The German Lieferkettensorgfaltspflichtengesetz (Supply Chain Act – LkSG) came into force on 1 January 2023. The law establishes human rights and environmental protection standards throughout the supply chain. Under the Supply Chain Act, companies now have an obligation to
- establish risk management as part of a staggered approach (in particular, conducting a risk analysis within their own organisation as well as at their direct and indirect suppliers; see our blog post from September),
- establish further preventive measures (control mechanisms, the implementation of a human rights commissioner, reporting obligations),
- and take remedial action in case of a compliance violation.
Hence, the Supply Chain Act not only sets standards on how to assess and mitigate human rights and environmental risks, but also establishes specific follow-up measures in case such risks materialized into violations. This blog post provides an overview of the remedial action to be taken and analyses the practical requirements before diving into possible sanctions in case of non-compliance.
The duty to take remedial action
Under the German Supply Chain Act, a company is required to take remedial action if human rights or environmental standards have been violated or if such a violation is imminent. If a company has taken remedial action, these usually have to be reviewed annually, but also ad hoc, e.g. when new products or manufacturing processes are introduced. If these prove to be unsuitable or ineffective, they must be adapted. The legal requirements for remedial action depend on whether the compliance violation occurred within the company itself or (merely) in the supply chain (“concept of staggered responsibility”).
Let’s take a closer look at the different spheres of influence:
Compliance violation in the company’s own area of business
In the company’s own business, the remedial action must stop the compliance violation. There are no exceptions.
The law recognizes the management’s somewhat limited sphere of influence over the company’s operations abroad and vis-à-vis its subsidiaries. If the compliance violation is committed there, the remedial action must only “generally” result in the termination of the compliance violation.
Compliance violation at the level of a direct supplier
If the compliance violation occurs in the sphere of a direct supplier and cannot be remedied within a foreseeable period, the company must immediately (without culpable hesitation) draw up a step-by-step plan for minimization and termination (so-called remediation plan). It is advisable to involve all affected departments and suppliers and to ensure compliance through appropriate contractual clauses. However, the law recognizes that the obligated company cannot independently remedy the violation if it lies outside its direct sphere of influence. In this case, the LkSG provides for several escalation levels. Ultima ratio is the suspension and termination of the respective business relationship. This is required if serious human rights violations have been identified and previous remedial measures have not been successful within the time schedule (“enablement before rescission”).
Such a remediation plan could be structured as follows:
1. Warning and setting of a deadline
As soon as a compliance violation has been identified, a warning must be issued to the supplier and a deadline set for remedying the compliance violation.
2. Individual concept development
A concept based on the individual case is to be set up to minimize and terminate the violation(s) of duty of care. This includes an adapted schedule for terminating the compliance violation.
3. Warning and setting of deadlines
The relevant supplier shall assure that it will implement the individually established remediation plan within the agreed deadline. If the supplier refuses to take the appropriate remedial action, the company shall set a (new) deadline for taking follow-up action for the current business relationship.
4. Assurance and obligation to implement
The breaching company shall provide assurances on the planned implementation and the assurances and implementation commitment shall be documented and verified.
5. Industry initiatives
The LkSG envisages as a possible remedy the alliance with other companies in form of an industry initiative or by setting industry standards. This way multiple companies together can increase their influence on the violating company. Industry initiatives and industry standards serve to standardize specifications, increase the company’s own ability to exert influence, and achieve human rights standards through synergy effects.
6. Appropriateness test
By assessing all the circumstances of the individual case, the company must consider which follow-up measures are appropriate, whether it is necessary to resort to the last resort.
7. Ultima Ratio: Suspension and Termination of Business Relationships
As a last resort, the company has to terminate or suspend the business relationship with the company if serious human rights violations have been identified, an increase in the company’s “capacity to influence” is not sufficient and other measures have not been successful within the time schedule.
The establishment and implementation of the remedial action plan shall be documented on an ongoing basis.
Compliance violation at the level of an indirect Supplier
If the compliance violation occurs at the level of an indirect supplier, measures must be taken to end the compliance violation. The company must intervene if it has substantiated knowledge of a breach of duty, i.e. verifiable and serious information (substantiated knowledge). The company must first carry out a risk analysis and take appropriate preventive measures accordingly. If the obligated company itself can influence the indirect supplier, it has the discretion to create and implement a remediation plan with the indirect supplier itself (according to the model outlined above) or to involve the direct supplier to create and implement a remediation plan.
For all violations of the Supply Chain Act, fines can be imposed. This includes the failure to take remedial action. Even delayed action is a punishable offence. Even though it is still unclear under which circumstances the Federal Office of Economics and Export Control (BAFA) will levy sanctions, caution is advised, especially due to the far-reaching sanction options.
Possible fines range from €100,000 to €800,000. For legal entities and associations with an average annual turnover of more than €400m, the fine range is increased to up to 2% of the average worldwide turnover. The law follows a rather broad approach, calculating the worldwide average annual turnover on the last three tax years and the worldwide turnover of all legal entities operating as economic units. The concrete amount is calculated based on various criteria which the law only lists as examples (nature of the offense, motives, objective, as well as the weight, scope, and duration of the violation).
Similarly, companies that violate the law can be excluded from the award of public contracts for up to three years. Exclusion from the award of public contracts is “the sharpest sword of the LkSG”. The wording “shall be excluded” suggests that exclusion is the rule if the conditions are met and that only atypical individual cases give room for a different decision (intended discretion). In view of these harsh and potentially “bet-the-company” consequences, the company has in any case the possibility of creating the preconditions itself to be considered for the award of public contracts again by means of self-cleaning.
Outlook for the affected companies
To be best positioned for the new obligations under the LkSG, companies are well advised to obtain an overview of all remedial action already in place and to know their own “ability of influence” in order to be able to take appropriate remedial action in individual cases. Furthermore, companies should consider drafting a sample remedial action plan complying with the LkSG’s requirements. This draft remedial action plan can be individually adapted to the situation at hand when necessary. If compliance violations are foreseeable soon, the remedial action plan must be drawn up immediately in accordance with the (direct) supplier and implemented accordingly.
All future contracts concluded with direct suppliers should contain a section governing the proceedings in the event of a compliance violation relevant under the LkSG and for the course of remedial actions.
Industry dialogues and additional BAFA handouts are expected to provide further clarity. BAFA plans to issue handouts on the adequacy of sub-measures and the complaint procedure. Watch this space.