Possible future impact of "ESG" obligations in your contracts: a first consideration

Environment, Social & Governance ("ESG"), in a nutshell, stands for the ever-growing expectation of investors, trading partners, employees, consumers and society as a whole that companies pursue environmental and social sustainability, respect human rights and are held accountable for any wrongdoing. 

• CSR Directive  

The call for corporate social responsibility has not escaped the notice of the European legislature. In order to foster the harmonised ESG framework, the Corporate Sustainability Reporting Directive ("CSR Directive") was published in the Official Journal of the European Union on 16 December 2022 and subsequently entered into force on 5 January 2023. As was already the case under the Non-Financial Reporting Directive ("NFR Directive"), the CSR Directive imposes reporting obligations which have as consequence that companies are not merely assessed on the basis of their financial performance, but also on the basis of their social and environmental impact. Compared to the NFR Directive however, the CSR Directive significantly broadens this obligation both in terms of (i) companies falling within its scope and (ii) information to be provided:[1]

1. Companies falling within the scope of the Directive: first of all, listed companies, credit institutions and insurance undertakings that employ more than 500 employees and were already subject to sustainability reporting under the NFR Directive are targeted. For them, a first report (concerning the previous financial year) under the CSR Directive is due in 2025. As from 2026, the reporting obligation will apply to non-listed companies that employ more than 250 employees, have an annual net turnover of more than EUR 40 million and/or have a balance sheet total of more than EUR 20 million. As from 2027, the obligation will also apply to small or medium-sized listed companies, credit institutions and insurance companies, excluding micro-enterprises. Finally, as from 2029, non-EU companies will be subject to this obligation if they have a subsidiary or branch in the EU through which they generate a net turnover of more than EUR 150 million. 
2. Information to be provided: secondly, sustainability reporting now includes in particular the principal adverse impacts on sustainability matters connected with a company’s own operations as well as its entire value chain, including its products and services, its business relationships and its supply chains. 

Importantly, the CSR Directive will also have an impact on companies which fall outside of its scope. Since companies falling within the scope of the CSR Directive will have to report not only on their own performance, but also on that of their value chain (including their (non-EU) suppliers), these in-scope companies will obviously start imposing conditions on their value chain in order to comply with their obligations. This could include requesting sustainability information or imposing specific contractual obligations on their value chain.

• CSDD Directive 

Furthermore, a new proposal for a Directive on Corporate Sustainability Due Diligence ("CSDD Directive") was launched on 23 February 2022. This Directive is meant to enhance sustainable and responsible corporate behaviour through a direct, substantive obligation to identify and, where appropriate, prevent, end or mitigate the adverse impacts on a sustainable economy and society of their global value chain.

This CSDD Directive would apply to all companies that employ more than 500 employees and generate a net worldwide turnover of more than EUR 150 million, or companies that employ more than 250 employees and have a net worldwide turnover of more than EUR 40 million provided that at least half of this latter turnover is generated in one or more ‘high-impact sectors’ (i.e. sectors with a high risk of adverse impacts such as textile production, agriculture, food production, mineral resources extraction...). In addition, the due diligence obligation would also apply to companies that are not established in the EU but do generate in the EU a net turnover of more than EUR 150 million, or more than EUR 40 million provided that at least half of their worldwide net turnover was generated in one or more high-impact sectors. 

Small and medium-sized companies prima facie fall outside the scope, but – just like companies that fall outside the scope of the CSR Directive – they will still be affected to the extent that they form a part of the value chain of a company that would be covered by the CSDD Directive.

How exactly the new ESG obligations will be implemented in Belgian law remains to be seen. However, we can already highlight some key points to bear in mind in the management of your contracts. 

As explained above, quite a few large and/or listed companies will have to publish information on the principal (existing or potential) adverse impacts related to their entire value chain under the CSR Directive in a dedicated section of the management report (the 'sustainability report'). 

If your company will be subject to sustainability reporting, it would first of all be a good

dea to map out exactly what information will need to be reported, not only with regard to your own activities, but also with regard to your suppliers and other business relationships, both upstream and downstream and both within and outside the European Union. On the basis of the sustainability report, your business partners and customers will gain insight into the sustainability risks and impacts of your entire value chain in order to compare them with other companies, where appropriate. Likewise, you yourself should in the near future check the sustainability report of your large or listed business partners before engaging with them. 

Under the CSDD regime, companies will have to pay even more attention to their contractual relationships in the value chain. Indeed, where the CSR Directive introduces a reporting obligation, the CSDD Directive proposal creates a concrete due diligence obligation: in-scope companies will have to prevent, end or mitigate as much as possible any adverse effects on human rights or the environment of their own activities, those of their subsidiaries as well as those of their (established) business partners throughout the value chain. The CSDD Directive thus clarifies the way in which companies must conduct their research before reporting about it under the CSR Directive.

To this end, companies are specifically required to seek the necessary contractual assurances from their business partners – as well as from their respective business partners that are part of the value chain of the company in question through contractual cascading – so as to make them comply with the company's ESG policy. 

Hence, the importance of these contractual assurances should not be underestimated. Indeed, if your company fails to take adequate measures to prevent, end or mitigate the adverse impacts on sustainability in the value chain, your company risks being held liable in the near future for any damages resulting from those adverse impacts, be it through the behaviour of your own company, your subsidiaries or that of your business partners. 

In order to protect your large and/or listed company against such liability risks, you should first agree with your business partners on specific contractual safeguards ('warranties') concerning the relevant ESG obligations, where applicable. In addition, it is worth agreeing on specific indemnity obligations ('indemnities') in order to avoid liability for any damages suffered by third parties due to any act or omission of your business partners. 

A warning for the small (non-listed) company: as an actor in the supply chain, you will have to comply with the contractual guarantees imposed by your (larger) contract parties or provide the sustainability information they request because of any reporting and/or due diligence obligation applicable to them. In order to secure your contractual relationships for the future, it is therefore in your interest to already draw up your own sustainability policy and, where appropriate, provide the necessary liability or indemnity clauses in the contracts with your own suppliers. 

In short, your company's ESG policy and/or that of your business partners will increasingly determine your contractual relationships and have at least a significant impact on them. This way however, the trust of both external and internal stakeholders in your company will only grow. 

Thanks to our multidisciplinary approach, you can contact Lydian for all your legal questions regarding ESG at esg@lydian.be.