A Primer

Why is HREDD-alignment so important? ​

HREDD, as set out in the UNGPs and OECD Guidance, is the foremost standard for managing human rights impacts in supply chains. Although these international instruments remain ‘soft law’ in most jurisdictions, an increasing number of national and supranational laws are either in force or coming into existence requiring in-scope companies to conduct HREDD in their own operations and supply chains in line with the UNGPs and OECD Guidance.

Examples of mandatory human rights and environmental due diligence (HREDD) laws and sustainability disclosure laws already enacted include:
  • The German Supply Chain Due Diligence Act (LkSG),  in force since January 2023
  • The Corporate Sustainability Reporting Directive, in force since January 2023
  • The Norwegian Supply Chain Transparency Act, in force since July 2022
  • The French Duty of Vigilance Law, in force since March 2017
As concerns compliance with the LkSG, which is already in force in Germany, the German Helpdesk on Business and Human Rights (a governmental entity), in collaboration with the BAFA, the regulatory authority that is in charge of enforcing the German Supply Chain Act, recently published guidance clarifying that contracts cannot be used to shift responsibility and that contracts are a type of preventive measure that must be designed in an effective fashion to be compliant with the law (see here for an English-language opinion on this). The guidance uses the term “shared responsibility” throughout the text, emphasizing the no-shift point. Thus traditional contracts, which tend to focus on risk-shifting techniques for governing human rights risks and are ineffective with respect to mitigating these risks, let alone remedying actual adverse impacts, are likely to be viewed as noncompliant with the German law.

Another law of interest to investors and that is already in force in the EU is the CSRD, which requires large companies to make sustainability related disclosures based on a “double materiality” standard.  Under that standard, companies must report on: (1) the impacts of their activities on people and the environment, and (2) how they are being affected and expect to be affected by sustainability matters. The contents of these reports could affect portfolio companies’ share prices, but also serve as a kind of HREDD alarm system in that, if a company’s reports reveal many or significant HRE issues, that could indicate that there will be other compliance problems down the line under the HREDD laws (especially if the CS3D is eventually adopted in the EU). 

Yet another significant development is the EU Taxonomy Regulation. A cornerstone of the EU’s sustainable finance framework, the EU Taxonomy Regulation helps direct investments to the economic activities most needed for a just transition in line with the European Green Deal objectives. The Taxonomy is designed to ensure that investments or activities labeled as “Taxonomy-aligned” meet certain minimum governance standards and do not violate social norms, including human rights and labour rights. The Regulation specifies that one of the three criteria for economic activities to be considered sustainable is that they are “carried out in compliance with the minimum safeguards.”[1]  This includes an assessment as to whether or not the company has established an adequate HREDD process as outlined in the UNGPs and OECD Guidance. Contracting practices form a critical component of broader HREDD practices and should be considered in the evaluations of UNGP-alignment. 

The EU is also in the process of negotiating the final text of the CS3D under which companies that generate above a certain threshold of revenue within the EU—regardless of whether they are EU companies—will be required to conduct HREDD within their own operations and supply chains.  At this time, the latest consensus text for the CS3D clearly articulates that contracts should not be used to transfer HREDD-related responsibilities from in-scope companies to other companies (e.g., suppliers) in their supply chains. Additionally, responsible purchasing practices (e.g., fair pricing that covers a living wage or a minimum wage, whichever is higher, and providing assistance to business partners to uphold HRE standards) are discussed in the text as an important component of effective HREDD. 

As such, rather than pursuing the traditional, risk-shifting contracting approach, in-scope companies would be better off proactively aligning their contracts with due diligence principles, as proposed in the SMCs, the MCCs 2.0, the EMCs, and the broader, still-expanding RCP Toolkit, which will soon include Responsible Investor Model Clauses (RIMCs). All of the Clauses in the RCP Toolkit are drafted to align with both best practice and existing and emerging legislation. 

​In addition, the due diligence processes that underlie a commitment to responsible contracting will also better position companies to avoid importing goods made with forced labor into the United States, risking enforcement under the Tariff Act of 1930 or the UFLPA.  In the event that a Withhold Release Order (WRO) is issued and goods are stopped at the border under suspicion of being made with forced labor, the due diligence collected will help the company either contest the WRO and have the goods released or to remediate and have the WRO lifted. 
[1] See also Final Report on Minimum Safeguards. Platform On Sustainable Finance. Oct 2022. https://finance.ec.europa.eu/system/files/2022-10/221011-sustainablef inance-platform-finance-report-minimum-safeguards_en.pdf
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