What is the Lieferkettensorgfaltspflichtengesetz (LkSG)?

The German Supply Chain Act, known by its rather lengthy official title, Lieferkettensorgfaltspflichtengesetz (LkSG), represents a major step forward in enforcing corporate responsibility. This regulation requires companies to intensify their commitment to human rights and environmental standards. This article explores the key aspects of LkSG, highlighting its applicability, the specific risk factors it targets, and the stringent penalties for non-compliance. We will also detail the obligations and proactive measures that companies and suppliers must undertake. 

👉 What is the LkSG? What companies will be impacted by the legislation? And what can companies do to prepare?

The Lieferkettensorgfaltspflichtengesetz, more commonly referred to as LkSG or the German Supply Chain Act (GSCA), is a significant regulatory framework implemented in Germany, designed to enforce corporate accountability for human rights and environmental protection. 

Enacted in January 2023, this law obligates companies headquartered in Germany, as well as foreign corporations with a registered branch, employing 1,000 or more staff, to transparently disclose their due diligence processes. These processes must focus on identifying, preventing, and mitigating any potential human rights abuses and environmental damages in their operations and supply chains.

💡 LkSG not only affects these large companies but also extends its influence to a vast network of their suppliers, both within and beyond Germany. This creates a ripple effect of responsibility and vigilance across global supply chains.

Under this law, companies are obligated to conduct comprehensive risk assessments regarding human rights and environmental issues. These assessments must be carried out regularly (at least once a year) and include both direct and, in certain circumstances, indirect suppliers (ie. when there is credible evidence of human rights or environmental abuses, companies must also perform targeted risk analyses on their indirect suppliers).

Non-compliance can lead to severe penalties, potentially amounting to as much as two percent of a company's annual global turnover. To assist companies in meeting these obligations, the German Federal Office for Economic Affairs and Export Control (BAFA) offers comprehensive guidance, facilitating an effective alignment with the requirements of the LkSG.

The LkSG, effective from January 1st, 2023, applies to companies that have more than 1,000 employees and are either based in Germany or are German-registered branches of foreign companies. This expansion of scope from the initial threshold of 3,000 employees, effective from January 1st, 2024, significantly broadens the range of businesses affected by the legislation. With this change, it's anticipated that around 2,800 companies will now be encompassed by the LkSG.

The LkSG's applicability extends to companies with their central administration, principal place of business, administrative headquarters, or statutory seat in Germany. It also includes employees working abroad in the employee count. Furthermore, the LkSG is relevant to any company with a branch office in Germany employing more than 1,000 workers within the country. 

❗️Even if your company doesn't meet the specified thresholds, smaller businesses, including small and medium-sized enterprises (SMEs), will likely feel the impact. This is because the larger companies targeted by the law will probably extend their legal obligations for due diligence to their suppliers. Going forward, these smaller companies may fall under the influence of the German Supply Chain Act, even though they are not directly subject to its requirements.

Direct and indirect suppliers

The German Supply Chain Act requires companies to oversee and address any violations within their own business processes and those of their direct global suppliers, from raw material extraction to product delivery to the final customer.

Moreover, if there is credible information about potential human rights or environmental breaches by an indirect supplier, the company is obligated to carry out a risk assessment for these specific violations.

The Lieferkettensorgfaltspflichtengesetz (LkSG) centers on managing risks and safeguarding human rights within corporate supply chains. The law ensures that companies operating in Germany meet the standards set out in the United Nations (UN) Guiding Principles on Business and Human Rights and the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises. It helps companies in detecting, averting, and rectifying violations related to human rights and the environment. 

The law highlights a range of human rights concerns, including child and forced labor, modern slavery, wage and gender discrimination, ethnic discrimination, and illegal evictions.

In terms of environmental protection, the LkSG addresses risks associated with the manufacturing and use of mercury products, aligning with the Minamata Convention. It also covers the production and utilization of prohibited chemicals as per the Stockholm Convention and regulates the import and export of hazardous wastes in line with the Basel Convention. Additionally, the legislation is concerned with the contamination of natural resources, including soil, water, and air, and focuses on issues like excessive water use and other notable environmental pollution. 

The German Supply Chain Act is overseen by the Federal Office for Economic Affairs and Export Control (BAFA). The BAFA is responsible for reviewing annual due diligence reports submitted by companies. There are stringent penalties for non-compliance. These sanctions are designed to ensure that companies adhere to their due diligence obligations:

• Fines - Companies may face financial penalties for non-compliance. These fines can reach up to 8 million euros. For companies with an average annual turnover exceeding 400 million euros, fines can increase to as much as 2% of their average annual turnover. Additionally, periodic penalty payments of up to EUR 50,000 can be imposed during administrative enforcement proceedings.
  
• Exclusion from public tenders - Violations can lead to companies being barred from participating in public contract bids in Germany for a period of up to three years. This exclusion acts as a significant deterrent, especially for businesses that rely on government contracts.
  
• Civil liability - Companies may also face civil claims under section 823 of the German Civil Code (BGB) for breaching duty of care obligations. The Act enhances the procedural capability of domestic trade unions and non-governmental organizations (NGOs) to represent third-party rights violations in German courts. This means that individuals who claim to be victims of human rights violations can authorize trade unions and NGOs to initiate legal proceedings on their behalf, increasing the potential legal repercussions for companies.

👉 These penalties underscore the seriousness with which the German government approaches corporate responsibility in human rights and environmental protection, emphasizing the importance of adherence to the Act's provisions.

Under the German Supply Chain Act, companies are required to undertake a series of steps for human rights and environmental due diligence. These steps are designed to ensure compliance with the Act's regulations:

• Establish a risk management system - Companies need to create a system to manage risks related to human rights and the environment, both within their operations and across their direct suppliers.
  
• Define a responsible party - A designated 'human rights officer' (or equivalent role) must be appointed within the company. This role can be integrated into existing departments and is responsible for overseeing supply chain risk management. Senior management must be briefed annually on the officer's activities.
  
• Conduct regular risk analysis - Companies must conduct risk analyses at least annually, and also in response to new products, projects, or business fields.
  
• Issue a policy statement - Companies must declare their strategy and approach to fulfilling the Act's obligations and expectations for employees and suppliers.
  
• Implement preventive measures - Appropriate procurement practices must be implemented, along with training and control measures to ensure adherence to the strategy.
  
• Take remedial action - In cases of violations, companies must act promptly to prevent or minimize the violation. This includes setting a concrete timetable and working collaboratively with the involved party. Business relationship termination is a last resort for serious violations. The effectiveness of preventive and corrective actions must be evaluated annually and when significant changes in risk exposure occur.
  
• Establish a complaints procedure - A public procedure for reporting violations in the company or its direct suppliers must be set up, with annual reviews and updates as necessary.
  
• Address risks at indirect suppliers - If a company becomes aware of misconduct by indirect suppliers, it must act immediately to manage the risks and update its policy statement accordingly.
  
• Document and report on due diligence activities - Annual public reporting on due diligence compliance is required, with reports available on the company's website for seven years.

These obligations ensure that companies are actively involved in preventing human rights abuses and environmental damage, extending their responsibility throughout their supply chains.

What should companies do now to ensure that they’re compliant with LkSG? 

Step 1: Commitment and resource allocation

• Invest in human and capital resources - Enhance your human rights and environmental due diligence risk management system by investing in the necessary internal resources.
• Cultivate leadership support - Establish support from the top and embrace the LkSG proactively. Acknowledge that businesses with fair, efficient operations, and supply chains attract more capital, and talent, and have better reputations.

Step 2: Supply chain mapping and risk assessment

• Understand your supply chain - Map your operations and identify risk areas. Be transparent about weaknesses and areas for improvement.
• Go beyond tier 1 suppliers - While legal due diligence often focuses on tier 1 suppliers, strive to understand your entire value chain, including tiers 2 and beyond.

Step 3: Data-driven risk management

• Utilise third-party data - Make use of third-party risk data to create a risk heat map and prioritize actions. Update this assessment annually.
• Materiality assessment - Conduct a materiality assessment to identify and prioritize the most significant ESG and human rights issues in your supply chain.

Step 4: Human rights impact assessment

• Implement UNGP principles - Incorporate the UNGP human rights impact assessment methodology to assess risks thoroughly, focusing on scale, scope, remediability, likelihood, and attribution.

Step 5: Monitoring and assessment

• Establish a monitoring system - Set up a system to monitor events that require risk assessments, like indirect supply chain violations or significant changes in business activities.

Step 6: Documentation and data systems

• Record due diligence activities - Ensure all activities are well-documented for annual reporting, demonstrating progress over time.
• ESG and supply chain data systems - Implement robust systems and processes for accurate ESG and sustainability reporting.

Step 7: Communication strategy

• Strategic communications - Develop a communication approach that balances honesty and caution, especially for sensitive human rights and environmental issues.

Step 8: Abuse prevention and remedy

• Focus on prevention and remedy - Prioritise preventing abuses within your business, mitigating those in your supply chain, and providing remedies. Establish robust grievance procedures and foster a culture of openness.

Additional considerations

• Awareness of broader ESG compliance - Acknowledge the growing obligations under the EU’s sustainability and ESG frameworks, including the DNK (Deutscher Nachhaltigkeits Kodex otherwise known as the sustainability code), CSRD, and ESRS.
  

By adhering to these guidelines, companies and their suppliers can effectively align with the LkSG's requirements, thereby promoting ethical and sustainable business practices.

👉 To learn more about the CSRD and ESRS head over to our blog. 

At Greenly we can help you to assess your company’s carbon footprint, and then give you the tools you need to cut down on emissions. Why not request a free demo with one of our experts - no obligation or commitment required. 

If reading this article has inspired you to consider your company’s own carbon footprint, Greenly can help. Learn more about Greenly’s carbon management platform here.