To view the German translation, please click here.

The Act on Corporate Due Diligence Obligations in Supply Chains (“Supply Chain Due Diligence Act” or the “Act”) creates human rights and environmental due diligence obligations for companies with a significant number of employees in Germany (our Business and Human Rights team has formerly outlined the application thresholds here). The law’s human rights due diligence obligations add to the growing range of obligations on companies that fall under the “S” pillar of companies’ Environmental, Social, and Governance (ESG), together with other legislative activities of the German government such as the laws concerning the minimum quotas for women on management and supervisory boards (we reported on the Second Leadership Positions Act; the corresponding article can be found here) and the Whistleblower Protection Act, which the German legislature has enacted to implement the European Whistleblower Directive (link to registration and to on-demand webinar on the draft Whistleblower Protection Act can be found here). The Supply Chain Due Diligence Act requires subject companies to take measures to identify, prevent, and mitigate human rights risks in their own operations and supply chains, including by establishing risk management systems and appointing a responsible person, such as a human rights officer, to monitor the risk management systems.

Why should companies be concerned about this?

There is a threat of draconian penalties if companies violate the obligations arising from the Supply Chain Due Diligence Ac. Fines of up to EUR 8 million can be imposed, or, in the case of a global group with annual turnover of more than EUR 400 million, up to 2% of global annual turnover. In addition, companies can be temporarily excluded from being awarded public contracts if the fine imposed is equal to or above EUR 175,000. Furthermore, legally binding decisions imposing fines are entered in the competition register.

The executive bodies also face (even more extensive) liability

Companies’ directors and senior officers may also face significant liability for failure to comply with the Act. The competent authority—the Federal Office of Economics and Export Control (BAFA)—can impose fines of up to EUR 800,000 on natural persons, such as managing directors of a German Limited Liability Company (GmbH) or members of the board of directors of a German Stock Corporation (AG), in the event of an intentional or negligent breach of the duty of care. The main difference between a GmbH and AG is that the bodies of a GmbH are the shareholders’ general assembly and the management. This legal form provides for a separation of capital and management. The shareholders are the owners of the company shares and can make decisions on all matters concerning the company. Interventions in the operative business are also possible, as they have the right to issue instructions to the management. In a stock company, the executive bodies are separated by function: there is the board of directors (Aufsichtsrat), the management board (Vorstand) and the general assembly (Hauptversammlung). The managing board is responsible for the management of the company and is monitored by the board of directors. The general assembly brings together all shareholders – the owners of the company. Concerning the powers of the shareholders, there is a decisive difference between an AG and a GmbH. In contrast to the shareholders, the equity holders of a GmbH have the possibility to intervene in the management at any time – equity holders cannot do this. In the case of AGs, there is a strict separation between the management and the capital, i.e. the shareholders.

In addition to the fines outlined above, such individuals may also face internal liability vis-à-vis the company (Section 93 (2) sentence 1 Stock Corporation Act or Section 43 Limited Liability Companies Act). Managing directors and board members have a duty of legality, i.e. they must act legally and monitor their employees to ensure that they comply with the duties incumbent on the company. The duty to fulfill extends, among other things, to all duties arising from the Supply Chain Due Diligence Act. Of course, managing directors and board members can delegate these duties to reliable and competent employees. However, they remain responsible for their selection and supervision. Such delegation does not automatically absolve them of liability. Companies’ executive bodies should therefore be guided in particular by the standards of supreme court rulings on the fulfillment of their organizational duties, especially with regard to obtaining legal advice.

In addition to the liability under regulatory and corporate law, there is also a potential external liability vis-à-vis the members of the executive bodies that should not be underestimated. For example, case law has held that the managing director may have a guarantor obligation to protect the property of third parties on the basis of his/her position on the board. However, such a guarantor obligation only exists for the protection of very important protected legal positions and protected interests/assets, according to the German law so-called “third-party legal assets” which, such as body or health, are protected in absolute terms (i.e. without the possibility of a waiver) pursuant to Section 823 (1) of the German Civil Code. Therefore, external liability is the exception. Nevertheless, it is important that the executive bodies are aware of this liability potential and align their behavior accordingly.

Labor and employment elements of the Supply Chain Due Diligence Act

The human rights-related concepts covered under the Act include several core labor and employment issues. For example, the law focuses on concepts like equal pay, non-discrimination, freedom of association (i.e. the right to establish and join interest groups like trade unions), and protecting vulnerable groups (such as children).  For each of these concepts, the law requires companies to conduct due diligence as it relates to both their own operations and those in their supply chain.

The due diligence requirements of the Act include (in each case, combined with documentation and reporting requirements):

  • implementing effective risk management with regard to human rights and environmental risks,
  • conducting risk analysis,
  • developing a human rights strategy,
  • establishing internal organizational responsibilities,
  • developing appropriate and effective preventive measures,
  • the establishment of a complaints procedure and grievance management,
  • implementing/updating existing risk management systems.

Aspects of co-determination law – economic committee and works council

The Supply Chain Due Diligence Act does not contain any regulations on co-determination within the company. This means that this Act as such does not contain any provisions that give the works council a right to be involved in measures taken by the employer. If the works council has a right of co-determination, the employer cannot take measures/establish provisions that require co-determination if it has not properly involved the works council in this. However, a new Section 106 (3) no. 5 lit. b Works Constitution Act (Betriebsverfassungsgesetz – BetrVG) will be introduced (as of January 1, 2023), according to which the economic committee must also be informed about issues of corporate diligence in supply chains. The scope of this duty to inform is still unclear. In any case, however, the employer will have to provide information on the economic consequences of the due diligence obligations under the Act. The report to be prepared in accordance with Section 10 (2) of the Act can be used as the basis for the corresponding information. Furthermore, the business committee must be informed about the company’s policy statement on human rights strategy. In the case of a reference to the economic situation of the company, the employer must also inform the business committee about measures for risk analysis, prevention and remediation as well as the complaints procedure and complaints management.

In Germany, employee representatives have a strong legal position as a counterweight to the employer. If works councils are elected, they have extensive co-determination rights to protect employees from the employer’s unilateral perception of their interests. Such a right of co-determination exists, for instance, with regard to provisions of the employer concerning the behavior of the employees in the company. Therefore, if, e.g., the employer establishes binding rules of conduct for employees in connection with the establishment of a compliance system and/or risk management, for example by making use of a specific form mandatory, the works council has a right of co-determination pursuant to Section 87 (1) No. 1 BetrVG. However, the existence of a right of co-determination must be examined with regard to each individual regulation of corresponding procedural rules or compliance codes (e.g. Code of Conduct). According to the so-called “Honeywell decision” of the Federal Labor Court, the existence of a right of co-determination with regard to one or individual regulations does not lead to bracketing with other provisions; these are not “infected” by a co-determination obligation with regard to other regulations. Rather, it must be examined for each individual measure whether it is subject to co-determination as such. If the employer sets up digital channels for the complaints procedure and/or integrates electronic systems into risk management, the works council also has a right of co-determination pursuant to Section 87 (1) No. 6 BetrVG (technical monitoring). For this right of co-determination to apply, it is sufficient that the electronic systems are objectively suitable for monitoring the behavior or performance of the employees. It does not matter whether this is subjectively intended by the employer.

The EU legislator is expected to pass a harmonizing Directive

In order to avoid a distortion of competition in the internal market due to differently designed “due diligence” regulations in the various member states, the European Commission is striving for harmonization. To this end, it presented a proposal for a directive on corporate sustainability due diligence in February 2022. Among other things, the proposal would require Member States to provide for civil liability of companies under certain circumstances (unlike the German law which leaves existing rules on civil liability largely unchanged). The impact of these harmonization efforts on German law remains to be seen.

Photo of Walter Born Walter Born

Walter Born is a partner in the Frankfurt office. He advises clients on a variety of legal and business issues, with an emphasis on restructuring measures and the negotiation of reconciliation of interests and social plans, outsourcing transactions and German TUPE provisions, employee…

Walter Born is a partner in the Frankfurt office. He advises clients on a variety of legal and business issues, with an emphasis on restructuring measures and the negotiation of reconciliation of interests and social plans, outsourcing transactions and German TUPE provisions, employee data protection, dismissals (mass lay-offs) and related litigation, internal investigations, employee benefits and ERISA litigation. Walter counsels clients on employment advice, including drafting employment, managing directors’ and board members’ contracts and settlement agreements. He also has experience advising on collective labor law matters, and counsels on immigration matters, social security law, enforceability of post-contractual non-compete covenants and many other related matters. Walter Born is Managing Partner for Legal Personnel of the Frankfurt office.

Photo of Dr. Nadine Kramer Dr. Nadine Kramer

Dr. Nadine Kramer is a special counsel in Covington’s labor and employment law and executive compensation and employee benefits department. She has many years of experience in advising on labor law aspects with respect to M&A transactions, complex HR topics and reorganizations, especially…

Dr. Nadine Kramer is a special counsel in Covington’s labor and employment law and executive compensation and employee benefits department. She has many years of experience in advising on labor law aspects with respect to M&A transactions, complex HR topics and reorganizations, especially with a focus on negotiations with works councils, and a corresponding networking within the law firm as well. Furthermore, she has a great experience in drafting of social plans, evaluating of pension liabilities and managing labor law-related proceedings, especially with regard to wrongful termination litigations at all levels of seniority and management participation programs.