Ahead of the Curve
Leveraging the German Supply Chain Act to Gain a Competitive Edge Ahead of EU Obligations
Calls to repeal or significantly narrow the personal scope of the German Supply Chain Due Diligence Act (SCDDA) have gained attention. Critics argue that the SCDDA imposes excessive costs and bureaucratic burdens, particularly on small and medium-sized enterprises (SMEs), creating competitive disadvantages. They further caution that its stringent human rights and environmental standards risk prompting companies to divest from SMEs in developing countries, disenfranchising the very rights-holders the Act aims to protect.
This article argues that repealing or amending the SCDDA would diminish the competitive edge of German companies. Compliance with the Act notably equips them to meet the forthcoming obligations under the EU Corporate Sustainability Due Diligence Directive (CSDDD), offering them a head start and competitive advantage. Moreover, it seeks to demonstrate that compliance with the Act can be achieved without overburdening SMEs and excluding SMEs in developing countries from global supply chains, by interpreting the Act in line with international standards, namely the UN Guiding Principles on Business and Human Rights (UNGPs) and the OECD Guidelines for Multinational Enterprises on Responsible Business Conduct (OECD Guidelines). German companies should embrace their leading role in responsible business practices, leverage their experience under the SCDDA to navigate compliance with the CSDDD with greater confidence, and reap related reputational benefits and attract investments.
Direct and Indirect Obligations
The SCDDA applies to large companies based in Germany with more than 1,000 employees (sec. 1(1) SCDDA). The Act obliges in-scope companies to respect human rights and comply with certain pre-defined due diligence obligations. To prevent human rights abuses and environmental harm, companies are notably required to obtain contractual assurances from their suppliers regarding their compliance with human rights and environmental standards and monitor implementation (sec. 6(4) no. 2 and 4 SCDDA). As suppliers of in-scope companies, the Act may thus indirectly oblige SMEs to comply with the human rights and environmental standards set out therein.
Similarly, human rights and environmental due diligence obligations under the CSDDD will apply to large EU and non-EU companies above certain turnover and employee thresholds from July 2027 onwards (art. 2(1) and 2(2) in conjunction with art. 37(1) CSDDD). Under the CSDDD too, the use and monitoring of contractual assurances vis-à-vis business partners is a required preventative measure (art. 10(2)(b) and 10(5) CSDDD). Even if the SCDDA is abolished or its personal scope considerably narrowed down, German companies, including SMEs, that maintain business relationships with in-scope companies, will eventually have to comply with the human rights and environmental expectations set out in the CSDDD. Preparing now under the SCDDA ensures German businesses are well-positioned for this transition.
Risk Assessment and Prioritisation
Under the SCDDA, companies must identify human rights and environmental risks with respect to their own business activities as well as the activities of their direct suppliers (sec. 5(1) SCDDA) and then prioritise the identified risks according to their severity, reversibility, and probability of materialising (sec. 5(2) in conjunction with sec. 3(2) SCDDA). Regarding indirect suppliers, in-scope companies are only required to adopt due diligence measures if they have “substantiated knowledge” of potential human rights abuses or environmental harm (art. 9(3) SCDDA). The German Federal Office for Economic Affairs and Export Control (BAFA), i.e. the competent German authority for the enforcement of the SCDDA, recommends to conduct these risk assessments in two steps: First, companies should map human rights and environmental risks abstractly, including sector-, country-, and product-specific risks, based on readily available information such as OECD guidance and NGO reports. Second, companies should then conduct a plausibility check of the findings and identify and prioritise risks in specific context such as sites, facilities, and suppliers (BAFA, Guidance on Risk Analysis, 11 ff.). In practice, the focus on first-tier suppliers under the SCDDA has unfortunately resulted in companies sending out generic questionnaires to all their direct suppliers, irrespective of the concrete level of risk. Besides placing an unnecessary burden on suppliers with low-risk profiles to process large numbers of enquiries, including SMEs with limited resources, this approach to risk assessment is also ineffective and does not align with the BAFA’s recommendations (cf. BAFA, Guidance on Collaboration, 19).
Rather than focusing on their own business activities and the ones of their direct suppliers, companies must assess and prioritise human rights and environmental risks across their own operations, subsidiaries, and both direct and indirect business partners under the CSDDD (art. 8(1) CSDDD). Compared to the SCDDA, the CSDDD is also more detailed in its requirements for conducting risk assessments and explicitly prescribes a two-step approach similar to the BAFA’s recommendations (art. 8(2) CSDDD). Additionally, it stipulates that companies must meaningfully engage with stakeholders to identify, assess, and prioritise risks (art. 13(3)(a) CSDDD). This measure enhances the effectiveness of risk assessments, as rights-holders can provide critical insights into potential risks on the ground, and is aligned with international standards, which highlight the importance of meaningful stakeholder engagement (UNGP 18(b); OECD Guidelines, Commentary on Chapter II, para. 28).
To prepare for their obligations under the CSDDD, companies falling under the personal scope of the SCDDA are thus well advised to conduct risk assessments in line with the BAFA’s recommendations and international standards, and not solely rely on generic questionnaires sent out indiscriminately. This would also reduce the compliance burden for SMEs.
A Shared Responsibility Approach
As previously mentioned, sec. 6(4) no. 2 and 4 SCDDA requires in-scope companies to conclude contractual agreements with their suppliers and implement control mechanisms to ensure that the latter uphold certain human rights and environmental standards. When doing so, the BAFA calls on in-scope companies to ensure that these agreements remain balanced and do not simply shift the compliance burden to suppliers. In addition, the authority calls on companies to consider appropriately sharing monitoring costs (e.g. audit costs). To illustrate this shared responsibility approach, the BAFA uses the example of a company that not only sends their suppliers their code of conduct, but provides training at its own cost covering the SCDDA, the company’s expectations, and ways to collaborate to meet due diligence obligations together (BAFA, Guidance on Collaboration, 22 f. and 25).
The CSDDD enshrines the shared responsibility approach more explicitly and contains detailed obligations of in-scope companies vis-à-vis their business partners in this regard, particularly SMEs. For instance, art. 10(5) and 11(6) CSDDD underline that when contractual assurances are obtained from SMEs, the terms must be “fair, reasonable and non-discriminatory”. Moreover, art. 10(2)(e) and 11(2)(f) CSDDD require in-scope companies to provide “targeted and proportionate support” for SMEs that are their business partners where necessary in view of their resource and knowledge constraints. This support includes capacity-building, training, and under certain circumstances even financial support. To assist companies in meeting their obligations regarding responsible contracting, the EU Commission will develop voluntary model contract clauses (art. 18 CSDDD). Guidance developed by business and human rights practitioners and academics on responsible contracting is already publicly available.
Therefore, interpreting their obligations under the SCDDA in line with the BAFA’s recommendations will give German companies a head start in complying with the CSDDD and help minimise the regulatory burden on SMEs, including in developing countries.
Embracing Industry and Multistakeholder Initiatives
Pursuant to sec. 7(2) SCDDA, companies shall take appropriate measures to address imminent and actual violations of human rights and environment-related obligations under the Act. This includes increasing their leverage by collaborating with other companies in industry and multistakeholder initiatives to influence the entity that may cause or has caused the harm in question. Besides increasing companies’ leverage over business partners to influence their conduct, participation in such initiatives can support companies in meeting their due diligence obligations in numerous other ways and is thus encouraged in international standards (OECD Guidelines, Commentary on Chapter II, para. 27).
For instance, joining such initiatives can furthermore help companies gather relevant information for their risk assessment, which can contribute to reducing complexity and thus costs. It can also harmonise the human rights and environmental requirements of in-scope companies vis-à-vis suppliers within certain industries or regarding certain issues. This harmonisation can help avoid overburdening suppliers with different or even conflicting requirements, which is crucial for SMEs in view of their resource constraints (cf. OECD Guidelines, Commentary on Chapter II, paras. 12 and 26).
The CSDDD explicitly considers industry and multistakeholder initiatives as a means to support companies in meeting their due diligence obligations under the Directive in multiple ways, including when developing measures to prevent and end human rights abuses and environmental harm (art. 10(2)(a) and 11(3)(b) CSDDD), when verifying compliance with contractual assurances (art. 10(5) and 11(6) CSDDD), and under certain conditions when meaningfully engaging with stakeholders (art. 13(6) CSDDD). At the same time, art. 29(4) CSDDD underscores that companies do not meet their obligations under the Directive by merely participating in such initiatives and can still be held liable for breaches. This is in line with international standards that call on companies to critically assess the credibility and effectiveness of such initiatives (OECD Guidelines, Commentary on Chapter II, para.12). Art. 20(4) CSDDD tasks the EU Commission with issuing guidance to enable companies to do so.
To reduce the complexity of compliance with the SCDDA, save costs, and prepare for their obligations under the CSDDD, companies falling under the personal scope of the SCDDA should thus embrace industry and multistakeholder initiatives as complementary tools for the effective implementation of due diligence obligations. The participation of in-scope companies in such initiatives also benefits SMEs by streamlining human rights and environmental requirements.
Responsible Disengagement
Sec. 7(3) SCDDA frames the termination of supplier relationships as a last resort. This is an important clarification to discourage in-scope companies from disengaging too readily from challenging contexts (cf. BAFA, Guidance on Collaboration, 25). Terminating supplier relationships lightly, before seeking to address human rights and environmental concerns collaboratively, risks excluding SMEs in developing countries from global supply chains. Such exclusion can negatively affect workers and their families and have wider repercussions on the sustainable development of these states. For these reasons, international standards also emphasise the importance of treating disengagement as a last resort, with careful consideration of its potential impact on rights-holders (Commentary to UNGP 19; OECD Guidelines, Commentary on Chapter II, para. 25).
The CSDDD mirrors the SCDDA’s approach, but explicitly mandates companies to assess the ramifications of terminating the business relationships for rights-holders, meaningfully consult stakeholders before making the decision to divest, and prevent, mitigate or end the impacts resulting from the termination (art. 10(6) and 11(7) CSDDD). In this regard, the CSDDD is more closely aligned with international standards.
The concern that SMEs in developing countries may be excluded from global supply chains due to more stringent human rights and environmental expectations is valid. However, this risk can be mitigated. Companies falling under the personal scope of the SCDDA should take their obligation to disengage responsibly seriously and interpret it in light of international standards, thereby ensuring they are prepared for their obligations under the CSDDD.
Reputational and Investment-Related Incentives
Human rights and environmental considerations are increasingly shaping purchasing and investment decisions. Against this backdrop, civil society organisations are intensifying scrutiny of corporate human rights and environmental performance, sharing findings that garner media and public attention (see, e.g., benchmarks published by the World Benchmarking Alliance). To attract investments and reap reputational benefits, companies should therefore continue to adhere to the responsible business practices developed under the SCDDA, irrespective of its potential repeal or weakening.
Conclusion
Responsible business practices undeniably come at a cost. However, the present contribution explored ways in which the compliance burden under the SCDDA can be reduced for both in-scope companies and suppliers, particularly SMEs, by interpreting due diligence obligations under the Act in line with the BAFA’s recommendations and international standards. Crucially, doing so also positions German companies ahead of the curve, equipping them to meet the forthcoming obligations under the CSDDD, granting them a competitive edge, and reaping them reputational and investment-related benefits.
