The German Supply Chain Due Diligence Act and its implication for businesses in the People`s Republic of China

Part I: Short overview of the German Supply Chain Due Diligence Act

On June 11, 2021, the German parliament passed the Supply Chain Due Diligence Act (the “Act”) after a lengthy back-and-forth. The draft bill had been the talk of the town since at least February 2021. After months of wrangling, the German Government initially agreed on a compromise on human rights due diligence in the supply chain and presented a draft to this effect. However, the draft continued to be the subject of hot debate. In the end, a final compromise was reached, and the German Parliament passed an amended version of the bill before the upcoming federal election in Germany.

According to the German Government, the Act aims to improve the international human rights situation by ensuring responsible supply chains for companies based in Germany. It refers in particular to the UN Guiding Principles on Business and Human Rights, which set out legally non-binding due diligence obligations in the area of human rights. While implementing the German National Action Plan for Business and Human Rights, it became clear that voluntary commitments were not sufficient for companies to adequately fulfil their human rights due diligence. The German Government therefore found it necessary to establish legally binding human rights due diligence obligations as well as official enforcement mechanisms.

The Act specifies what companies are obliged to do in order to comply with their new human rights due diligence obligations and determines the limits of their duty to act. The German Government explains that violations of legal positions protected by human rights already pose an incalculable reputational risk for many companies. Many companies have therefore already taken action. Due to the lack of legally binding provisions, however, the requirements that companies pass on to their suppliers vary widely. The German Government concludes that there is a need to intervene at a political level and take regulatory action to establish a common legal framework.

The human rights due diligence obligations of companies shall, in principle, extend to the entire supply chain, albeit graded according to the degree of influence. Priority is therefore given to the implementation of due diligence obligations in the company's own area of business and towards its direct suppliers. Indirect suppliers should also be included on a case-by-case basis as soon as the company has substantial knowledge of human rights violations or related risks at this level. The due diligence obligations include conducting a human rights risk analysis, taking preventive and, where appropriate, remedial action, establishing grievance mechanisms and reporting on their activities.

The law will apply from 1 January 2023 to German-based companies with over 3,000 employees in Germany; from 1 January 2024, this is extended to German-based companies with 1,000 employees or more in Germany. The legal form of the company is irrelevant (i.e. foreign companies with headquarters in Germany are also affected). Furthermore, the Act also applies to foreign companies with a registered branch in Germany provided that the aforementioned number of employees is exceeded in Germany. Within affiliated companies, employees are attributed to the parent company. Accordingly, the parent company’s own area of business also includes that of affiliated companies if the parent company exercises a determining influence over them.

Probably the most important final amendment concerns civil liability. In this regard, a new provision was included which reads as follows: "A breach of the obligations under this Act shall not give rise to civil liability. Civil liability established independently of this Act shall remain unaffected." However, the Act provides for fines and other administrative penalties if a company either fails to introduce due diligence responsibilities within their own organisation or fails to ensure that suppliers respect and comply with these responsibilities. The German Federal Office for Economic Affairs and Export Control is mandated with monitoring compliance with the Act.

Part II: Short Introduction on general compliance matters or Corporate Social Responsibility ("CSR") reflecting the requirements of the Act

Human rights due diligence, as such, is not a new topic but rather one (important) element of a company’s Corporate Social Responsibility (CSR) or Sustainable Corporate Governance. The Act is therefore based on international instruments such as, in particular, the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises. However, these instruments are so-called “soft law” and do not, in principle, create any legally binding obligation for companies.

The real news is therefore that the Act introduces legally binding human rights due diligence obligations that apply to companies across all business sectors where the employee thresholds are met. This is, however, not unprecedented. France already introduced the Loi de Vigilance. The European Commission is currently working on an EU Corporate Due Diligence Directive. The German Government might therefore have to amend the Act in the future in order to comply with the EU Directive, which would provide for a harmonised framework across the European Union and, thus, a more level playing field.

What exactly do companies have to do now to comply with the Act? Well, companies will have to:

establish a policy statement on human rights protection in their supply chains;
establish or adapt a risk management system and regularly perform risk analyses;
implement preventive measures within their own organisation and vis-à-vis direct suppliers;
take remedial action and/or mitigate risks;
implement a complaint system; and
document their processes.

Companies should immediately start a dialogue with direct suppliers about any measures required to implement the Act, including the issue of how the lower levels of the supply chain can be reached and made to commit to comply via the direct suppliers. This is particularly advisable if it is already clear that human rights risks lurk at the beginning of the supply chain, especially in the sourcing of raw materials.

As a direct supplier of a company that is bound by the Act, you should be prepared for the fact that the customer will approach you with corresponding requirements. In this case, it makes sense to proactively establish your own human rights policy and to ensure compliance in the further supply chain. Already, the practice of requiring suppliers to commit to comply with and to pass on human rights standards in the supply chain and to be subjected to audits in supply contracts is becoming increasingly common.

Part III: General Observations on Compliance/CSR in the PRC in light of the Act

One of the key elements of the Act is the requirement to establish and implement an adequate and effective risk management system. This shall be designed to identify human rights-related risks and prevent, end or minimise infringements of protected legal positions or environmental in the case such risks or infringements were caused by an entity within its supply chain or where a company has contributed thereto. The requirements of an adequate and effective risk management system are thus determined by two main factors, i.e. what constitutes a potential risk of a human rights related legal positon and/or an infringement thereof.

Pursuant to the Act, an infringement is a "violation of any prohibition for the protection of human rights-related legal positions as provided in the Act" and a risk shall be "a condition in which, on the basis of factual circumstances, there is a reasonable likelihood of an infringement".

The human rights related legal positions provided in the Act include e.g. fair and favourable working conditions, compliance with certain living standards, the prohibition of child/forced labour, and matters pertaining to occupational health as well as the protection of the (working) environment. In order to determine the actual scope of these human rights related legal positions, the Act refers to international conventions (e.g. International Covenant on Civil and Political Rights (ICCPR), International Covenant on Economic, Social and Cultural Rights (ICESCR) and certain ILO conventions such as No. 29 regarding Forced Labour), and to national legislation as a criterion.

Thus, laws and regulations applicable in countries/regions to which a company's supply chain extends, either through its own operations or where direct/indirect suppliers operate, are relevant. This consideration applies in particular to the PRC as one of the major, if not the major player in German/international supply chains.

Contrary to the general perception, the PRC has incorporated matters pertaining to the aforementioned legal positions and obligations into its legal system and the concept of Compliance/CSR is explicitly enshrined in the PRC Company Law. Here, it is provided that "a company shall, when engaging in business activities, abide by laws and administrative regulations, observe social moralities and business ethics, act in good faith, accept the supervision of the Government and the general public, and undertake social responsibilities."

In recent years, the PRC has set up a comprehensive system of labour law/labour law-related legislation that comprises basic employees' rights and extends to complex obligations for employers regarding work safety and the protection of the environment. Key factors of PRC legislation in this area are as follows:

Underaged workers:

The employment or recruitment of minors that have not yet reached the age of 16 is prohibited and considered "child labour". Only limited activities in the fields of literature, arts, sports or alike may be performed by minors as provided by law and only where they are concurrently able to attend compulsory education. Special labour protection measures apply to "underaged workers", i.e. minors aged between 16-18 years. It is e.g. prohibited to assign work to underaged workers which is considered dangerous, excessive, toxic, hazardous, or may in any other way damage the physical and mental health of an underaged worker/minor. Minors below the age of 16 are expressly prohibited from starting a business or engaging in individual business operation activities.

The abduction/trafficking of a child for labour/forcing a child into labour constitutes a crime under PRC Criminal Law. Further, it is e.g. prohibited to make use of children for the purpose of begging.

Forced labour and slavery:

Forced labour and slavery are prohibited. Companies that engage in forcing a person to work by resorting e.g. to violence or intimidation, or by restricting an individual's personal freedom, or by resorting to humiliation or corporal punishment, or by illegally searching or detaining a worker will be subject to administrative sanctions. Depending on the severity of the matter, such conduct may constitute a crime and be investigated and punished in accordance with PRC Criminal Law. Employees who are subject to any of the aforementioned conduct have the right to terminate the labour contract with immediate effect.

Occupational health and safety:

The PRC Law on the Prevention and Control of Occupational Diseases and the PRC Law on Work Safety (as well as related legislation) provide for a comprehensive legislative framework ensuring a safe work environment. Compliance and the enforcement thereof by the competent authorities have become more and more pronounced in recent years. While certain basic requirements apply to all employers, there are specific requirements for different industry sectors reflecting the individual circumstances of those industries, e.g. noise and particle emissions. Further determining factors include company size or location, etc. The PRC Law on Work Safety primarily focuses on work safety, work accident prevention, protection of the health of employees and safety, while the PRC Law on the Prevention and Control of Occupational Diseases focuses on the prevention, control and elimination of occupational diseases and risks of occupational diseases, as well as health protection and related rights and the interests of employees. Employers are required to set up effective internal risk analysis and management systems and comply with external reporting obligations towards the competent PRC authorities. This includes e.g. internal risk analysis, the setup of reporting lines and extends to specific requirements regarding the construction of facilities (both office spaces and industrial plants). Industry-specific standards set forth detailed obligations e.g. concerning emissions, waste disposal, noise protection or thresholds for air pollutants. If an employer fails to enact legally compliant occupational health and work safety measures, employees may refuse to work or disobey their employer's instructions.

Trade unions:

Employees in the PRC have the right to form or join trade unions. Trade unions shall "represent and safeguard labourers' lawful rights and interests, and independently carry out activities in accordance with law". In general, trade unions play an important role in labour relationships, e.g. in negotiating collective bargaining contracts with the employers on the following matters: remuneration, working hours, rest periods and leave, health and safety as well as insurance and welfare. Further, certain actions of employers require the involvement of the trade union, e.g. in case of the dismissal of an employee. There is no express prohibition of the right to strike, however, this right is not enshrined in PRC legislation.

No discrimination:

PRC Labour Law requires employees to be treated impartially in employment regardless of their ethnic backgrounds, races, gender or religious beliefs. It expressly stipulates that women and men shall have equal rights in employment.

Renumeration:

Employers are entitled to set salaries at their discretion, and based on the rule of "equal pay for equal work" (e.g. no distinction may be made based on race, gender, religion or on an arbitrary basis). Salaries may not be lower than the locally published minimum wage standards set by the local governments. The minimum wages reflect the specific living conditions in different locations throughout the PRC. Factors to be reflected by the local government in determining the local minimum wage include minimum living costs and the average number of family members a worker supports, the average wage level, labour productivity, the overall employment situation, as well as regional differences in the level of economic development.

Environmental Risks:

The PRC has ratified both the Minamata Convention on Mercury and the Stockholm Convention on Persistent Organic Pollutants (POPs), however having made use of certain right as regards to the implementation thereof as provided therein. Based on these Conventions, the legislator has formulated several actions plans to translate these Conventions into national legislation.

Part IV: PRC Anti-foreign Sanctions Law/Conflict of Law

On 10 June 2021, the Standing Committee of China’s National People’s Congress passed the PRC Anti-foreign Sanctions Law ("Sanctions Law"), with immediate effect. Contrary to what the name of the law indicates, it is not only a response to specific sanctions issued by another country's government at State (policy) level but should also serve as a tool to respond to any act that would “violate basic principles of international relations, contain or suppress China by using any pretext or its domestic law, impose discriminatory restrictive measures against Chinese citizens or organisations, interfere with China’s internal affairs or otherwise endanger China’s sovereignty, security and development interests" (jointly referred to as "Discriminatory Measures") – all terms yet to be defined.

Hence, the Act itself (e.g. if it is considered domestic legislation containing or suppressing China) or any actions required thereunder (e.g. termination of a business relationship with a PRC subsidiary/supplier) might be construed as a Discriminatory Measure and thus be subject to the Sanctions Law.

The Sanctions Law provides that individuals or organisations that directly or indirectly participate in the formulation, decision or implementation of Discriminatory Measures may be included in a "countermeasure list" (hereinafter referred to as "List", "Listed Person" and "Listed Organisation") with the List further extending to the

spouse/immediate family members of a Listed Person,
senior executives/actual controllers of a Listed Organisation,
organisations in which a Listed Individual serves as senior executive, and
organisations which are actually controlled by, or established by or operated with the participation of, a Listed Individual or a Listed Organisation

all possibly being subject to the following countermeasures:

refusal of visa issuance/cancellation of visa, denial of entry into the PRC, deportation
the seizure/freezing of property located within the RPC
the imposition of a ban/restriction on any transaction/cooperation with any organisation or individual that is located within the PRC
any other necessary measures.

Entities intending to ensure that their business and supply chain comply with the Act are well-advised to closely monitor the implementation of the PRC Sanctions Law as to avoid being subjected to conflicting legal obligations.

Dr André Depping
Simon Henke
Dr Daniel Walden