 2022 11:38 PM