Corporate Governance and the Corporate Sustainability Due Diligence Directive

After much political haranguing, the Corporate Sustainability Due Diligence Directive (‘the Directive’) was finally adopted in May 2024. The Directive’s adoption was remarked on by lead MEP Lara Wolters as being ‘a milestone for responsible business conduct and a considerable step towards ending the exploitation of people and the planet by cowboy companies’. From a corporate governance standpoint, the Directive does seem to have the potential to be impactful, but several of its shortcomings suggest that one should be only cautiously optimistic about its effects.

Corporate Governance Aims of the Directive

The Directive was concluded in the broader context of the EU’s commitment to an economy that ‘achieves a just transition to sustainability’. It is also part of the EU’s overarching commitments to deliver an improved sustainable corporate governance regulatory framework. It further

recognizes the key role of the behaviour of companies in meeting the EU’s sustainability objectives.  Indeed, the EU sees corporate behaviour as essential to meeting its just transition goals.

Thus, it is not surprising that the Directive aims at improving both corporate accountability and corporate governance practices to better integrate human rights and environmental risk management and mitigation processes into corporate strategies.

Corporate Governance Impacts of the Directive

From a corporate governance viewpoint, the Directive is expected to bring about various impacts on corporate governance that align with the EU’s goal of encouraging companies to contribute to sustainable development and a just transition. These include proactive management of human rights and environmental risks by business; a better understanding of the company’s supply chain; greater attention to stakeholder interests; and adoption of a climate transition plan. In addition, the Directive will force companies to treat their operations on a consolidated basis, which will mitigate two benefits of company law that drive corporate activities, namely separate legal personality and limited liability.

Since the Directive obliges companies to engage in human rights and environmental due diligence in its own operations as well as at the subsidiary and supplier levels, it ignores the separate legal personality of these different entities, effectively treating the company as one consolidated entity. Parent companies are expected to engage in oversight via human rights due diligence for both subsidiaries and suppliers. This results in the company in effect treating these separate entities as a consolidated entity. Similarly, by imposing the possibility of corporate liability for harms done at the subsidiary level, some of the benefits of limited liability may also be taken away. In doing so, boards are more likely to exercise greater care over activities at the subsidiary and supplier levels. Companies will also be less incentivized to outsource risky corporate activities, which could cause human rights and environmental harms. Moreover, by stipulating the possibility of liability for companies that cause harm to claimants, boards will be more incentivized to exercise proper oversight over their own activities and over activities in their subsidiaries and supply chains.

One novel impact of the Directive may be that it gives rise to an EU standard of corporate governance. This could be a side effect of the extraterritorial nature of the Directive, since it applies not only to EU companies but to those with significant turnover or other ties to the EU.  These affected companies may not have any choice but to adopt EU equivalent standards of corporate governance or else risk penalties or liability.

Corporate Governance Shortcomings

While the Directive takes a good first step towards companies better incorporating sustainability issues within corporate decision-making, if the aim is to reorient companies’ actions toward just transition aims, the Directive is poised to fall short. This is because the Directive fails to define a sustainability-related purpose for companies, omits the inclusion of a director’s duty to consider sustainability issues, and contains provisions which may enable companies to evade liability under the Directive.

One shortcoming of the Directive is its failure to specify a corporate purpose. Outlining the purpose of a corporation is important because it can act as a driving force in the company’s decision-making processes and specify the beneficiaries of a corporation’s actions. Given the competing and contradictory shareholder-stakeholder corporate purpose debate which continues to persist, specifying which of these views the EU espouses would have been helpful to defining aspects of corporate governance.

In particular, such a purpose could have helped define director’s duties. Defining a director’s duty can be integral to shaping the way a corporation acts or orienting it towards a desired direction since it is ultimately the board of directors that determines the corporation’s strategy. Therefore, a failure to prescribe a just transition/sustainability-oriented director duty seems not to align with the EU’s aim of relying on corporate behaviour to achieve its just transition goals.

Finally, one of the aims of the Directive was to increase corporate accountability. It does this by imposing fines, penalties or liability on the corporation if it fails to act in accordance with the Directive’s requirements. Consequently, a prudent board would incorporate sustainability considerations into its strategy to avoid such consequences. However, it would be less inclined to do so if it knew such consequences were unlikely.

Unfortunately, the Directive makes it difficult for claimants to establish liability through its onerous causation and burden of proof requirements. Claimants must demonstrate that the company’s acts caused their damage, but the Directive leaves the standard of causation, which is known to vary and cause confusion, undefined. Similarly, the Directive does not specify who bears the burden of proof in demonstrating liability, leaving this to national law to define. The causality requirement combined with an uncertain burden of proof may complicate—or even thwart efforts—by claimants to impose liability on companies. While the ability for Supervisory Authorities to impose penalties on companies for non-compliance may somewhat ease these difficulties, the arduous nature of establishing liability could prompt companies to only half-heartedly embrace the Directive’s requirements. In turn, this could compromise changes to a company’s corporate governance.

Conclusion: Achieving Corporate Governance Aims?

While the Directive will likely encourage board consideration and awareness of sustainability issues, given its shortcomings, it is unlikely to reorient companies towards sustainability aims, such that they could make a meaningful contribution to the EU’s just transition goals. Moreover, with such muted effects, it is unlikely that the Directive will have a profound impact on affected companies’ corporate governance.

This post is based on ‘Corporate Governance and the Corporate Sustainability Due Diligence Directive’, a chapter in C. Bright and M. Scheltema (eds), Corporate Sustainability Due Diligence Directive – A Commentary (Edward Elgar) (Forthcoming).

Barnali Choudhury is a Professor of Law at Osgoode Hall Law School and Director at the Nathanson Centre on Transnational Human Rights, Crime & Security.