Reporting ESG

The German Supply Chain Act (LkSG) defines corporate due diligence obligations

Jun. 16, 2022

From 2023, the German Supply Chain Due Diligence Act (German: Lieferkettensorgfaltspflichtengesetz, LkSG) requires certain large companies in Germany to ensure compliance with human rights and certain environmental due diligence obligations in their global supply chains.

What is the Supply Chain Act?

On January 1, 2023, the German Supply Chain Due Diligence Act (LkSG), or Supply Chain Act for short, came into force. The implementation of the Act is monitored by the German Federal Office of Economics and Export Control (BAFA).

The law regulates corporate responsibility for the observance of human rights and the protection of the environment. This applies both to the company's own business operations and to the actions of contractual partners and other suppliers along the entire supply chain. The due diligence obligations require the establishment of effective risk management to identify, avoid or minimize risks of human rights violations and damage to the environment.

The corporate due diligence obligations include:

  • the implementation of a human rights-related risk management system

  • the implementation of an in-house body, responsible for human rights protection

  • the implementation of a human rights-related risk analysis

  • the declaration of basic principles for the protection of human rights in business

  • the implementation of preventive measures in the own business area and vis-à-vis direct suppliers

  • remedial action in the event of a human rights violation

  • the implementation of a complaints procedure with regard to the notification of human rights violations

  • the implementation of due diligence measures with regard to risks connected to indirect suppliers

  • the implementation of documentation and reporting measures connected to the fulfillment of mandatory due diligence obligations

Which companies are affected by the Supply Chain Act?

The German Supply Chain Due Diligence Act obliges companies with their head office, principal place of business, administrative headquarters, statutory seat or branch in Germany to respect human rights by implementing defined due diligence requirements. In addition, controlled companies are included in the business area of German companies; they are not considered direct suppliers.

The LkSG applies to companies with at least 3,000 employees (from 2023) and to companies with at least 1,000 employees (from 2024) in Germany.

However, small and medium-sized companies are also affected by the requirements of the Supply Chain Act, even if they do not meet the minimum size specified. If a company is a direct supplier to a company covered by the Act, it may be obliged to implement the due diligence requirements as part of the contractual relationship.

From when must companies comply with due diligence obligations?

The Supply Chain Act will apply to companies with at least 3,000 employees in Germany from 2023. From 2024, the threshold will be lowered to companies with at least 1,000 employees in Germany.

Companies falling under the scope since January 1, 2023, do not have to fulfill all due diligence obligations on the same day. Some obligations are only to be implemented in the course of the first audit year.

In detail, this means that from January 1, 2023, all companies affected by the law must have regulated responsibility for monitoring risk management as well as introduced a functioning complaints management system through which employees can point out risks and violations in the company or the supply chain. From the time a company becomes subject to the Act, it must begin to fulfill its other due diligence obligations.

Reporting according to the Supply Chain Act

When do companies have to report?

After the end of a fiscal year, a report on the fulfillment of due diligence obligations in the previous fiscal year must be prepared. This report must be submitted to BAFA no later than four months after the end of the fiscal year and published on the company's own website.

What do companies need to do?

The obligations to be fulfilled for supply chains are graded according to the actual influence that large companies can exert. They are to be taken into account through the introduction of risk management and vary depending on whether

  • the company's own business unit

  • a direct contractual partner and thus a direct supplier

  • or a more indirect supplier

is involved.

In order to support companies in implementing their due diligence obligations, the BAFA has developed and published a handout document.

What do companies face in the event of non-compliance?

As a supervisory body, BAFA has powers of intervention and can impose coercive fines and penalties in the event of non-compliance with the corporate due diligence obligations. These can amount to up to 8 million euros or up to 2 percent of global annual sales. The latter only applies to companies with an annual turnover of more than 400 million euros. If a fine is imposed above a certain minimum level, there is also the threat of being excluded from the award of public contracts in the future.

Who benefits from the Supply Chain Act?

The LkSG contains an exhaustive catalog of eleven internationally recognized human rights conventions. The legal rights protected therein are used to derive behavioral requirements for corporate action in order to prevent the violation of protected legal positions. These include:

  • protection against child labor, forced labor, and discrimination

  • protection against land grabbing

  • occupational health and safety

  • the right to fair wages

  • the right to form trade unions

  • protection against environmental violations

The introduction of the Supply Chain Due Diligence Act will benefit people in poor countries in particular. For example, around 75 million children worldwide are currently affected by child labor. But people along the supply chain and in companies, as well as consumers, can also benefit from the LkSG.

The importance of the LkSG for the future of companies

For affected companies, in addition to the new threats of fines, there is also a significant reputational risk if they do not comply or only partially comply with the obligations. This also applies to indirectly affected companies.

In addition, companies should keep an eye on the development of the Corporate Sustainability Due Diligence Directive (CSDDD). Its proposal was published by the European Commission on February 23, 2022. Compared to the LkSG, the European draft is even broader in scope and targets companies with significantly fewer employees. In addition, the current proposal makes no distinction or gradation between the company's own business units and direct and indirect suppliers.

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