German Supply Chain Due Diligence Act: new guidelines on supply chain cooperation cause confusion

As reported previously, the Federal Office for Economic Affairs and Export Control (BAFA) publishes practical guidelines for the interpretation of the German Supply Chain Due Diligence Act (Lieferkettensorgfaltspflichtengesetz – LkSG) from time to time, as provided for by the LkSG. These guidelines are generally very helpful for companies because they provide practical guidance where the law only stipulates general standards, thereby also making administrative action more predictable. The most recently published guidance on cooperation in the supply chain has, however, caused significant uncertainty among businesses. It not only complicates implementation of the Act in practice, but leaves companies with more questions than answers, effectively expecting them to square the circle.

Background

The LkSG obliges companies above certain employee thresholds in Germany to observe human rights and environment-related due diligence obligations in their supply chains (read more in our client alert). However, the new law also impacts out-of-scope companies that directly or indirectly supply in-scope companies. This is because the LkSG – as BAFA acknowledges in its latest guidelines – necessarily requires that in-scope companies cooperate with their suppliers to fulfil their due diligence obligations.

The BAFA's guidance

With its recent guidelines – published over half a year after the LkSG came into force for companies with more than 3,000 employees – BAFA intends to explain how this cooperation may look like and what in-scope companies can and cannot ask of their suppliers when implementing the LkSG. The handout is supplemented by FAQs for small and medium-sized enterprises (SMEs) as well as an executive summary.

At the outset, BAFA clarifies that although some degree of cooperation between in-scope companies and their suppliers is necessary, this cannot result in extending the LkSG’s scope of application to smaller companies. Consequently, according to BAFA, in-scope companies must not transfer their obligations under the Act. BAFA further states that an in-scope company does, for example, not meet its obligations under the LkSG if it requires its suppliers to comply with the Act’s obligations and relies solely thereon. Also, BAFA opines that requesting a written assurance from the supplier that all relevant human rights and environmental provisions are complied with goes too far. While it is, in general, understandable that it is insufficient to (solely) rely on a sweep pass-on of the Act’s due diligence obligations to suppliers, BAFA complicates the application of the LkSG with very detailed and far-reaching “recommendations” regarding the four key due diligence obligations: risk analysis, preventive measure, remedial measures and complaint procedure:

• BAFA emphasises that in-scope companies must conduct an independent risk analysis to ensure that they meet their obligations under the LkSG. It is not sufficient to request extensive information from suppliers without reference to a specific situation or a specific identified risk. In-scope companies must take into account the risk analysis’ results when requesting information from suppliers. In BAFA’s view, comprehensive information requests that do not differentiate between the suppliers’ risk profiles are unreasonable. BAFA therefore not only advises suppliers to ask for detailed explanations when receiving information requests by in-scope companies but also notes that a practice of extensive and general information requests might result in supervisory measures by BAFA. Furthermore, suppliers are reminded to redact sensitive information and/or insist on non-disclosure commitments and to carefully consider data protection when answering information requests.
• Concerning preventive measures, BAFA reiterates that in-scope companies may not pass on the implementation of such measures to suppliers across the board. Rather, requests for preventive measures, including in the form of contractual agreements, must take into account the results of the in-scope company’s own risk analysis and be appropriate and effective in light of the individual case. Solely referencing a written or contractual assurance from the supplier will, in principle, not suffice to fulfil one’s due diligence obligation under the LkSG. To the contrary, BAFA states that such an approach might trigger supervisory measures. Further, according to BAFA, in-scope companies should also explain to their suppliers the risks identified and their prioritisation. BAFA also addresses the widespread practice of asking direct suppliers to adhere to code of conducts together with a commitment to cooperate and to implement control measures. BAFA urges suppliers to exercise caution before entering such contractual obligations and advises to thoroughly review in detail what will be required of them, including by seeking legal advice. In this context, BAFA also opines that it is, in principle, the in-scope company’s responsibility to ensure training of the suppliers.
• Regarding remedial measures, BAFA emphasises the need for cooperation between in-scope companies and their suppliers. It is possible for the supplier to carry out the measure itself according to BAFA, but the in-scope company must support the implementation and ensure an appropriate sharing of costs. BAFA elaborates its view on how costs for remedial measures should be shared on four pages and gives three criteria which ought to be considered: (i) what resources are available to the companies involved, (ii) influence on the direct perpetrator, and (iii) the company’s contribution to the harm. BAFA also adds that the termination of business relationships is only allowed in exceptional circumstances.
• BAFA acknowledges that supplier participation is necessary when setting up an effective complaints procedure. According to BAFA, the in-scope company does not fulfil its obligation by referring to a supplier’s complaint mechanism as the in-scope company must have its own complaint mechanism or participate in an external complaints procedure. It remains, however, possible, for example, to ask suppliers for support in making its complaints procedure accessible by having the supplier receive complaints for the customer. In any case, the in-scope company must, in principle, bear any costs of the supplier’s cooperation.

BAFA opines that any measure taken or agreed on with the supplier must take into account the supplier’s individual capabilities. Measures which evidently ask too much of a supplier considering the supplier’s resources, size, branch, and position in the supply chain as well as the specific local circumstances are, in principle, invalid according to BAFA. Moreover, BAFA announces that it will comprehensively examine compliance with the LkSG and initiate appropriate measures where an in-scope company requests excessive measures.

What’s next?

BAFA’s latest guidelines put all companies affected by the LkSG in a difficult position: In-scope companies made great endeavours and went through enormous troubles to comply with Act’s requirements (e.g., by compiling and analysing information for the obligatory risk assessment, drafting policy statements and supplier codes of conduct, negotiating contractual adjustments, implementing complaint mechanisms, often with tens of thousands of direct suppliers). Well after the Act’s entry into force, BAFA now publishes 35 pages of guidelines which, in essence, suggest that BAFA has reservations about the implementation to date. In general, it seems that the guidelines are intended to correct the practical effects on suppliers that were already foreseeable when the law was passed and are necessary to achieve the legislator's objectives.

For now, the new guidelines might make the Act’s implementation even more complicated than it already was:

• BAFA’s expectation that in-scope companies must individually explain to their suppliers why they request specific information will significantly increase the in-scope companies’ resources necessary for ensuring compliance with the LkSG. It remains to be seen whether BAFA’s assumption will come true and industry initiatives step in to facilitate the process of analysing the risks in supply chains. BAFA will, however, have to remember that it advised suppliers to move with caution when answering information requests when it assesses whether an in-scope company has fulfilled its obligations under the LkSG. Companies are well-advised to carefully document their endeavours to implement the Act, including their efforts to obtain information from their suppliers and the suppliers’ responses. Companies will also have to document why they requested certain information from its suppliers.
• Further, it is difficult for an in-scope company to ascertain when the preventive measures it included in its contracts with suppliers are – in BAFA’s opinion – unreasonable. While BAFA expects that the preventive measures implemented reflect the risk assessment’s result, it is unclear whether the guidelines fully account for the in-scope companies’ need to contractually implement the means to take effective preventive measures right from the start. It will prove rather difficult to implement a more extensive preventive measure by amending the contract later as the supplier might not be open to renegotiate the contract. Considering the legislation's objective, BAFA’s constant reminder that certain preventive measures may violate the LkSG’s principle of appropriateness and be invalid under the law on general terms and conditions is questionable, and in any event not helpful. This notwithstanding, certain contractual mechanisms can provide flexibility in introducing more extensive preventive measures into the contract later, also with a view to future changes of the law, but they require very careful drafting.
• What might strike many companies as quite the surprise is BAFA’s focus on cost sharing when it comes to remedial measures. Implementing BAFA’s guidelines into practice will certainly lead to intricate contract negotiations, with criteria that are not in line with economic realities and practice.

As BAFA frequently underlines, navigating the LkSG’s requirements and its implementation will often require involving specialised legal advisors because a solution must take into account the circumstances of the specific case and be seamlessly embedded into existing contracts law, e.g., the law on general terms and conditions. This is only good news for advisors, who certainly should not be among the beneficiaries of the law, and the complexity is likely to increase further with the EU’s Corporate Sustainability Due Diligence Directive. Once adopted, BAFA’s guidelines will need to be aligned with the directive, in particular the currently envisaged provisions on contractually cascading contractual assurances for compliance with the company’s code of conduct and prevention action plan. Changing the regulations again will inevitably place a new burden on those companies that are already covered by the LkSG and have made great efforts to comply with its provisions.

Please do reach out if you have any questions or wish to have any of the issues raised above explored further!