ESG harms and supply chain due diligence – is the UK falling behind?

ESG harms and supply chain due diligence – is the UK falling behind?

Novel claims for alleged environmental and human rights harms in the operations and supply chains of household name companies are mounting.  They highlight a gap in the UK’s regulatory regime and the risk of falling behind where it once proclaimed its lead.

No matter how diligent a company is, it is always possible that unacceptable practices will occur in its complex supply chains across the global economy.  There are difficult questions regarding to what extent a company can or should be expected to have oversight and liability for its suppliers’ actions.  However, if compliance issues can be easily pushed down the supply chain, then harm is merely passed not prevented.  The UK must ensure that its regulatory regime surrounding supply chain due diligence and ESG harms remains fit for purpose.

The current UK position

The increasing regulatory focus on ESG compliance raises the question how significant harm to individuals and the environment can occur in the supply chains of major UK companies.  There have been numerous recent high-profile supply chain concerns: a rape occurring in a factory in Thailand supplying Tesco, allegations of labour abuses at a Malaysian supplier of Dyson and 1,700 instances of child labour in the supply chain of ethical chocolate brand, Tony’s Chocolonely.  Sectors such as fashion, food and technology have been particularly implicated.

There are currently no UK due diligence requirements for corporates relating to adverse impacts to human rights and the environment in their supply chains.

Whilst the Modern Slavery Act 2015 (“MSA”), heralded as providing world-leading protections, envisages a degree of transparency regarding supply chains, it is not a panacea.  Although it requires certain UK corporates to publish a slavery and human trafficking statement each financial year, this is of limited scope and unsurprisingly does not cover, for example, environmental harms.  The need to publish the statement is mandatory but the contents specified in the MSA are only advisory; whilst covering due diligence is suggested, it is not required.  The statement must be published on an organisation’s website, but there are no criminal offences or penalties for non-compliance.

Ground-breaking claims for damages and other remedies have been pursued to fill the void, often driven by campaign groups, activist investors and NGOs, with an associated risk of significant reputational harm through adverse publicity.

A recent example is the unsuccessful crowd-funded application for judicial review brought by the World Uyghur Congress.  This application was intended to prompt the investigation of alleged breaches of the Proceeds of Crime Act 2002 and other legislation relating to the importing into the UK of cotton produced in the Xinjiang Uyghur Autonomous Region under forced labour conditions (R on the application of World Uyghur Congress v Secretary of State for the Home Department, Commissioners for His Majesty’s Revenue and Customs Service, National Crime Agency [2023] EWHC 88 (Admin)).  The stumbling blocks for the application included the payment of adequate consideration for goods providing a money laundering defence, and the need for specific property associated with criminal conduct to be identified, rather than a reverse burden of proof based on the provenance of the product.  As a result of the judgment, the government was criticised for making the UK an international outlier and safe haven for importers of goods produced as a result of crimes against humanity and genocide.

Recent weeks have also seen a civil claim against Shell for pollution of water sources in Nigeria by a subsidiary and a separate claim against its board of directors for alleged failures to manage risks posed to the company by climate change.

The EU position

How does the UK’s supply chain due diligence stance compare to our neighbours?  In France, the ‘duty of vigilance’ is a step forward from the MSA, mandating supply chain vigilance for human rights and environmental harms.  A current frontrunner is Germany which, in January 2023, passed a new law (the Supply Chain Due Diligence Act) going further than the French ‘duty of vigilance’ regarding companies in scope and penalties.

On an EU-wide basis, the Corporate Sustainability Due Diligence Directive is expected to follow Germany’s lead and seek to ensure that certain adverse impacts to human rights and the environment are prevented in large EU companies’ own operations and supply chains.  Some large UK companies with an EU presence will be directly affected and other smaller UK companies supplying in scope EU companies will be indirectly affected.  The adoption and transposition of the directive is anticipated to occur over the next few years.

Calls for change

The Corporate Justice Coalition (“CJC”) has called for a new law against human rights abuses and environmental harms in supply chains based on the ‘failure to prevent’ (FTP) mechanism i.e. modelled on the FTP bribery and facilitation of tax evasion offences.

The Law Commission’s ‘Corporate Criminal Liability: an options paper’, dated June 2022, set out a potential option for corporate criminal liability to be extended to FTP overseas human rights abuses (including offences under s.1, MSA), following a submission by CJC and others.  The Law Commission noted the possibility that making core human rights abuses extraterritorial may be preferable and added that “there is a stronger case in principle for introducing failure to prevent offences in relation to economic crime than for most other areas of crime” due to the particular risk of economic crimes being committed to benefit organisations.

Whilst FTP offences are in the spotlight, the existing examples require, in the case of bribery, that a person associated with the company bribe another intending to benefit the corporate offender and, in the case of the facilitation of tax evasion, a person associated with the corporate offender facilitate UK tax evasion (by a corporate’s client).  They require a monetary or harm-based outcome and a benefit to the corporate directly, or indirectly by benefitting its clients i.e. a degree of complicity.  There is a nexus between the act to be prevented (bribery or the facilitation of tax evasion) and the corporate with the duty to prevent it.

The Law Commission’s options paper elaborated on the benefit requirement by proposing a general principle for FTP offences:

Organisations should generally only be liable for failure to prevent commission of an offence that was

(a) intended to confer a business advantage on the organisation, or

(b) intended to confer a benefit on a person to whom the associated person provides services on behalf of the organisation, but the organisation should not be liable under the second of these where the conduct was intended to cause harm to the organisation”.

Depending on how a FTP offence is drafted, there may be difficulties proving a nexus between human rights and environmental harms in a corporate’s supply chain and a benefit to a corporate which is said to have failed to prevent them.  For example, did the harm confer a business advantage on the organisation or is there an argument to depart from the general principle above for environmental and human rights harms?  Would lower prices caused by a supplier harming human rights or the environment constitute a business advantage?  How would this be proved in practice?

A supply chain due diligence offence would not require any person associated with the corporate offender to cause any harm whether in the UK or abroad (although harm could of course be relevant to whether a prosecution is warranted and the penalty).  It would not require that any harm was intended to benefit the business or its clients.  A supply chain due diligence offence could apply to a company’s own operations, its subsidiaries and supply chains where a company fails to implement appropriate due diligence.  Such an offence avoids arguments surrounding territoriality as the compliance failure would be in the UK.  The rationale would be that irrespective of why harms to human rights and the environment occur (e.g. who they benefit), they have no place in UK supply chains as much as they have no place in the UK.

Clear regulatory guidance would be important in demonstrating what compliance looks like and national or international registers or notifications of supply chain harms could be used to assist compliance and, where ignored, demonstrate companies acting recklessly.

UK action

Following EU action in this field and calls for the UK to follow suit, will the post-Brexit UK decide to implement supply chain due diligence and/or FTP offences in relation to human rights and environmental harms?

The government intends to implement changes to the MSA following a consultation in 2019, mandating the areas that modern slavery statements must cover and creating a new enforcement body with the power to issue financial penalties for non-compliances.  It is also currently pushing forward with plans to create an offence of FTP fraud, false accounting and money laundering, but there are no active publicised plans in relation to FTP human rights abuses or environmental harm.

Whilst the supply chain due diligence requirements contained in Schedule 17 of the Environment Act 2021 appear a positive step forward, subject to how they are implemented by secondary legislation, they will only apply to deforestation risks in UK companies’ supply chains rather than wider harms.

The government stated in May 2022 that it had no current plans to implement supply chain due diligence for human rights and environmental harms, citing the burden of regulation on businesses.  It may be waiting to see the final form of the EU directive before considering any further action.  Its approach to date has been to rely upon self-regulation and businesses voluntarily deciding (whether or not) to implement supply chain due diligence in line with international principles such as the United Nations Guiding Principles on Business and Human Rights and the Organisation for Economic Co-operation and Development (OECD) Guidelines on Multinational Enterprises.  The balance between regulation and costs to business, whilst an important factor, was recently brought into sharp focus by the Grenfell Tower disaster and the potential dangers posed by a deregulatory agenda need diligent consideration.

The UN’s Guiding Principles themselves provide that states should “periodically … assess the adequacy of [laws requiring business enterprises to respect human rights] and address any gaps”.  There will be increasing pressure on the UK as compliance standards raise globally against the backdrop of intensifying demand for ESG compliance by consumers.  Implementing a due diligence requirement could provide benefits such as ensuring clarity of duties, levelling the playing field for businesses and avoiding those applying higher standards being penalised, providing greater consistency with key global trading partners, and bolstering the UK’s international reputation in the fight against ESG harms.  This approach is supported by household name companies such as Tesco, ASOS, Primark and John Lewis.

The reasons which make due diligence attractive as a way to attach regulatory liability are the same reasons to require care in its implementation and enforcement.  It can create a risk of significant penalties for minor failings, rather than focusing attention on the most serious cases.  No matter how diligent a company is, it is always possible that unacceptable practices will occur in its complex supply chains across the global economy.  However, where the UK once helped to guide in this field is a gap which risks turning into a gulf, and careful consideration of regulatory reform is needed.

There is a clear trend towards action being taken to address ESG harms and this growing risk area should be a key focus for corporates.

Richard Reichman is a partner specialising in regulatory investigations and enforcement, corporate crime and financial crime. He is ranked in Chambers UK and The Legal 500. He has extensive experience representing companies and individuals in the most serious, complex and high-profile contentious matters across a broad range of risks. He advises regarding investigations and prosecutions involving offences such as corporate manslaughter, gross negligence manslaughter, health and safety, food safety and hygiene, environmental, fire safety, and product safety. He is frequently involved in significant cases involving ESG compliance issues. He also advises regarding financial offences such as fraud, bribery, insider dealing, market manipulation and money laundering.

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