The law on due diligence in the supply chain (LkSG): New benchmarks for global responsibility and its links to CSDDD and EUDR

Elisabeth Kraut

She has set herself the goal of supporting companies in the transformation process towards a more sustainable and circular economy.

Globalisation has fundamentally changed the world economy and led to complex supply chains that connect countries and continents. In addition to the economic benefits, this interconnectedness also brings with it major challenges, particularly in the areas of human rights and environmental protection. Against this backdrop, Germany has set a milestone with the Due Diligence in Supply Chains Act (LkSG), which requires companies to fulfil their global responsibility. This law is not isolated, but is part of a larger movement within the European Union, as demonstrated by the planned Corporate Sustainability Due Diligence Directive (CSDDD) and the EU Disposal Regulation (EUDR).

Background and objectives of the LkSG

The law on due diligence in supply chains, which came into force on 1 January 2023, marks a turning point in German economic policy. It was created against the backdrop of growing criticism of practices in global supply chains that violate human rights and are harmful to the environment. Cases of child labour, forced labour, unacceptable working conditions and serious environmental damage brought the responsibility of multinational companies into focus. Germany responded to these developments by passing a law that obliges companies to comply with human rights and environmental due diligence obligations along their supply chains. According to Section 1 of the LkSG, the aim of the law is to “uphold international human rights and promote the protection of the environment by obliging companies to exercise due diligence in their supply chains”. The law is intended to help improve living and working conditions in production countries while ensuring fair competition.

The LkSG initially applies to companies that have their head office, principal place of business, administrative headquarters or registered office in Germany and generally employ at least 3,000 employees (Section 1 (1) LkSG). From 1 January 2024, the threshold will be lowered to 1,000 employees (Section 1 (2) LkSG). Foreign companies with corresponding subsidiaries or branches in Germany are also covered by the law, provided they reach the aforementioned number of employees. This regulation means that large companies in particular are initially affected. However, the law also has an impact on smaller companies that are involved in the supply chain as suppliers, as the large companies must fulfil their due diligence obligations along the entire supply chain.

Obligations and duties for companies

The law on due diligence in the supply chain sets out detailed requirements that companies must fulfil. The focus here is on human rights and environmental due diligence obligations. Companies are obliged to set up an appropriate risk management system that is integrated into all relevant business processes (Section 4 (1) LkSG). This risk management should serve to identify and assess potential human rights and environmental risks. The risk analysis must be carried out at least once a year and updated if the risk situation changes significantly (Section 5 (1) LkSG). Based on the risk analysis, companies must submit a policy statement on the human rights strategy (§ 6 para. 2 LkSG). This should set out the company’s human rights and environmental expectations of its employees and suppliers. In addition, appropriate preventive measures must be taken to avoid or minimise identified risks (Section 6 (1) LkSG). These include training, adjustments to procurement strategies and the integration of sustainability criteria into contracts.

If a company discovers that human rights or environmental obligations have been violated, it must take immediate remedial action (Section 7 (1) LkSG). In addition, companies are obliged to set up an effective complaints procedure that enables those affected to draw attention to risks or violations (Section 8 (1) LkSG). The fulfilment of due diligence obligations must be documented on an ongoing basis (Section 10 (1) LkSG). In addition, companies must prepare an annual report that must be made publicly accessible (Section 10 (2) LkSG). This report must contain detailed information on the measures taken and their effectiveness.

The LkSG distinguishes between a company’s own business activities, direct suppliers and indirect suppliers. While comprehensive due diligence obligations apply to the company’s own business activities and direct suppliers, indirect suppliers are obliged to act if the company obtains “reasonable knowledge” of possible violations of the law (Section 9 (3) LkSG). In this case, the company must immediately carry out a risk analysis and, if necessary, take preventive or remedial measures. Failure to comply with these obligations can lead to severe penalties. According to Section 24 LkSG, fines of up to 8 million euros or up to 2% of the average annual turnover can be imposed for violations if the turnover is more than 400 million euros. In addition, a company can be excluded from awarding public contracts for up to three years (Section 22 LkSG). The Federal Office of Economics and Export Control (BAFA) is responsible for monitoring compliance with the law (Section 14 LkSG).

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Connections to CSDDD and EUDR

The Corporate Sustainability Due Diligence Directive (CSDDD) is a planned EU directive to create a standardised European due diligence regime. It is intended to oblige companies to fulfil human rights and environmental due diligence obligations along their supply chains and goes beyond the German LkSG in some aspects. The CSDDD is intended to apply to larger companies with more than 500 employees and a global net turnover of more than 150 million euros. For certain high-risk sectors such as textiles, agriculture or minerals, companies with 250 employees or more and a turnover of 40 million euros are to be covered.

In contrast to the LkSG, the CSDDD provides for civil liability, i.e. affected parties can assert claims for damages against companies if they violate their due diligence obligations. In addition, the CSDDD contains stronger provisions on stakeholder involvement and the alignment of corporate governance with sustainability goals. A key difference to the LkSG is the greater emphasis on climate protection and environmental aspects in the CSDDD. Companies are to be obliged to develop and implement climate protection plans that are in line with the Paris Agreement. This expands the focus of due diligence obligations to include aspects relevant to climate protection.

The LkSG can be seen as a precursor to the CSDDD and offers German companies the opportunity to prepare for the extended European requirements at an early stage. However, companies should note that the General Data Protection Regulation provides for stricter and more extensive obligations in some cases. It is therefore advisable to adapt compliance structures at an early stage.

The EU Deforestation Regulation (EUDR) was introduced by the European Union to combat global deforestation and ensure that products entering the EU market do not contribute to forest destruction. The regulation applies to companies that import or market certain raw materials such as wood, coffee, cocoa, soya, palm oil and beef in the EU. The EUDR obliges companies to carry out a due diligence process to ensure that their products are free from deforestation. This includes collecting detailed information about the supply chain, including the exact geographical origin of the raw materials. Companies must prove that the raw materials do not originate from areas that were deforested after the cut-off date of 31 December 2020.

There are overlaps between the obligations under the LkSG and the EUDR, particularly in the area of environmental due diligence obligations. While the LkSG generally considers environmental protection to be part of the due diligence obligations (Section 2 (3) LkSG), the EUDR specifies detailed requirements for the prevention of deforestation. Companies that fall under both the LkSG and the EUDR must expand their due diligence obligations accordingly and fulfil the specific requirements of both sets of regulations. By implementing a comprehensive due diligence system, companies can fulfil the requirements of both the LkSG and the EUDR. An integrated approach makes it possible to utilise resources efficiently and avoid duplication of work. It also promotes transparency and sustainability along the entire supply chain.

The coexistence of LkSG, CSDDD and EUDR presents companies with complex compliance challenges. It is important to develop a holistic compliance management system that takes into account the different requirements. Companies should consider the following steps: Analysing the relevant regulations, integrating due diligence, involving stakeholders, technological solutions and training and sensitising employees. Compliance with legal requirements not only offers legal certainty, but also the opportunity to position yourself as a responsible company. Consumers and investors are attaching increasing importance to sustainability and ethical behaviour. Companies that fulfil these expectations can gain a competitive edge and tap into new market segments.

The law on due diligence in supply chains sets new standards for corporate responsibility and is part of a European movement to strengthen human rights and environmental protection in global supply chains. The planned Corporate Sustainability Due Diligence Directive and the EU Waste Management Regulation complement these efforts and expand the requirements for companies. For companies, this means rethinking and adapting their compliance strategies. The early and proactive implementation of legal requirements is not only a legal necessity, but also an opportunity to promote sustainable business practices and gain the trust of customers, investors and society. The challenges are undoubtedly great, but the benefits outweigh them. A sustainable and responsible business model is the key to long-term success in an increasingly interconnected and conscious global economy.