Contracting on Sustainability: the Corporate Sustainability Reporting Directive

In the near future, the Corporate Sustainability Reporting Directive¹ ("CSRD") will require large² and listed undertakings to report on sustainability matters. These are not only matters within the actual undertaking, but also matters within the undertaking's value chain. After all, the biggest sustainability risks are often found in that value chain. The value chain includes all trading partners involved in the business process: direct and indirect suppliers as well as distributors, resellers and end customers.³

To be able to report on the value chain, it is important to enter into good contractual arrangements with trading partners, notably with direct suppliers. This is the only way an undertaking will be able to report on sustainability matters from the value chain, impose sustainability targets, or deploy its policies within the value chain. In this article, we will explain which arrangements your undertaking will have to make under the CSRD and also, what the best way is to do so.

The CSRD imposes the obligation to be transparent on Environmental, Social and Governance ("ESG") topics for undertakings in their management report. An impact analysis will have to show which ESG topics are material. The undertaking has to consider its impact on people and the environment (inside out) and the risks of sustainability matters for the undertaking, its financial position and continuity (outside in). The Directive refers to this as the double materiality perspective. In the management report, the undertaking must report, among other things, on the business model and strategy, the policy and objectives with regard to the ESG sustainability elements, the measures taken and the results achieved, and the undertaking's biggest risks with regard to the material topics identified.

The CSRD does not impose any concrete standards. It only prescribes that an undertaking must be transparent on the relevant sustainability topics, so that its stakeholders (such as investors, NGOs, customers, suppliers, etc.) are better informed. The idea behind the CSRD is that the forced transparency will create a great incentive to actually make an organization and its business model more sustainable. Therefore we believe that – despite the absence of concrete standards – this Directive will have a big positive impact on how undertakings deal with sustainability. This will not only be the case for undertakings directly covered by the CSRD, but also for those within the value chain of these undertakings that have to report.

Before being able to report, an undertaking has to have the correct information. While some of this information will be available within the undertaking, much of it – relating to the value chain – will have to come from its trading partners. As mentioned, this value chain moves both upstream (from the direct supplier to the source of the product or service) and downstream (from the direct buyer to the end user or to the product’s end of life), and consequently includes an abundance of parties.

The CSRD appreciates that the necessary info from the value chain is not always readily and quickly available. In the first three years, the undertaking can still get away with reporting on the efforts it made to obtain the necessary information and explain why not all necessary information could be obtained.⁴ It must also describe its plans to obtain that information in the future. Despite this transition period, now is the time for undertakings to start working seriously on the value chain.

Two important reasons call for arrangements on sustainability within your value chain. First, you have to receive the right information to be able to comply with your own reporting obligations. Second, your undertaking may depend on its value chain to implement its sustainability policy and achieve targets. It is therefore important to control the value chain. The following rights and obligations may help the undertaking:

• The obligation to provide the necessary sustainability information;
• A right to instruct and a duty to cooperate in complying with policies or achieving certain targets;
• The right to impose more concrete standards depending on the undertaking's material themes. After all, these may change over time;
• The right to verify information and to check imposed policies, for example through audits or certification. This may include an obligation to cooperate with an accountant's audit or to answer his questions;
• A right to terminate a contract for non-compliance.

These are just a few contractual remedies available. Of course, the (often international) playing field and the bargaining power is relevant for the extent to which such contractual rights and obligations can actually be imposed.

Then an additional challenge presents itself. Contractual rights and obligations can only be agreed with a contracting party, whereas the value chain does not end there. Parties behind the contracting parties must also comply with these obligations. You can reach parties without a direct contractual relationship by including a perpetual clause. This requires your trading partner to make the same arrangements with its direct partners, and those in turn with their direct partners, etc. A third-party clause for the benefit of the undertaking may also be helpful. However, the contractual framework is not airtight. As soon as one party fails to pass on the obligations, the chain will be broken. Besides, a third-party clause may create problems in an international context, because not all legal systems know or acknowledge such a clause. It matters which law applies to the agreement.

A widely used way to impose standards is to declare a code of conduct or sustainability statement
applicable as part of the agreement. These often contain general standards trading partners have to comply with, such as a ban on child labour and discrimination, the right to a fair wage and equal treatment, or the obligation to minimise negative impacts on the environment.

While a code of conduct can be a good tool for imposing general standards and making clear what standards and values an undertaking stands for, these will often not be sufficiently concrete. Such a code lacks the necessary detail and customisation for the trading partner in question. Especially if that trading partner has substantial sustainability issues, your undertaking will want to be able to impose concrete sustainability policies and objectives. A clear contractual provision is more suitable for this, especially as it forces parties to start a debate and the trading partner will consciously agree to the obligations it enters into. The parties will then come to better and more concrete arrangements, and as a result have greater confidence those arrangements will be honoured.

Undertakings will have to start working on their value chain to comply with the CSRD. Not only to get the information flow going, but also to be able to enforce formulated measures. A contract is a more appropriate tool than a code of conduct, because – especially for trading partners that are considered to be part of a material topic – concrete and clearly formulated rights and obligations are in order, which must be transparent.

1 Directive (EU) 2022/2464
2 An undertaking is large if it meets two of the following three requirements: net turnover of 50 million, balance sheet total of 25 million, average of 250 employees or more
3 Art 19a(3) CSRD