Who does the CS3D affect?

Following our first post concerning (EU) Directive 2024/1760 on corporate sustainability due diligence (“CS3D”) (see Post | The CS3D in perspective), today we reflect on the types of companies the CS3D will apply to and the global market players it will affect.

The CS3D is an ambitious standard that aims to ensure that companies operating in the EU market uphold certain standards of conduct wherever they carry out their business—whether on their own behalf, through subsidiaries, or through business partners. In this post, we will focus on the following:

•  The “Cascade Effect” of the CS3D to explain that despite the directive setting high thresholds for its application, its effects will be passed on, either directly or indirectly, to smaller companies and to all sectors. Consequently, the standard contains provisions to lessen these effects. 
• The “Brussels Effect” of the CS3D to understand why companies from other parts of the world will also feel compelled to act in response to the effects that the standard will have on their commercial relations with their European partners.

 The scope established in the CS3D

The thresholds determining the companies subject to the CS3D are one of the elements that have undergone the most significant changes throughout the legislative process. See Legal Flash | Corporate Sustainability Due Diligence Directive enters final stretch.

In the end, the thresholds were set at high levels. In summary, the CS3D will be binding for the following companies:

• EU companies (or the ultimate parent of a business group) that have an average of more than 1,000 employees and a net worldwide turnover exceeding €450 million over a period of two consecutive financial years.
• Non-EU companies operating in the EU market that do not have subsidiaries incorporated under the laws of a Member State and meet the threshold of more than €450 million in turnover obtained, in this case, in the EU market. 
• And, finally, companies, both within and outside the EU, that carry out their business through franchises or licenses from third-parties, where the annual royalties they pay exceed €22.5 million and their net worldwide turnover (in the case of the former) or their EU turnover (in the case of the latter) exceeds €80 million.

 It is estimated that around 7,000 companies would fall within these thresholds, a figure that some find acceptable and others consider low.

However, the Directive's reach is broader: “the cascade effect”

The due diligence duty extends to the operations of the company that is subject to the obligation, those of its subsidiaries, and those of its chain of activities. Due diligence in the chain of activities has a cascading effect, extending “downstream” to direct business partners and “upstream” to both direct and indirect business partners, regardless of their size.

Aware of the standard's spillover effect and risks, the legislature has sought to minimize them through a series of provisions intended to protect business partners in the chain of activities and, particularly, SMEs. The following paragraphs together reveal how the legislature has conceptualized the due diligence obligation as a standard of conduct that must be met by companies subject to the obligation, which they must satisfy through support and engagement with (and not by passing on to) their business partners throughout the chain of activities:

• Order and efficiency in requests for information: Conditions are established for requests for information from business partners to assess the risks of adverse effects, so that they do not overload business partners in the chain of activities (article 8.4). 
• Review of internal purchasing policies and conditions: The company subject to the obligation cannot limit itself merely to establishing contractual commitments with its business partners, but must also review its own purchasing and hiring policies to eliminate risks of adverse effects throughout the chain of activities (articles 10.2 and 11.3). 
• Fair and balanced contractual clauses: When the company subject to the obligation requests commitments and contractual guarantees from its SME business partners as a measure to prevent, mitigate, and eliminate adverse effects throughout the chain of activities, it must do so through "fair, reasonable, and nondiscriminatory" clauses. The cost of auditing or monitoring compliance will be borne by the company subject to the obligation (articles 10.5 and 11.6). 
• Support: An obligation is established to provide support, including financial support, to SMEs in the chain of activities (articles 10.2, 10.5, 11.3 and 11.6). 
• Exiting a business relationship is acceptable, but only as a last resort and in a responsible manner: The solution of suspending or terminating the relationship with a business partner in the chain of activities on the grounds of compliance with due diligence duties is regulated as a last resort. In any case, it must be carried out in a responsible manner to avoid causing more severe adverse effects than those it seeks to avoid (articles 11.7 and 10.6).

Moreover, the Directive has effects beyond the internal market: “The Brussels effect”

The effects of CS3D on transnational chains of activities will cause the standard to travel outside the EU market. Due diligence in human rights and environmental matters will thus affect companies and economic operators that carry out their activities in markets in other regions of the world, and which are business partners, directly or indirectly, of companies bound by the European standard.

The "Brussels Effect" of the CS3D may accelerate the integration of due diligence into business conduct in other jurisdictions. In any case, and until then, the inclusion of clauses in contracts with companies from other jurisdictions must be accompanied by dialog, training, and engagement with business partners not subject to domestic regulatory pressure.

Moreover, the company subject to the obligation must maintain a broad and flexible approach concerning the material scope of real and potential human rights risks in its chain of activities, especially in countries in regions such as Latin America, where the materiality and importance of certain human rights, such as those of indigenous peoples and communities, have a weight that is not reflected in the CS3D.

In our next post we will discuss the material scope of the duty of due diligence, in other words, the human rights and environmental assets covered by the duty of due diligence set out in the CS3D.