Everyone is talking about the German Supply Chain Act (Lieferkettensorgfaltspflichtengesetz – LkSG) and many companies are trying to get an overview of what it means for their organisation and how they should prepare. Here we address the most important aspects and who is directly affected by it.
The Supply Chain Act was passed by the German Bundestag in mid-June 2021. It focuses on human rights and environmental due diligence obligations that companies operating in the German market must implement within their supply chains in order to prevent, minimise or eliminate risks.
To whom the Supply Chain Act applies
The law comes into force on 1 January 2023 and is initially mandatory for companies with more than 3,000 employees. Just one year later, the employee limit will be lowered to more than 1,000. In addition, foreign companies with branches in Germany will also be obliged to comply if they employ more than 3,000 employees in 2023 or 1,000 employees in 2024. Parliament has also kept the question open of whether the threshold should be lowered further.
What needs to be done
The specified due diligence obligations (§3, para. 1 LkSG) are the specifications that must be introduced within the companies and beyond with direct suppliers. These are:
- establishing risk management within the own organisation and the extended supply chain to manage due diligence.
- assigning internal responsibilities for reviewing risk management.
- the continuous analysis of risks in the supply chain.
- defining a policy on a human rights strategy.
- establishing preventive measures within the own organisation and with direct suppliers.
- establishment of mitigation measures
- establishment of a whistleblowing system along direct and indirect suppliers.
- implementing due diligence measures also with indirect suppliers when a violation becomes known.
- collecting all relevant documentation and producing publicly available reports.
Even though companies do not have to ensure that no human rights and environmental obligations are violated in the supply chain, there is an obligation to implement these due diligence obligations in order to identify and respond to risks in the supply chain.
The implementation and enforcement of these due diligence obligations poses different challenges for each company, depending on the size of the organisation, the depth of integration with suppliers, and the international spread of supply chains. Therefore, companies are required by law to carry out this due diligence in a way that is appropriate for them. For this reason, the Supply Chain Act makes the implementation of due diligence obligations dependent on the company’s business activities, as well as the company’s ability to influence the originator of potential risks and obligations. In addition, the expected severity of the breach of duty, the possibility of reversing it, and the probability of a breach of duty occurring are taken into account. Finally, the type of causation contribution of a risk or to the breach of a duty is also taken into account for the action.
Who enforces the law
The Federal Office of Economics and Export Control (Bundesamt für Wirtschaft und Ausfuhrkontrolle) is responsible for enforcing the law. Annual reports must be submitted to this authority via online access no later than four months after the end of the business year.
If the requirements for submission and fulfilment of the due diligence obligations are not met, the report may be required to be improved within a defined period of time.
The consequences of supply chain misconduct under the German Supply Chain Act are severe compared to previous supply chain-related regulations such as the EU Timber Regulation. Fines can be up to euros 800,000 (§24 para. 2 LkSG).
For companies with an annual turnover of more than euros 400 million, fines can even be up to 2% of the average annual turnover (§24 para. 3 LkSG). In addition, companies can be excluded from public tenders for up to three years in the case of fines of euros 175,000 (§ 22 para. 1 ff LkSG).
Although the financial risk can be estimated, the impact of reputational risk, financing risk, and risk of retaliation can have a significant impact on companies. However, civil liability for violations is not implemented by this law.
What the future holds
The Supply Chain Act is not just an isolated German law that will never affect other countries. In February 2022, the European Commission published a draft for the EU Directive on Corporate Sustainability Due Diligence, which has strong similarities with the German Supply Chain Act but defines more profound regulations. This directive targets a much larger number of companies and also includes civil liability for violations. Additionally, due diligence obligations must be implemented with indirect suppliers in addition to one’s own company and direct suppliers. This obligation represents a considerable expansion of the scope compared to the German Supply Chain Act.
Are you interested in how the Supply Chain Act can be implemented for your company? – Then contact us! We will be happy to present our solution to you without obligation.