The New German Supply Chain Act: Spotting ESG-Related Supply Chain Risks in M&A Transactions

With environmental, social, and governance (ESG) considerations in M&A transactions becoming increasingly important, it is essential for an acquiror to have a clear understanding of the risks associated with the target company’s supply chain. This is all the more true as supply chain risks related to ESG are no longer confined to reputational damages. A key development of recent years has been a shift from voluntary guidelines to mandatory legislation. Recognizing that the voluntary approach is insufficient, several countries (e.g., France and the Netherlands) have introduced national legislation requiring companies to screen their global supply chains.

The latest example of this trend is the German Supply Chain Act (Lieferkettensorgfaltspflichtengesetz), which its proponents call the most ambitious supply chain legislation in Europe. It is also promoted as a template for a future harmonized framework at EU level.

Below is a summary of key features of the Supply Chain Act of which M&A investors in target companies operating in Germany should take note.

What is the Supply Chain Act about?

As of January 1, 2023, in-scope companies must comply, in their supply chains, with certain duties of care, with the aim to prevent or minimize risks related to human rights or the environment or to stop the violation of obligations related to human rights or the environment. These duties of care require

• establishment of a risk management system (including a dedicated in-house responsibility and regular risk analyses) and an internal complaints procedure
• adoption of a policy statement on the company’s human rights strategy
• implementation of preventive measures in the company’s own business area and vis-à-vis the company’s direct suppliers and, if a violation has already occurred or is imminent, taking of remedial actions
• prompt reaction to situations where the company becomes aware of facts that indicate a possible violation at the level of indirect suppliers

Compliance with the Supply Chain Act must be documented on an ongoing basis and presented annually in a public report. While the term “supply chain” is defined broadly, by including all steps in Germany and abroad necessary for the manufacturing of products and the provision of services, the Supply Chain Act requires only “appropriate” measures. This allows companies to take into account various case-specific factors such as the type and scope of their businesses as well as the circumstances of the violation in question.

Which companies are in scope?

The Supply Chain Act will apply to companies from all sectors, regardless of their legal form, that

• have their head office, their principal place of business, their administrative headquarters, or their statutory seat in Germany; and
• generally employ at least 3,000 employees in Germany

As regards non-German companies, note that the Supply Chain Act will also apply to companies that have a branch office in Germany and generally employ at least 3,000 employees in Germany.

Within a group of companies, the employees of all affiliated companies belonging to the group shall be included in the calculation of the number of employees of the parent company, if and to the extent they are employed in Germany.

As of January 1, 2024, the aforementioned thresholds of 3,000 employees will be reduced to 1,000 employees.

What are the consequences of a breach?

The German Federal Office for Economic Affairs and Export Control (Bundesamt für Wirtschaft und Ausfuhrkontrolle – BAFA) will be responsible for monitoring and enforcing the new regime. To that effect, BAFA will be equipped with an extensive regulatory toolbox comprising powers to access premises, summon individuals, and order concrete measures to prevent or remediate breaches.

Furthermore, breaches may entail administrative fines that, depending on the circumstances, may amount to €800,000 for individuals and €8 million for legal persons. Administrative fines for companies with an average annual global turnover of more than €400 million during the past three years may even reach 2% of the average turnover. In case of serious infringements, companies may also be excluded from public procurement for up to three years.

During the legislative process, any proposals to introduce a new legal basis for civil liability were met with fierce opposition — even from within the government. Therefore, the final wording of the Supply Chain Act expressly states that noncompliance with obligations thereunder won’t give rise to civil liability. However, any civil liability established independent of the Supply Chain Act remains possible, and any person claiming to be the victim of the violation of certain essential human rights may authorize a German-based labor union or NGO to assert the relevant rights in court.

What comes next?

Legal efforts to clean up global supply chains are also on the agenda of the EU institutions. On March 10, 2021, the European Parliament adopted recommendations for drawing up an EU directive on a harmonized supply chain framework. While these recommendations send a strong political signal, the ball is now in the court of the European Commission. Reportedly, the publication of a formal draft of the directive, which was initially expected for June 2021, has now been postponed until fall 2021. Striking the right balance between the conflicting views of stakeholders across the EU Member States on delicate matters of corporate accountability will be challenging. Hence, it remains to be seen if and to what extent the EU-wide initiative will follow the recommendations of the European Parliament or any precedents set at national level, such as the Supply Chain Act in Germany.