Private Enforcement in the EU Corporate Sustainability Due Diligence Directive—A critical comparative law and economic analysis of the Final Compromise

The European Green Deal aims to implement a harmonized supply chain statute, the Corporate Sustainability Due Diligence Directive, also known as CSDDD or CS3D. In a recent study (Thomale & Schmid 2024, under review), we discuss shortcomings of existing litigation on human rights, environmental and climate issues. The study focuses on 'private enforcement' in the supply chain: this includes, first, what we call 'Third Party Private Enforcement', which means the enforcement of international conventions initially addressed to countries by private companies, and second, the private law enforcement of those due diligence obligations (‘Private Enforcement’). The study assesses the proposed supply chain statutes’ effectiveness and efficiency, especially in comparison to alternative regulatory instruments. This blog post outlines key findings and shortcomings of the Final Compromise. For a detailed descriptive overview of the ‘Final Compromise’ we refer to already published overviews (eg Schmidt 2024; Triponel 2024).

1. Implementation of harmonized European Supply Chain Legislation (CS3D)

a. Legislative Process

The CS3D has rekindled the enduring debate on corporate social responsibility (CSR). Embracing climate sustainability, it has broadened and transposed CSR into environmental social governance (ESG). Furthermore, these policy objectives are pursued via a detailed system of public and private enforcement measures against companies, which arguably coincides with a fundamental shift towards stakeholder value theory. The legislative process reflecting this transition has been met with contention (Pacces 2023; Lafarre 2022; Mittwoch et al 2024), and it remains to be seen whether the Council will give its essential vote on the ‘Final Compromise’ (ST 7327/1/24 REV 1) proposed in mid-March 2024 in the Council's Coreper (Schmidt 2024). The European Parliament has already adopted the Final Compromise on April 24, 2024 (‘CS3D-P’ P9_TC1-COD(2022)0051).

b. Companies as a Key Factor for the Transition towards a Sustainable Economy

The European legislator has assigned to the private sector a pivotal role in achieving the ambitious objectives of the European Green Deal. In contrast to other ESG statutes like the Corporate Sustainability Reporting Directive (CSRD), the Sustainable Finance Disclosures Regulation (SFDR) or the Taxonomy Regulation, which emphasize disclosure and transparency, functioning as a ‘nudging tool’ (Thaler/Sunstein 2003), the CS3D imposes stringent and comprehensive ESG obligations on companies. With the CS3D, the European Union seeks to harmonize existing but diverging European Member State supply chain statutes already in force, notably in France (Loi de Vigilance) and in Germany (LkSG). Building on these legislations and generalizing them at an EU level, CS3D is supposed to prevent competitive disadvantages for individual Member States.

The CS3D’s rationale is based on the observation that companies often capitalize on lower production standards in emerging economies without fully internalizing the costs they impose on people, environment, and climate. Given that the EU, as a regulator, lacks direct means to enforce human rights, environmental protection, and climate emission awareness in third countries, it uses its indirect influence, normally through free trade agreements or sanctions. The CS3D is a new instrument to this end: European companies are expected to leverage their contractual relationships with business partners, eventually reaching third country private and public actors and creating what is referred to as a ‘trickle-down effect’ (Recital 46 CS3D-P). The ultimate objective of the CS3D is to ensure the internalization of the social and environment costs across the entire activity chain (Pacces 2023).

2. Shortcomings of the CS3D

a. Third Party Private Enforcement

i. Activity filter to the Detriment of International Division of Labour

The CS3D has not been analysed sufficiently from an institutional economic perspective. Warnings that EU supply chain regulation could lead to a net welfare loss have not been refuted conclusively. This is because CS3D increases transaction costs, which threatens to reduce purchases from entrepreneurs in developing countries. Hence, supply chain statutes are an activity filter impeding international division of labour. This has a negative impact on real per capita income, especially in developing countries. First empirical findings on the German Supply Chain Act (LkSG) show that these considerations are not merely hypothetical: according to these findings, imports in the textile industry from risk countries such as Pakistan or Bangladesh have fallen by 20 percent since the introduction of the LkSG (Kolev-Schaefer & Neligan 2024).

​​​​​​​ii. More resilient Value Chains through a Consolidation of Procurement Paths?

As compliance costs scale with each additional (in)direct business partner, the CS3D creates an incentive to minimize the number of contractual partners. This reduces the number of suppliers and thus counteracts the objective of ‘more resilient supply chains’, which should be achieved through a diverse range of suppliers. By minimizing contractual partners, investments in third countries are also less diverse and there is a risk of monopolization among suppliers, which further threatens a loss of efficiency.

​​​​​​​iii. Extensive Compliance Costs and Competitive Disadvantages

Due to its vague wording and vast scope, the supply chain due diligence obligation will impose significant costs on European companies. As these costs must be ultimately passed on to consumers, the statute creates competitive disadvantages for European companies. Therefore the question arises, whether the Final Compromise is proportionate pursuant to Art. 5 para 4 TEU as further specified in Protocol No 2: According to the principle of proportionality, EU measures must be suitable and necessary to achieve the desired end and must not impose a burden on the individual that is excessive in relation to the objective sought to be achieved.

In this regard, the regulatory approach chosen by the CS3D is subject to sweeping criticism (Felbermayr et al 2024; Kolev-Schaefer & Neligan 2024). According to the CS3D system, third-country suppliers are not audited centrally and therefore singularly. Instead, the CS3D chooses a decentralized approach. As a result, multiple self-audits must be carried out by European companies. Costs could be significantly decreased by focusing on third country firms directly, rather than on bilateral relationships along the activity chain. In this spirit, a certification system has been proposed: certification companies accredited and supervised by public authorities could carry out due diligence audits in a centralised fashion and in return assume the (insurable) liability risk for companies that rely on their assessment (Felbermayr, Friesenbichler & Klimek 2023). This system is comparable to the audit of annual financial statements. Alternatively, a single supervisory authority could be established, which would use negative lists to classify suppliers that infringe rights listed in the CS3D (Felbermayr, Friesenbichler & Klimek 2023). Hence, companies could limit their due diligence monitoring to the simple question, whether a foreign supplier appears on these lists. The provisional agreement on a proposal for an EU regulation on prohibiting products made with forced labour on the Union market introduces a database similar to this system (Art 8). ​​​​​​​

iv. Over-deterrence and Nearshoring/Reshoring due to extensive Sanctions

Initial experiences from Germany and France indicate that even a modest range of sanctions, such as exclusions from procurement procedures (Para 22 LkSG; Art 31 CS3D-P), already come with a potential of over-deterrence. In addition, high pecuniary penalties have a considerable deterrent effect (Art 27 para 4 CS3D-P).

Such over-deterrence must be prevented: If a draconian supply chain statute is passed, the indirect regulatory objective to create a higher level of due diligence in third countries through supplier contract relationships (‘stay and behave/improve’) will be compromised, as the relationship with these foreign suppliers will be terminated (‘cut and run’). In this respect, an excessive range of due diligence obligations and sanctions jeopardizes the regulatory instrument.

​​​​​​​v. Result: Proportionality Concerns

Since the Final Compromise chooses a regulatory approach that (i) imposes far-reaching due diligence obligations on companies and, at the same time, (ii) could potentially undercut the intended objective, while (iii) alternative, more efficient regulatory options are available, proportionality concerns under Art. 5 para. 4 TEU cannot be entirely dismissed. The Final Compromise of the CS3D is therefore unsatisfactory. This approach also ties up resources for unnecessary bureaucracy, resources which could be used to improve the human rights situation locally. ​​​​​​​

b. Private Enforcement

i. Unclear, extensive Liability Regime with a Differentiation Deficit

Although the scope in Art 2 CS3D-P has been controversial, it is not the key element of the CS3D. This is because companies outside its scope will also be affected indirectly through the ‘trickle-down’ effect. The ‘trickle-down’ effect describes the contractual delegation of CS3D obligations to suppliers. Therefore, the material and trans-subjective scope of the due diligence obligations is more important. In this regard, the CS3D is not only a harmonization of the regulatory models implemented in France and Germany, but rather an extension of existing concepts.

The CS3D holds companies liable for the entire activity chain of a company as defined in Art 3 para 1 lit g CS3D-P. This includes both the upstream and downstream activities not only of the company itself, but also of its direct and indirect business partners (Art 3 para 1 lit f CS3D-P). Moreover, the material scope is vastly broad: regarding the adverse impacts a company must prevent or mitigate (Art 3 para 1 lit d CS3D-P), the CS3D refers to numerous international treaties listed in its Annex.

To summarize, the scope is enormous and a company’s liability for actions of its non-contractual business partners is problematic, as a company within the scope of CS3D cannot significantly influence the business conduct of unrelated entities. Generally, from a comparative legal perspective, well-established principles of tort law enshrine the basic idea that liability presupposes a qualified connection or influence. Liability is therefore limited to the company's own organizational sphere. In corporate group constellations, this sphere can potentially include subsidiaries, although they are separate legal entities. In supplier constellations, where merely a contractual connection exists, such qualified influence is usually absent, which is why purchasers cannot be held liable for wrongdoings of their suppliers. The CS3D does not differentiate adequately between those two situations. Moreover, the CS3D poses the threat of liability multiplication in the sense that a ‘perpetrator behind the perpetrator’ is held liable despite no qualified geographical, organizational, or social connection.

​​​​​​​ii. Harmonization against the Victim’s interests

By declaring the liability in Art 29 CS3D-P to be an internationally overriding mandatory provision which ousts the tort law provisions designated by ordinary conflict of laws rules, CS3D harmonizes, potentially against the interests of an injured party. Because of the common law history of many manufacturing countries, injured parties, according to the applicable law of torts, have access to punitive damages, grief damages and other remedies not available under Member State law. This could lower the probability of enforcement. It might have been preferable to recognize a plaintiff's right to choose the applicable law of torts in supply chain litigation similar to Art 7 Rome II Regulation. A proposal therefore has already been brought forward in Art 6a of a report of the EP.

​​​​​​​iii. Achilles’ heel: Procedural Issue

1. Jurisdiction

The CS3D does to not address the actual issues of private law enforcement: In fact, the key challenges do not lie with a defective substantive law, as the EU seems to assume, but are rather rooted in procedural enforcement deficits (Peters et al 2020; Lafarre 2023; Wagner 2023). High litigation costs, a lack of access to legal aid, a ban on contingency fees and corruption are some reasons for the reluctance to litigate in third countries. Regarding litigation in Europe, long duration of proceedings as well as complex and plaintiff-unfriendly rules of evidence present an obstacle to private enforcement. So effective legal protection is hampered by the inadequate procedural and institutional environment of private enforcement, but not by a lack of available substantive legal bases.

To solve these primarily third-country enforcement deficits, an international venue in the EU is essential. However, this issue is not even addressed by the legislator. To be sure, companies with their statutory seat, central administration or principal place of business in an EU Member State can be sued in the EU pursuant to Art 4 of Brussels Ia Regulation. However, the situation is different for foreign subsidiaries or suppliers, which are also subject to the CS3D-P pursuant to Art 2 para 2. If the CS3D does not intend to create a regulatory competitive disadvantage for companies domiciled in the EU, an establishment obligation similar to Art 23 CS3D-P in conjunction with jurisdiction for private enforcement would be crucial. Failure to do so would open the door for liability arbitrage by moving out of the EU market, as recently announced by Shell (see also Davies 2023). Companies would therefore be incentivized by the CS3D to leave the European Union and choose a location where they cannot be prosecuted due to a lack of international jurisdiction.

Legal certainty could be achieved through the extension of closely connected claims (Art 8 para 1 Brussels Ia Regulation) and the establishment of a harmonized forum necessitatis in the Brussels Ia Regulation. The latter should apply in cases where foreign courts are unable to protect the interests addressed in the CS3D. This would also allow to take legal action against the immediate tortfeasor, being the cheapest cost avoider, rather than against a distant company at the top of the supply chain. However, such jurisdiction could be perceived as a further interference with the sovereignty of third countries (Hein 2020): This is because the EU would not only elevate European companies as enforcement agents for the obligations listed in the annex of the CS3D along the entire global activity chain, but also the European courts, which would be even competent in cases in which there is only a slight connection to the EU. Therefore, chances are that a decision rendered on such flimsy jurisdictional basis would not be recognized in the third country, where one would like to enforce it.

​​​​​​​2. Burden of Proof

Another issue for plaintiffs could arise in proving a company’s non-compliance (Lafarre 2022), in particular the wrongful act and causation. According to the Final Compromise, the question of the burden of proof is at the discretion of the Member States (Recital 81 CS3D-P). However, the CS3D introduces a ‘disclosure procedure light’ (Art 29 para 3 lit e CS3D-P). It is questionable whether this new idea provides a suitable answer to this enforcement obstacle.

3. Conclusion

The Final Compromise would become the most ambitious ESG legislation hitherto promulgated. With the CS3D, the EU wants to impose a new, wide-ranging duty of care on large companies and use them as enforcement agents for obligations under international law that were originally addressed to states. Art 29 of the CS3D-P formulates a framework for civil liability across upstream supply and downstream distribution relationships, thereby explicitly extending private enforcement to supply chain regulation.

The intention to improve living conditions in the global South and to hold the global North accountable for this is understandable. However, the end does not justify the means. It is doubtful whether the proposed self-auditing by companies and the associated civil tort liability are effective means to that noble end. The mixed experiences with the French loi de vigilance and the German Supply Chain Due Diligence Act demand caution in monitoring the impact of CS3D in order to reevaluate and amend it in due course.

Stephan Schmid is Research Assistant at the Department of Commercial and Business Law and the Centre for Comparative Corporate Finance Law (C³FL) at the University of Vienna.

Chris Thomale is Professor of International Commercial and Business Law (University of Vienna), Comparative Law (Università Degli Studi Roma Tre) and Co-Director of the Vienna Centre for Comparative Corporate Finance Law (C³FL).