Human rights due diligence as a new business imperative


August 2022

Human rights due diligence as a new business imperative

In a major development for human rights due diligence legislation globally, on 21 June 2022, the Uyghur Forced Labor Prevention Act (UFLPA) took effect and made it United States policy to assume that all goods manufactured in the China’s Xinjiang region are made with forced labour and therefore banned. The UFLPA continues the global trend of mandatory human rights due diligence legislation, a trend which began in France in 2017 and will soon spread across the European Union by way of a Corporate Sustainability Due Diligence Directive (CSDD). The UFLPA and proposed CSDD signal that, for companies providing goods and services in the North American and European markets, human rights due diligence is becoming a business imperative.

New legislation seeks to ensure that businesses are not involved in human rights abuse

Recent negative corporate impacts, ranging from environmental disasters and land grabbing to serious violations of labour and human rights in supply chains, have been blamed on corporate failures to exercise due diligence with respect to their impacts on human rights.

Statistics on human rights abuse and the involvement of business offer sobering snapshots of the extent and severity of the global problem. In 2021, more than 160 million children worldwide were engaged in child labour, 79 million of which were in hazardous labour; and more than 24 million people were in forced labour. More than 156 types of goods from 77 countries were produced by child or forced labour, while an estimated €50.08 billion in products produced by child labour were imported into the EU in 2019 alone. Child and forced labour are only some of many types of human rights abuse with which businesses may be involved.

Yet, until relatively recently there were no broad legal requirements with enforcement mechanisms to compel businesses to exercise human rights due diligence. Other types of pressure have been exerted on business to operate with respect for human rights and the environment, including:

  • the adoption of international soft-law standards – namely, the United Nations Guiding Principles on Business and Human Rights (UNGP) and the OECD Guidelines for Multinational Enterprises (OECD Guidelines) (together International Standards);
  • the litigation of claims involving human rights impacts in high-profile transnational and national tort lawsuits, securities and other “greenwashing” litigation, and in international arbitration claims and counterclaims;
  • scrutiny by investors, financial institutions and regulators of companies’ claims and performance with respect to human rights, with dramatic disclosures and impacts increasingly punished by the markets;
  • the conditioning of overseas support and procurement by governments on businesses’ human rights performance;
  • the inclusion of human rights within the scope of illicit financing, sanctions and anti-money laundering laws; and
  • a growing appreciation of the critical business risks associated with poor human rights performance, including the risk that access to capital or social or legal licenses to operate will be lost.

While these developments have driven some businesses to focus on human rights due diligence, they have not made human rights due diligence a business imperative for most companies. Moreover, voluntary corporate due diligence processes often focus on the materiality of the risks to the company, despite the international standards emphasizing that the relevant risks extend beyond risks to the company to focus on risks to affected rights-holders.

Momentum has been building in recent years to make human rights due diligence a mandatory legal requirement. Some countries in Europe have already adopted (France, Germany, Norway and Switzerland) or are planning to adopt (Austria, Belgium, Finland, the Netherlands, Luxembourg and Sweden) broad initiatives in this regard, while the Netherlands has already adopted a legislative measure focused specifically on child labour. Now the US has enacted the UFPLA and the EU is debating the proposed CSDD.

These two recent legislative initiatives may be the final step in driving human rights diligence to the fore as a business imperative alongside anti-corruption and anti-money laundering diligence for multinational businesses. It is, therefore, worth considering the obligations they impose and their enforcement mechanisms, including by way of comparison (as below), as a way to anticipate and prepare for the future.

The risk of fragmentation regarding the approach to due diligence

International Standards conceive of human rights due diligence as both a standard of care (i.e., the degree of prudence and caution required of a company that is under a duty of care) and a process that a reasonable company would undertake in order to demonstrate that it had met the requisite standard of care. The process should be continuous, circular and comprised of four stages:

  1. Identification and assessment of actual and potential impacts that company may cause or contribute to through its own activities, or which may be directly linked to its operations, products or services by its business relationships;
  2. Acting upon the findings of that assessment and integrating its findings about its impacts into decision making;
  3. Tracking the company’s efforts to address its impacts, to ensure they these actions effective
  4. Communicating how the company is addressing its impacts.

Mandatory due diligence legislation, such as the UFLPA and CSDD, elevates human rights due diligence to a core business concern. That concern may be quite fraught at present for some multinational companies, given that each of these pieces of legislation takes a different approach to mandatory due diligence and consequences for non-compliance, and deviates from International Standards in significant ways, including:

  • Scope of companies covered: All companies are expected to adopt due diligence processes adapted to their size, operating context and risk profile under the international standards. However, the UFLPA applies to all importers equally, regardless of their size and the amount of in-scope material in their imported goods; while the CSDD applies only to very large companies and large companies in high-risk sectors.
  • The financial sector: The international standards treat the financial sector as subject to the same, or even heightened (e.g., by way of the UN Principles for Responsible Investing and Equator Principles), expectations regarding due diligence as the corporate sector. While the UFLPA does not specifically address the financial sector, the CSDD treats the financial sector differently from the corporate sector. The CSDD requires the financial sector to conduct due diligence only at the pre-contractual stage and with respect to the activities of large corporate clients. It also exempts the sector from the blanket requirement to terminate relationships when adverse impacts are not remediated.
  • Scope of due diligence duty: Under international standards, the recommended scope of due diligence extends beyond a business’ own activities to its entire value chain. By contrast, under the UFLPA, the due diligence obligation extends to a business’ entire supply chain; and, under the CSDD, it extends only to “established business relationships” in the value chain.
  • Scope of civil liability: International standards do not support extending the scope of civil liability to the entire value chain without regard for a company’s involvement in the human rights harm. Nor does their expansive due diligence obligation displace national law and any limits it may place on civil liability for human rights harm. However, the proposed CSDD extends the scope of civil liability for a failure to prevent or stop harm to the entire value chain, limiting it only by reference to whether there is an “established business relationship” with the entity causing the harm. The CSDD’s expansive civil liability regime also displaces national law on civil liability for situations covered by the law, unless that law is stricter than the CSDD. The ULPFA does not create a new civil liability regime.
  • Demonstrating compliance: According to international standards and the UFPLA Guidance, companies should take a range of appropriate and proportionate measures to address identified harms and demonstrate due diligence. By contrast, the CSDD indicates that auditable contractual assurances are sufficient on their own to demonstrate due diligence and avoid legal liability with respect to indirect business relationships.
  • Affected stakeholders: International standards focus on engagement with affected stakeholders, including by way of grievance processes. The UFPLA Guidance includes engaging stakeholders, but not maintaining a grievance process, as among the core elements of effective due diligence; while the CSDD includes maintaining a grievance process as among the core elements of effective due diligence, but otherwise downplays the importance of engaging with stakeholders.
  • Remediation: The international standards expect that human rights remedies (which include rehabilitation, restitution, financial or non-financial compensation, satisfaction and guarantees of non-repetition) should be provided for human rights harms. The UFPLA Guidance requires “full remediation” of adverse impacts without explaining what remediation should entail; while the CSDD gives only one example of a way to “neutralize” impacts, which is through the provision of financial compensation.

Legal mandates elevate human rights to a core business concern

This fragmentation of due diligence requirements creates legal uncertainty for businesses and stakeholders as regards expected behaviour and liability. Nonetheless, the behavioural and liability rules created by these legislative initiatives are likely to have significant effects on corporate behaviour.

For example, the UFPLA and the CSDD, if adopted as currently proposed, will change corporate behaviour with respect to higher-risk territories, entities and sectors. The UFPLA will prompt many US importers, fearing that their goods will be seized if any element was made in XUAR or by a company on the entity list, to distance themselves from the XUAR and designated entities. That is just as Congress intended in passing the UFPLA, knowing that it will be very difficult, if not impossible, for importers to demonstrate due diligence and show that in-scope goods are made without forced labour. With so many supply chains in scope, experts anticipate that the UFLPA will have an impact on trade patterns “measured in the many billions of dollars.”

Likewise, the CSDD as drafted will cause large companies operating in the European single market, fearing that they may be held liable for any human rights harm anywhere within their value chains, to distance themselves from high-risk markets or entities. This will be the likely result of the EC proposal to extend the scope of legal liability to the entire value chain of established business relationships regardless of a company’s involvement in the human rights harm. That result will be compounded by the proposal to make the CSDD’s expansive liability regime of overriding mandatory application regardless of the law that would otherwise be applicable to the claims. That change will have a dramatic impact on transnational tort litigation, in which the applicable law is usually that of the country where the harm occurred. It will also have a dramatic impact on global trade patterns, potentially even greater than the impact of the UFPLA.

Both pieces of legislation are likely to prompt in-scope companies to begin to see human rights due diligence as a business imperative. As a result, companies that have already begun integrating International Standards into their policies and practices are likely to continue on that path, while other in-scope companies will begin their journeys towards effective human rights due diligence. For many companies, designing and implementing appropriate due diligence systems and controls and embedding them into operations, could take several years. Making codes of conduct binding through cascading contractual clauses and establish credible auditing systems also could take time. Therefore, even while the CBP ramps up its enforcement capability and the CSDD winds its way through the legislative process, companies should begin focusing on human rights due diligence right now.