Sustainable Supply Chains – The Supply Chain Act and sustainable contract design

Efforts at German and European level to create a supply chain law are becoming more and more concrete and it is only a matter of time before such a law is passed. A supply chain law would oblige companies to exercise human rights due diligence along the entire supply chain which would avoid human rights and environmental violations.

The planned Supply Chain Act puts the onus on companies to actually do something and not just write or report something. Specifically, the current key issues paper requires companies with more than 500 employees to:

• identify and analyse human rights-related risks;
• take appropriate preventive and remedial measures and review their effectiveness;
• establish complaint mechanisms;
• report transparently and publicly.

The basis is therefore initially a risk analysis that the company must carry out. A company must examine where its activities (could) have an adverse impact on human rights, working conditions, health and environmental standards.

Once a company has carried out a risk analysis and identified certain areas for action, it must take appropriate measures to avoid negative repercussions on human rights in the supply chain.

One of the appropriate measures to avoid human rights violations is sustainable contract design. An earlier draft of a due diligence law from 2019 even explicitly required companies to work towards the avoidance of violations in strategically important contracts “by means of appropriate agreements”.

In sustainable contract design, the following four areas can be roughly formed:

Typically, CSR regulations will be found in the contract itself, especially if individual human rights risk areas are particularly affected by the contract. In addition, most companies use a supplier code of conduct that describes the supplier’s obligations and sanction mechanisms in a generalised form.

In general, companies should take care to formulate the contractual regulations with a CSR reference in accordance with general terms and conditions law. Above all, the obligations of the supplier must be sufficiently defined, the contract must not contain any surprising clauses and in particular the sanctions must not constitute an unreasonable disadvantage for the contractual partner. Otherwise, the corresponding provision may be invalid.

Obligations of the supplier

The supplier’s obligations can in turn be divided in particular into:

• Conduct obligations → What exactly does the supplier have to comply with? What does he have to ensure? At this point, reference is regularly made to established standards such as the ILO core labour standards. In essence, this is about the prevention of “forced labour, child labour, discrimination, violation of freedom of association, violation of occupational health and safety, destruction of living space, wages that threaten the existence of a worker”, etc.
• Reporting obligations → Which infringements must the supplier notify to the contracting party and how?
• Auditing obligations → Which insights does the supplier have to provide to the contracting partner? Self-disclosure, auditing by the contracting partner, auditing by third parties can be considered.

An interesting question in this context is the extent to which obligations can also be extended to sub-suppliers, so that the supplier must ensure, for example, that its sub-suppliers also adhere to the code of conduct. Such comprehensive extensions are difficult from a legal point of view. After all, the sub-supplier is not a vicarious agent of the supplier. Such requirements could interfere with the supplier’s authority to act as it chooses.

Sanctions

Typical sanctions standardly found in a supplier code of conduct are contractual penalties, liquidated damages, indemnification requirements and termination options. With all sanctions – in addition to a legally precise formulation that also meets the requirements of current case law – it must be ensured that sanctions are only effective in the event of a culpable violation by the supplier, i.e. if the supplier has violated an obligation intentionally or negligently. Sanctions in the case of misconduct by upstream suppliers are accordingly only possible within narrow limits.

Incentives

The mere imposition of obligations and threats with consequences are already often found in contractual regulations. However, this does not make a sustainable contract – especially against the background that the legislator considers a supply chain law necessary. More potential will regularly lie in possible rewards for the supplier. Incentives include:

• Bonus schemes;
• Participation in sustainability investments of the supplier;
• Extension of the business relationship / contract extension option.

A company could therefore, for example, pay a bonus to suppliers who manage to achieve certain sustainability-related target agreements.

Own measures

As a contractual partner, one should also ask oneself where further control options can be found in order to avoid human rights violations. If the contractually agreed price is too low, the own payment terms too long or the delivery dates too tight, the supplier often has no resources to implement CSR measures. Fair contract terms and “own sacrifices” in the contract signal to the business partner that the desired improvements in CSR are a joint effort – and not a responsibility that is shifted onto the supplier. To match this, the appropriate communication channels should also exist and any problems that arise should be solved cooperatively from the outset.

Companies that want to indicate sustainability in contracts are therefore well advised to do the following:

• Identify where your company’s activities (could) have a negative impact on human rights, working conditions, health and environmental standards – the basis for sustainable contract design.
• Designate requirements for suppliers in contracts and a supplier code of conduct in a legally secure manner and in conformity with the law on general terms and conditions – unencumbered regulations tend to have a counterproductive effect.
• Set incentives and come up with your own measures that make it clear that your requirement is towards sustainable products and services. Supplier obligations and sanction mechanisms are important, but they do not make a contract sustainable.