The German Supply Chain Due Diligence Act and Its Impact on Corporate Transactions and M&A Processes.
The Act on Corporate Due Diligence to Prevent Human Rights Violations in Supply Chains (Supply Chain Due Diligence Act—LkSG) imposes extensive due diligence obligations on companies with regard to their organizational structure.
The Supply Chain Due Diligence Act took effect in Germany on January 1, 2023, and requires affected companies to respect human rights and environmental standards in their supply chains. To this end, the law provides for far-reaching risk management measures.
Scope of Application of the Supply Chain Due Diligence Act (“LkSG”)
The LkSG applies to companies that have their head office, main branch, administrative headquarters, statutory registered office, or a branch office in Germany. Starting in 2023, the law will apply to companies based in Germany with more than 3,000 employees. Foreign companies headquartered in Germany are also covered. Starting in 2024, the law will then also apply to companies with more than 1,000 employees. After 2024, the scope of application is to be reviewed again.
Even companies that do not fall within the scope of the LkSG should prepare for the law’s requirements, as they may also be required to demonstrate compliance with the law as part of a supply chain of obligated companies.
Protected Legal Statuses
The protected legal rights are defined in § 2 of the LkSG. The LkSG lists the international conventions in which human rights are enshrined. These include, among other things, the prohibition of child labor, protection against slavery and forced labor, freedom from discrimination, protection against unlawful expropriation of land, occupational safety and related health hazards, the prohibition on withholding fair wages, the right to form labor unions or employee representative bodies, the prohibition on causing harmful soil degradation or water pollution, and protection against torture. Environmental risks are also covered.
Duty of Care for Affected Companies and Penalty Ranges
Affected companies must take the following measures to help prevent human rights and environmental violations:
- Establishment of an effective and appropriate risk management system to identify and prevent violations
- Definition of Internal Responsibilities (Internal Control System)
- Conducting regular risk analyses within one's own business unit and throughout the supply chain
- Issuance of a Policy Statement by Management
- Implementation of preventive and corrective measures
- Establishment of a complaint procedure for reporting violations
- Documentation and Reporting to the BAFA (Federal Office for Economic Affairs and Export Control)
The LkSG provides for substantial fines in the event of violations of the above obligations. In certain cases, companies that fail to comply may face fines of over 400 million euros or up to 2 percent of their average annual revenue, imposed by the Federal Office for Economic Affairs and Export Control.
Impact on Corporate Transactions
The Supply Chain Due Diligence Act also affects corporate acquisitions and should be taken into account as part of the due diligence process.
When acquiring a company, the scope of application of the LkSG should be reviewed. If, for example, a target company falls within the scope of the LkSG, the law’s extensive due diligence obligations must be implemented accordingly. In the case of a target company that is part of a corporate group, § 1 (3) LkSG must be observed. Accordingly, within a group of affiliated companies, the employees of all group companies working in Germany must be included when calculating the parent company’s headcount. It follows that the parent company must include the employees of its domestic subsidiaries if they are affiliated companies within the meaning of Section 15 of the German Stock Corporation Act (AktG). Employees of foreign subsidiaries are not included. Employees of the respective parent company are not counted toward the subsidiary’s total (bottom-up calculation).
In addition, the consultants should evaluate potential risks related to human rights violations or environmental damage in the target company’s supply chains as part of the due diligence process. Any risks identified may have an impact on the purchase price, contract negotiations, and the company’s future business strategy.
