Since 1 January 2023, companies have had to implement the obligations arising from the Supply Chain Sourcing Obligations Act(LkSG). However, many of the companies concerned are lagging behind in this task. At least, this is what emerges from a report by the Tagesschau, which is based on a study by the German Association of Materials Management, Purchasing and Logistics(BME). According to the study, just four per cent of the companies surveyed said they were well prepared for the obligations of the LkSG. A full 70 %, on the other hand, considered themselves to be moderately to poorly prepared. In view of the years of debate before the Supply Chain Act came into force and the high fines, these are alarming figures. Not entirely innocent of this situation is at least the responsible supervisory authority BAFA. This is because the law offers room for interpretation in many places due to its broad scope of application. A first handout on risk analysis was published by BAFA only at the end of August 2022, only four months before the law came into force.
The article provides an overview of the obligations associated with the Supply Chain Act and shows the points at which contracts and general terms and conditions must be adapted.
Protection of people and the environment
The Supply Chain Act aims to implement human rights in global supply chains and better protect the environment from destruction. The law was initiated because voluntary commitments by companies in the past have not sufficiently addressed human rights and environmental problems in supply chains. The focus of the Supply Chain Act is therefore on the companies of the global West at the end of the supply chain. They are supposed to use their economic superiority to improve human rights and environmental protection standards along their supply chain and to fight slavery, economic exploitation, child labour, unequal treatment in the workplace, contamination of soil, air and water or land grabbing. From a legal perspective, this is a paradigm shift in the accountability of companies for the actions of third parties – who previously could not be held accountable for violations of human rights and environmental standards in the supply chain through no fault of their own.
Companies with 3000 or more employees
Companies with their headquarters in Germany and at least 3000 employees in Germany are affected. However, this does not mean that all other companies can sit back and relax. From 01.01.2024, the threshold for intervention will be 1000 employees. In addition, companies that are below this threshold will also feel the effects of the Supply Chain Act. If they themselves are part of a supply chain, they will be obliged by their contractual partners to comply with the legal requirements. The Supply Chain Act therefore not only has a direct effect, but also an indirect one.
8 million euros fine
Anyone who violates the obligations of the Supply Chain Act commits an administrative offence. Depending on the severity of the violation, the fine ranges from 100,000 to 8 million euros. For companies with an average annual turnover of more than 400 million euros, the fine can even amount to 2% of the annual turnover. So there are severe penalties here, which is why the implementation of the obligations should not be neglected. In addition, trade unions or NGOs have the option of exercising the rights of workers and suing companies for damages within the framework of voluntary litigation. This also allows workers in a factory in Brazil to assert their rights against a company based in Germany if they work for a supplier of the company.
Declaration of Principles and Annual Report
The obligations are monitored by the Federal Office of Economics and Export Control (BAFA). In order to be monitored, companies must draw up a declaration of principles on their human rights strategy and prepare an annual report. The human rights strategy must explain which procedures are used to comply with the obligations, which risks have been identified and what expectations exist vis-à-vis employees and suppliers. It is important to document whether and how the due diligence obligations are fulfilled. The annual report must contain a detailed evaluation of these duties and be published on the website as well as submitted to BAFA.
What is a supply chain?
Companies are subject to the duties of the Act if their supply chain is affected. In this context, the term supply chain encompasses all steps at home and abroad that are necessary to manufacture the company’s products and provide its services. This ranges from the extraction of raw materials to delivery to the end customer. The law takes into account both the company’s own business area as well as that of the direct and indirect supplier and ties these areas to different levels of obligations. Overall, the law is based on a broad scope of application. On the one hand, it can cover plantations for the extraction of resources for paper, textile or food production in South America, programmers in India or call centres in the Philippines. On the other hand, however, it also includes the hydraulics specialist in Hesse.
Duty of care and appropriateness
Although the duty to make an effort is not standardised in the law, it is already apparent from the government draft. In contrast to a duty to succeed, a violation of human rights or environmental obligations does not necessarily result in a breach of the duty to make efforts. Conversely, however, a violation can also exist even though humans or the environment were not actually harmed. The assessment of whether a violation has occurred is based on the criterion of appropriateness. According to this criterion, the type and scope of business activity, the ability to influence the actual polluter, the severity of the violation and the nature of the actual contribution to the cause are taken into account. However, no company may be required to do something that is legally and factually impossible.
Risk analysis
Affected enterprises must conduct an adequate risk analysis in relation to human rights and environment-related obligations each year as part of their risk management. The analysis is initially limited to an examination of the company’s own business area and direct suppliers. If the risk in the supply chain changes due to the introduction of new products or the development of new business areas, the risk analysis must also be carried out on an ad hoc basis. The restriction to the own business area and direct suppliers does not apply if companies try to circumvent the obligations of the Supply Chain Act or if there are actual indications of a violation of the obligations. This is to avoid that companies establish purchasing companies for the purpose of identifying only the purchasing company itself as a direct supplier and thus escape the obligations of the Supply Chain Act. In the case of violations by indirect suppliers, however, companies must only act if there are actual indications that a violation of a human rights or environmental obligation appears possible. It remains to be seen how detailed the indications must be in order to trigger the obligations of the Supply Chain Act. It can be assumed that the significance of reports by organisations such as Amnesty International or Greenpeace will increase.
Preventive measures
If risks are identified, preventive measures must be taken immediately. The law contains an exemplary list, according to which companies must implement their human rights strategy, develop and introduce appropriate procurement strategies, and carry out training and risk-based monitoring measures. The measures are effective if they identify human rights and environmental risks and prevent, end or at least minimise violations. This formulation is an expression of the effort principle and shows that not every violation must necessarily be remedied.
Risk management and remediation
As a further aspect of risk management, companies must establish a complaints procedure. Internal or external processes can be set up for this purpose. It is important that the procedure allows whistleblowing by affected persons or other whistleblowers. The law does not regulate exactly how the procedure works, but companies must publish written rules of procedure. It is problematic that the complaints procedure must be accessible to potentially involved parties. Especially in third countries, this will cause difficulties for companies. After all, a notice written in German on the company’s website will not lead to a factory employee abroad participating in the grievance procedure. Here, companies must develop solutions to inform those affected about the procedure at the place of employment.
Remedy
If a company finds that human rights or environmental obligations have been violated, it must take remedial action. For these measures, too, the law specifies a graduated standard of care consisting of prevention, cessation and minimisation. Violations of duties in the company’s own domestic business must be terminated immediately. In contrast, remedial measures in the case of violations in the company’s own business area abroad and in the case of group companies must only lead to termination as a rule. With respect to direct suppliers, a concept for terminating or minimising the violation must be drawn up with a concrete timetable. The text of the law does not list the termination of the business relationship as a mandatory consequence, but as a last resort. Only in the event that the violation of the protected legal position is very serious, the remedial concept has remained ineffective, no milder means are available and further exertion of influence appears to be futile, termination is required. In contrast, no mandatory remedial measures are provided for violations by indirect suppliers. This was already the subject of considerable criticism in the drafting history, because it is precisely with indirect suppliers that the most serious violations of rights take place.
A look at Switzerland and the EU
Unlike Germany, Switzerland and the EU do not (yet) have their own supply chain laws. Nevertheless, a number of reporting obligations must be fulfilled with regard to environmental protection and social standards. We address this topic and the associated need for adaptation of supplier contracts in a detailed article here.
How can contracts and GTCs be adapted?
As an important measure for fulfilling the obligations under the Supply Chain Act, companies must adapt existing contracts and general terms and conditions. The following points should be considered:
- Require direct suppliers to comply with the human rights and environmental expectations required by the company’s management.
- Require direct suppliers to address expectations along the supply chain and contractually obligate their direct suppliers to comply.
- Require direct suppliers to participate in training and education provided by the company.
- Agree on appropriate contractual monitoring mechanisms, including risk-based implementation, for direct suppliers to verify compliance with the human rights strategy.
- Agree on the right to issue instructions to direct suppliers to determine and implement further preventive and remedial measures.
Conclusion
The German Supply Chain Act contains a large number of new obligations, the concrete application and expediency of which must still be put to the test. For companies, it is currently not important to think through every constellation down to the last detail, but to implement the basics outlined in this article in order to avoid fines.
If you would like further input on the topic, you can watch the webinar entitled „The new Supply Chain Act – Obligations. Liability. Prevention. We would also be happy to advise you on specific questions regarding the implementation of the legal obligations arising from the LkSG.