My name is Johanna Reiter-Brüggemann. I’m a member of the EWOR Academy and specialise in international trade law, compliance, and white-collar crime. Today, I invite you to reflect on CSR and ESG from a legal perspective. Please note that this article is from a European point of view. In other jurisdictions, CSR and ESG may be less prominent or raise different questions.
The international division of labour and global price differences benefit businessess worldwide, including start-up companies. In international value and supply chains, this vertical specialisation presents both opportunities and risks.
There are numerous examples of the adverse impact of international trade and business on human rights or the environment. There is the 2012 factory fire at Ali Enterprises in Pakistan, which caused 259 deaths due to barred emergency exits. And also the forced labour and other human rights violations caused by the mining of conflict minerals and other raw materials (tin, tungsten, tantalum and gold – 3TG, cobalt, lithium). Or even recent reports about the forced labour of Uyghurs in China’s Xinjiang province.
First, I will explain the regulatory context and then, I will explain why early-stage start-ups should consider ESG factors.
From soft law to hard law
As founder or CEO, your first responsibility is to your start-up and its shareholders. National, European, and international business standards have emerged in recent years. From “shareholder primacy” to “broader stakeholder capitalism,” they outlined an expanded responsibility. We can see that in this Harvard Business Review, 10 ESG Questions Companies Need to Answer).
Initially, public and private regulatory initiatives set voluntary standards, known as soft law, proposing companies to implement ESG due diligence (including ESG risk assessment and management). Examples are the United Nation’s Guiding Principles on Business and Human Rights of 2011 and the OECD Guidelines for multinational enterprises.
Studies, however, show that few companies have adopted these soft-law proposals. The European Union and national legislators decided to create binding standards as follows (non-exhaustive list!):
- the French Loi relative au devoir de vigilance of 2017,
- the German Sorgfaltspflichtengesetz (entering into force on 01/2023),
- the Dutch Wet zorgplicht kinderarbeid (entering into force mid-2022)
- the European Unions Regulation (EU) 2017/821 introduces a supply chain due diligence for EU importers of conflict minerals.
More regulations are coming. After a long wait and many delays, the European Commission published its proposal for a Directive on Corporate Sustainability Due Diligence.
In light of this change, start-ups and established businesses should first identify all current and planned legal ESG instruments (including sector-specific provisions) applicable in their relevant jurisdictions. (Note that the examples referred to above are not exhaustive!).
The results will show that for SMEs, ESG due diligence is rarely mandatory. For example, the German Act on Corporate Due Diligence in Supply Chains will only apply to companies with more than 3,000 employees as of January 2023 and to companies with more than 1,000 employees as of January 2024.
What the law does not provide, a contract may require
Start-ups working at a B2B level might have to implement ESG due diligence due to contractual obligations. In B2-B relationships, customers are often big companies that are or will be bound by mandatory ESG law. To ensure their compliance, they typically impose clauses asking suppliers to also comply with ESG standards. Check out the American Bar Association’s Model Contract Clauses to Protect Workers in International Supply Chains, Version 2.0.
At the moment, many companies only ask their suppliers for declarations of intent. This will likely change once they are bound by mandatory law (in Germany as of 2023 or 2024, depending on the company size).
The Importance of ESG Data for Funding
Investment Funds and Private Equity investors regularly ask for and monitor ESG data and ratings of their portfolio companies. Angel investors and VC funds do so less frequently. Even impact investors often focus more on the impact created by the start-up’s products and less on ESG risk management. But early-stage investors are likely to increasingly ask for ESG risks once more and more potential acquirers will be bound by ESG regulation.
Compliance with ESG Standards might help you in case of litigation
Even though early-stage start-ups are usually too small to fall under the scope of mandatory ESG regulation, compliance with ESG standards can help to minimize litigation risks. This becomes more and more important. To give some examples:
- In May 2021, The Hague District Court held in a landmark case that Shell’s climate goals did not suffice to meet the company’s obligation to act against climate change.
- In the German Danzer case, German authorities had to decide whether to bring criminal charges against a German-based manager of Danzer Group accused of having failed to prevent human rights abuses (including rape and murder) by hired security forces in the Democratic Republic of Congo. The public prosecutor eventually decided not to bring criminal charges based on procedural considerations unrelated to the question of whether the manager in question could be held liable for negligence.
- In France, public prosecutors have opened proceedings against four textile companies accused of having tolerated forced labour in their supply chains.
For SMEs that are not bound by mandatory ESG regulation, the cases cited above are interesting for two reasons:
1) They show that ESG litigation and criminal charges are brought even if ESG risk management is “voluntary”.
2) Proper ESG due diligence could have either prevented the alleged violations and the litigation in its entirety or been a powerful defence.
Finding the right balance with ESG
As a start-up, you have one great advantage: you are building your venture from scratch. While your established competitors have great difficulties tracing all their existing, often obscure supply chains and checking them for risks, you can start with transparent, ESG-compliant value chains, communicate that you do so and thus add value to your start-up. Soon, this will be a great advantage for you and your business. It will allow you to win new customers and recruit talent to whom ESG matters.
ESG is an ongoing process. Start simple, educate yourself and your staff (especially those in procurement) and get professional legal help where you need it.
If you are based in Germany – start here to gain basic knowledge on the subject.