European Commission Sustainable Governance Initiative: Critical Concerns
“How human rights due diligence is translated into legislation and regulation is an iterative process that flows from the Guiding Principles but requires far more contextual and textual specificity.”
— JOHN RUGGIE & JOHN SHERMAN, “THE CONCEPT OF ‘DUE DILIGENCE’ IN THE UN GUIDING PRINCIPLES ON BUSINESS AND HUMAN RIGHTS: A REPLY TO JONATHAN BONNITCHA AND ROBERT MCCORQUODALE,” 28 EUROPEAN JOURNAL OF INTERNATIONAL LAW 3 (2017), 926
OVERVIEW
The European Commission’s Sustainable Corporate Governance Initiative is considering regulatory changes to “better align the interests of companies, their shareholders, managers, stakeholders and society.” The process so far has included a public consultation regarding the scope of directors’ duties vis-a-vis stakeholders, mandatory corporate sustainability governance, and expanded sustainability-related regulatory and civil liability. (Our complete responses to the Commission’s questions are here.)
There are many potential virtues in laws focused on sustainable corporate governance, including certainty, a level playing field, and redress for stakeholders. But there are also serious dangers—for stakeholders and business alike—in ill-conceived law. Legislation that is overbroad, vague, or impractical risks entrenching the flaws of voluntary standards in law and undermining sustainability governance with perverse incentives.
We raised two primary concerns with the regulatory paths being considered by the Commission: (i) overbroad fiduciary duty; and (ii) legally uncertain and idiosyncratic due diligence requirements. We excerpt below our answers to a few of the Commission’s more telling questions.
The European Commission’s Sustainable Corporate Governance Initiative is considering regulatory changes to “better align the interests of companies, their shareholders, managers, stakeholders and society.” The process so far has included a public consultation regarding the scope of directors’ duties vis-a-vis stakeholders, mandatory corporate sustainability governance, and expanded sustainability-related regulatory and civil liability. (Our complete responses to the Commission’s questions are here.)
There are many potential virtues in laws focused on sustainable corporate governance, including certainty, a level playing field, and redress for stakeholders. But there are also serious dangers—for stakeholders and business alike—in ill-conceived law. Legislation that is overbroad, vague, or impractical risks entrenching the flaws of voluntary standards in law and undermining sustainability governance with perverse incentives.
We raised two primary concerns with the regulatory paths being considered by the Commission: (i) overbroad fiduciary duty; and (ii) legally uncertain and idiosyncratic due diligence requirements. We excerpt below our answers to a few of the Commission’s more telling questions.
The perils of overbroad directors’ duties
Question 1:
Due regard for stakeholder interests’, such as the interests of employees, customers, etc., is expected of companies. In recent years, interests have expanded to include issues such as human rights violations, environmental pollution and climate change. Do you think companies and their directors should take account of these interests in corporate decisions alongside financial interests of shareholders, beyond what is currently required by EU law?
There is little doubt that non-financial risks, particularly social and environmental risks, can have a material bearing on the long-term financial performance of companies across sectors. That reality, however, does not warrant reconceiving the nature of the corporation as a public institution with inherently public responsibilities. While specific regulations—e.g., regarding environmental risk management, GHG emissions, fair treatment of workers and communities—are essential to ensure that business’s private pursuits do not come at the expense of people or planet, it is far more radical to designate corporate leaders as fiduciaries for the world. Such a breadth of perpetual obligation and potential liability could, on one extreme, paralyze decision-making or, on the other, accord directors unbridled discretion to run the corporation with minimal accountability.
Question 2:
Do you believe that corporate directors should balance the interests of all stakeholders, instead of focusing on the short-term financial interests of shareholders, and that this should be clarified in legislation as part of directors’ duty of care?
We are concerned that the question presents a false dichotomy. There are clear dangers in privileging short-term share value as the ultimate good of the corporation, particularly when such gains undermine long-term profitability or divert investment from innovation. But addressing those dangers does not require a radical expansion of directors’ duties in a way that would reform the fundamental nature of business and practically undermine accountability. Directors can remain focused on the success and resilience of the business by shifting relevant time horizons rather than expanding their array of masters. And, to the extent the concern is that directors exercise their discretion without harming stakeholders, that end can be accomplished through targeted regulation better than an amorphous and omnipresent duty—one which could, in practice, afford directors unlimited discretion, for an agent of all is accountable to none. [NB: This question inspired our memo on enlightened shareholder value.]
Question 3:
Which risks do you see, if any, should the directors’ duty of care be spelled out in law as described in question 8?
Several significant risks—sometimes bipolar—would flow from the uncertainty and expansive accountability of broadening fiduciary duty to make directors always accountable to all stakeholders.
- Unbridled director discretion as those responsible for everyone may, in practice, be accountable to no one.
- Corporate paralysis as directors and officers seek to avoid offending any stakeholder, particularly those with media savvy.
- Tenuous and tendentious litigation, perversely targeting the most responsible enterprises because of their greater sensitivity to public pressure.
- Ever-expanding D&O liability proceedings to accommodate perspectives of diverse, likely conflicting, stakeholders interested in a wide array of decisions.
- Diminished allure of corporate investment if (i) directors are not bound to pursue shareholder interests, (ii) stakeholders and their perspectives on distinct projects and business lines are unforeseeable, and (iii) core business aims themselves may be subject to sudden reversal.
Mandatory Due Diligence: Certainty & Coherence
Our primary concern with the scope of mandatory due diligence being considered by the Commission is legal certainty. The overarching principle constraining any law—particularly one so expansive in scope—should be to provide sufficient precision that a business or stakeholder, with the assistance of legal counsel if necessary, could reasonably predict what might create legal liability: “Owing to the general nature of statutes, their wording cannot be absolutely precise. … On the other hand, the use of overly vague concepts and criteria in interpreting a legislative provision can render the provision itself incompatible with the requirements of clarity and foreseeability as to its effects.” (European Court of Human Rights, Guide on Article 7 of the European Convention on Human Rights (31 Aug. 2020) ¶ 29) (Q15(d))
In this regard, it is critical that the legislation not simply copy the OECD Guidelines or the Guiding Principles. While each of these standards provide a helpful framework for responsible business conduct, they are not conceived to be legally certain. As John Ruggie and John Sherman have written: “How human rights due diligence is translated into legislation and regulation is an iterative process that flows from the Guiding Principles but requires far more contextual and textual specificity.” (“The Concept of ‘Due Diligence’ in the UN Guiding Principles on Business and Human Rights: A Reply to Jonathan Bonnitcha and Robert McCorquodale,” 28 European Journal of International Law 3 (2017), 926).
Voluntary standards are therefore effective as the beginning of legislation, but not its end.
Due Diligence Duty
For the purposes of this consultation, “due diligence duty” refers to a legal requirement for companies to establish and implement adequate processes with a view to prevent, mitigate and account for human rights (including labour rights and working conditions), health and environmental impacts, including relating to climate change, both in the company’s own operations and in the company's the supply chain. “Supply chain” is understood within the broad definition of a company’s “business relationships” and includes subsidiaries as well as suppliers and subcontractors. The company is expected to make reasonable efforts for example with respect to identifying suppliers and subcontractors. Furthermore, due diligence is inherently risk-based, proportionate and context specific. This implies that the extent of implementing actions should depend on the risks of adverse impacts the company is possibly causing, contributing to or should foresee.
Question 1:
Please explain whether you agree with this definition and provide reasons for your answer.
We disagree with this definition for several reasons:
- First, “due diligence” in the context of voluntary corporate responsibility standards has an idiosyncratically broad and legally unwieldy meaning. We would recommend developing a definition consistent with general commercial usage to enhance understanding and practical adoption. In commercial and corporate governance law, “due diligence” refers specifically to the identification of risks and impacts through investigation. That is conceptually distinct from meeting the “duty of care” or “standard of conduct”, which more accurately capture all aspects of reasonable business behavior.
- Second, the proposed substantive scope is confusing. “Human rights” under international law, for instance, inherently capture a variety of “health” and “environment” impacts (though climate change is more challenging).
- Third, the proposed scope of relevant business activities is too narrow. Limiting the duty of care to a company’s own operations and upstream business relationships is anachronistic and would miss some of the more significant (salient and material) impacts that companies can have on human rights and climate change through their products and services.
- Fourth, “foreseeability” should have no role in the definition unless it is inherently incorporated in the definition of causation. The inclusion of foreseeability as a distinct ground for creating corporate liability for an impact is at odds with civil and criminal law across EU jurisdictions (and beyond). Indeed, it diverges materially from how foreseeability is used in European human rights law, where the concept only matters as a limit on liability where factual causation is established. This novel use of the concept would also be counterproductive in encouraging due diligence in the first place: if foreseeability is material in determining responsibility for risk management, remediation, or disclosure, the legislation would create perverse incentives not to conduct more than “average” diligence—for that would create additional responsibility and potential liability. (See Y. Aftab & A. Mocle, Business and Human Rights as Law: Towards Justiciability of Rights, Involvement, and Remedy (LexisNexis 2019) at 105-111.)
We would suggest the following definition based on the concerns above:
For the purposes of this consultation, “duty of care” refers to a legal requirement for companies to establish and implement reasonable policies and procedures to identify, address, and account for risks to human rights and climate change [defined in Annex] in the company’s operations, products, services and value chain. “Company” includes subsidiaries, affiliates, and entities under the business’s control. “Value chain” refers to a company’s upstream and downstream “business relationships” and includes suppliers, subcontractors, distributors, and customers.
Question 2:
Please indicate your preference as regards the content of such possible corporate due diligence duty … (a) If … you are in favour of combining a horizontal approach with a theme or sector specific approach, please explain which horizontal approach should be combined with regulation of which theme or sector?
In the interests of certainty and practicality, we would propose focusing a narrow range of critical human rights that are salient across industries and can be defined with reasonable precision. In our experience, the following themes are critical across all industries and underpin respect for an array of other rights:
- Child Labor
- Forced Labor
- Freedom of Association
- Right to Just and Favorable Working Conditions (which includes fair pay, occupational health & safety, rest & leisure, and non-discrimination)
- Security of the Person
- Right to Health (which includes adverse impacts on the environment as well as product marketing and defects)
- Right to Privacy
- Right to Self-Determination (including free, prior and informed consent)
Climate Change (this would likely need to be a process-based definition to reasonably account for business context)
Focusing on a list of key human rights with specific definitions of adverse impact is a narrower commitment than many stakeholders seek. But it is also far more likely to lead to effective implementation and accountability than a comprehensive but amorphous list of wrongs that enable significant discretion regarding which impacts any company ultimately addresses. In addition, a narrow but clear list will enable companies to build the necessary infrastructure of procedures such that they (i) can be assessed effectively by regulators, (ii) can provide meaningful lessons across sectors, and (iii) will not immediately be overwhelmed by breadth.
Question 3:
Please provide explanations as regards your preferred option, including whether it would bring the necessary legal certainty and whether complementary guidance would also be necessary.
The necessary legal certainty will depend on precise definitions of core concepts, notably (i) what constitutes an adverse impact (particularly when the business is otherwise complying with national law); (ii) how a company can determine whether and how it is involved with an impact (or risk); and (iii) how a company should respond when it has a responsibility to remedy. To those ends, any regulation will need to be far more precise than existing voluntary standards.
For due diligence legislation to be effective in providing legal certainty, accountability, and a level playing field it needs to build on existing voluntary standards with clear definitions of “adverse impact”, “involvement”, and “rights-compatible” remedy so that companies can reasonably anticipate what they must do and stakeholders can fairly hold them accountable. The definitions will need to be in the legislation, coherent with existing corporate law, precise and practical enough to enable compliance, and flexible enough to apply to a diversity of corporate contexts. Supplemental guidance may help build understanding; but it cannot substitute for the certainty any legislation itself must offer to respect the rule of law.
Question 4:
If a mandatory due diligence duty is to be introduced, it should be accompanied by an enforcement mechanism to make it effective. In your view, which of the following mechanisms would be the most appropriate one(s) to enforce the possible obligation?
o Judicial enforcement with liability and compensation in case of harm caused by not fulfilling the due diligence obligations? [No]
We hesitate regarding “judicial enforcement” because of the formulation: determining when a failure to conduct due diligence caused an injury is exceptionally difficult in the human rights context, where so many risks are endemic. For example, all authorities accept that modern slavery and child labor are global, cross-industry plights that are fueled by myriad systemic forces, cultural practices, and criminal activities. It would be an extraordinarily high bar to demonstrate that the absence of one company’s due diligence is the cause of a systemic scourge; conversely, attributing responsibility to a company using this test would suggest an unrealistic expectation of what due diligence can legitimately accomplish in many cases. The better approach for judicial enforcement—consistent with civil tort/delict liability more generally—would be to create a due diligence defence, so that the judicial enquiry has two stages: (i) did the company cause or benefit from the harm; and (ii) if so, did it meet its duty of care to address such harms (including through due diligence, risk management, and remediation)?