Supply Chain Act: no contract without proof of human rights compliance

by Dr Andreas Pagiela, lawyer

What is the true price of fast fashion, inexpensive electronics and tropical fruit at every time of year? Since social media began bringing the world closer together, at the latest, the question of working conditions around the globe has increasingly come into public focus. Legislators have also addressed human rights in production and supply chains in order to protect those rights where they are frequently violated.

In practice, human dignity, from which we derive human rights, is unfortunately infringed time and again. The German Supply Chain Due Diligence Act (LkSG) (Lieferkettensorgfaltspflichtengesetz) now places responsibility on companies. However, it is far from easy for a company covered by the LkSG to verify that its suppliers around the world comply with human rights. In most cases, it will only be possible to assess suppliers using questionnaires and require declarations of commitment under the LkSG. As a rule, companies can only check whether the answers are plausible. Only future case law will show how far this plausibility check must go and whether further risk management measures are necessary. It is entirely conceivable that on-site inspections may also be necessary for large companies and that collaboration must be terminated where there is reasonable suspicion.

Economic power enforces the LkSG

A customer’s economic power enables it to demand further evidence or access rights from suppliers. Following the principle of “no contract without proof of human rights compliance”, companies have numerous ways of assessing their suppliers in relation to human rights. The limit will be the effort they are willing — and required — to make.

Section 6(4) LkSG provides clear guidance here: the company must establish appropriate preventive measures with regard to a direct supplier. At its core, this means “the contractual assurance by a direct supplier that it will comply with the human rights-related and environmental expectations required by the company’s senior management and address them appropriately along the supply chain”.

Supply Chain Act: what applies to SMEs

Small and medium-sized enterprises (SMEs) are indirectly affected by the LkSG as suppliers. A different assessment standard must be applied, however, such as their lower degree of influence over suppliers, which reduces the requirements under the LkSG. This is demonstrated by the LkSG’s balancing framework in Section 3(2):

The appropriate manner of acting in compliance with the due diligence obligations is determined by

1. the nature and scope of the company’s business activities,

2. the company’s ability to influence the party directly responsible for a human rights-related or environmental risk or the violation of a human rights-related or environmental obligation,

3. the severity of the violation that can typically be expected, the reversibility of the violation and the probability of a violation of a human rights-related or environmental obligation, and

4. the nature of the company’s causal contribution to the human rights-related or environmental risk or to the violation of a human rights-related or environmental obligation.

The Supply Chain Act therefore applies a pragmatic assessment standard: it shifts the issue from human rights protection standards to the question of how thoroughly companies can review those standards and exert influence on them. Only the most serious human rights violations are exempt from this approach. Companies must therefore engage with two questions:

• Which human rights standards apply generally in the supplier’s country and can be expected as the “average”?
• Where is the threshold below which standards can no longer be accepted?

This requires an in-depth examination of the human rights situation in each supplier country and of human rights standards overall. External expertise is usually necessary here in order to act with legal certainty. The legislator has created an area of responsibility that is entirely new and difficult for most companies to navigate.

LkSG: companies bear responsibility

The German Supply Chain Due Diligence Act is the result of recognising that politics alone cannot comprehensively enforce human rights. In business, commercial interests frequently lead to human rights violations. It was therefore decided to transfer responsibility in this area to businesses through self-monitoring. In fact, a very large proportion of human rights violations can be traced back to business activity — something that international human rights protection systems, with their focus on misconduct by states, are not designed to address. From a human rights perspective, this is certainly a very good approach, but it also has disadvantages: first, there is the administrative burden on companies, which are suddenly assigned an entirely new area of responsibility. Second, outsourcing human rights protection to the private sector must not lead the international community to delegate this responsibility to private companies. Article 1 of the German Basic Law states that all state authority has a duty to protect human dignity.

Severe penalties for breaches of the LkSG

The effectiveness of the Supply Chain Act is to be ensured not least through an effective sanctions mechanism: companies face severe sanctions if they fail to comply with the LkSG requirements on human rights. These range from exclusion from the award of public contracts to a fine of up to 2 per cent of average annual revenue for companies with annual revenue of more than EUR 400 million.

In the mid-range, fines from EUR 100,000 to EUR 500,000 and ultimately up to EUR 800,000 are provided for. As is so often the case, first infringements are punished considerably less severely — developments in the case law on this still-new area of law remain to be seen. One thing is clear, however: the level of the fines shows that legislators are serious about human rights protection under the LkSG.

A positive attitude towards human rights

How likely the Supply Chain Act is to change attitudes towards human rights in critical regions will be one of the interesting questions. Influencing the situation in other countries is an extremely complex matter, as experience with development aid has shown. It is very difficult to predict what effect individual measures will have. This also depends on numerous factors specific to individual industries and countries. The example of microcredit illustrates this problematic situation. Long regarded as an effective tool against poverty, it is now viewed in a distinctly critical light.

Attitudes towards human rights can indeed change as well. If a supplier’s customers consider the issue important, bind their partners to commitments and then monitor compliance, this clearly has an impact. These effects will certainly be stronger than state intervention in structurally weak countries. However, rapid success cannot be expected; perseverance will be needed.

Tips: turn an obligation into an advantage

To turn the administrative burden of the Supply Chain Act into an advantage for the company, the PR principle “do good and talk about it” is the right approach. Numerous campaigns have shown how seriously the media take human rights.

Companies should build up or be able to draw on expertise to monitor the LkSG requirements. A positive side effect is that this gives companies early warning of emerging crises in supplier countries.

Companies can also highlight their responsibility for human rights on products, in annual reports and on their websites. The LkSG obligations then also create a PR benefit that can easily outweigh the administrative effort. Not least, this commitment makes an important contribution for the people affected in suppliers’ operations.

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