On 1 January 2023, the highly anticipated Act on Corporate Due Diligence to Prevent Human Rights Violations in Supply Chains (the “Act”) became effective in Germany, and immediately placed novel and enhanced compliance obligations on companies registered and domiciled in Germany. The purpose of the Act is to regulate the conduct of German companies with respect to human rights in a global supply chain.

The applicability of the Act

The Act applies to companies that have their administrative headquarters, their principal place of business, or their central administration in Germany and who employ at least 3,000 employees. The employees can be those situated in Germany or employees that are located abroad. By extension, the Act is applicable to every direct and indirect supplier to German companies along the supply chain, from the extraction of the raw materials to the delivery to the end customer.

The Act also applies to foreign companies who have a branch office in Germany, and which have 3,000 or more employees in Germany.

From 2024, the Act will be applicable to companies with at least 1,000 employees in Germany, thereby displaying a trend of growing reach and scope. Smaller to medium size companies, whilst currently exempted, should ensure a thorough understanding and appreciation of the legislation and its due diligence obligations.

The purpose of the Act

The Act compels German companies to mitigate the risks of human rights violations in its supply chain, by imposing certain due diligence obligations to protect human rights, and in so far as they affect human health and well-being, these obligations extend to environmental rights as well. The protected human rights are largely drawn from universally ratified international treaties on human rights, and cover a broad spectrum of potentially targeted human rights violations such as; forced labour, child labour, occupational hazards, and modern-day slavery. While many of the aforementioned protections exist in the practice of corporate social responsibility, never before has it been a legislated compliance obligation.

The global supply chain

The “Supply Chain” within the meaning of the Act refers to all products and services of an enterprise and includes all steps in Germany and abroad that are necessary to produce the products and provide the services. The Supply Chain would cover the processes from the extraction of the raw materials to the finished product and delivery to the customer. Companies need to be cognisant of their actions in the creation and exploitation of their products and services, whether in Germany or abroad, including the activities of their direct and indirect suppliers forming part of their Supply Chain.

The due diligence obligations

Several due diligence obligations have been introduced to ensure that companies develop risk management systems for the effective monitoring and mitigation of human rights violations and environmental abuse.

Compliance and adherence to the obligations are regulated by the German Federal Office for Economic Affairs and Exchange Control. Non-compliance with the due diligence obligations invites an array of fines that are targeted at both natural and juristic persons. At present, a fine imposed upon a juristic person may well exceed EUR 400,000,000, and as much as 2% of the average turnover of the perpetrator.

Despite the stringent compliance obligations and the harsh penalties for non-compliance, the act establishes a duty of effort, and not a duty to succeed. Companies are thus not expected to provide a guarantee to the prevention of human rights violations, but must rather ensure that all reasonable efforts have been exhausted to mitigate and prevent human rights violations and the risk thereof. This creates a reliance on avoidance, prevention, and remediation in respect of the risk of human rights violations along the supply chain.

The establishment of the act and effects on German companies operating abroad has created an interesting dynamic of both local and international compliance obligations.

German companies operating in South Africa

The Act has a direct impact on German companies operating in South Africa - or anywhere in the world for that matter. However, these obligations on foreign direct and indirect suppliers are brought about through contractual obligations, rather than by the Act.

The obligatory measures required for foreign direct suppliers include; supporting the German company with the due diligence and monitoring of indirect suppliers, as well as conducting human and environmental rights risks analyses. This gives expression to compliance with the Act through contractual warranties and obligations between the German company and the foreign direct suppliers and by extension, indirect suppliers. The contractual warranties include compliance and co-operation in respect of protecting human rights against violations along the supply chain. Following the warranties, the contractual obligations demand that the foreign direct supplier and the German company must jointly provide solutions to mitigate or end any violation of human rights within a stipulated timeframe. Moreover, the foreign direct supplier must commit to supporting the German company in its determination and execution of preventative measures in respect of indirect suppliers who face, or may face, allegations of human rights violations. In respect of both the contractual warranties and obligations, the implementation and adherence to the Act and the accompanying supply chain management becomes the contractual duties of the foreign direct supplier.

The Act demands an understanding of the obligations, the due diligence requirements, supply chain management, and the developments of the related German laws which are increasingly becoming highly relevant for German companies operating in South Africa, and for South African companies operating in Germany. We envisage that the Act will have a significant effect on corporate compliance and mergers and acquisition in South Africa. Similar to the required compliance stemming from the United Kingdom’s Modern Day Slavery Act, we foresee compliance with international legislation where relevant to South African based investments.

Thinking ahead

With continued consumer pressures for corporate accountability and transparency, the Act is an expected, and welcome, development in recent and growing environmental, social, and governance (“ESG”) due diligence obligations. Like the Modern-Day Slavery Act, there is an increasing trend of ESG awareness, efforts, and its subsequent regulation.

Companies operating locally and regionally will increasingly be required to:

• establish a risk analysis and risk management system;
• develop a ESG Supply Chain strategy to identify human rights and environmental shortcomings along the supply chain;
• develop a human rights and environmental strategy with which their direct and indirect suppliers must comply with; and
• conduct ESG Merger & Acquisition due diligences in response to their counterparties’ ESG requirements.

The above thus creates an urgent need for foreign companies to understand their own ESG risk and opportunity.

Authored by Noushaad Omarjee and Khatija Kapdi l Dentons in South Africa