Controversy: Do supply chains need liability rules?

Prof. Freytag, what is wrong with due diligence obligations on human rights, environmental and social standards?

Prof. Andreas Freytag: Nothing. Of course, it is good that companies observe due diligence obligations. But what is the point of legally prescribing them? As far as I am concerned, nothing needs to be changed; so, the burden of proof lies with Ms Vasileva.

Veselina Vasileva: At the moment, German and internationally operating companies are not liable for human rights violations or violations of environmental and social requirements along supply chains as part of their business activities. It is time to level the playing field by introducing a law that recognises the efforts of companies that practice fair trade or have already initiated measures to conduct fair business. A supply chain law in Germany would also establish legal certainty and motivate German companies to make corresponding investments. Most of them only do that if their competitors are also encouraged to do so. Legal regulations can stimulate companies to implement human rights and environmental standards.

Do companies need these types of motivation? And if there is a due diligence obligation, why not a legally binding one?

Freytag: The question is which company would be subject to this law – certainly also which investors ...

Vasileva: We have 3.5 million companies in Germany, of which 3.1 million are small businesses with less than ten employees – all of them are not covered by this law. If the current proposal of the Federal Ministry for Labour and Social Affairs (BMAS) and the Federal Ministry for Economic Cooperation and Development (BMZ) is applied to companies with 500 employees or more, it would affect 7000 companies in Germany.

Freytag: Well, an investor first complies with the rules of the host country. You are implying that this country has no rules. Why should we impose our legal system on other countries? That is paternalistic and top-down approach.

Vasileva: However, I would like to remind you of the trade system we are in. The global competitive situation and the lack of rule of law make it impossible for many developing countries to comply with international law. The list of fragile states that cannot provide for their citizens is long. The Supply Chain Act is based on internationally recognised human rights catalogues. In other words, it is not about paternalistic imposition of German law, but about supporting companies to comply with human rights along their supply chains – I do not think that we are asking for too much. It is about the gradual introduction of appropriate risk mitigation measures as part of their business operations without adding responsibility. Real life has shown for years that voluntary measures have not been sufficient to realise the self-evident.

Freytag: I do not see German companies failing to comply with human rights across the board because I simply do not have any evidence of that. The question is: What can entrepreneurs do, and where do they have access? They have access to it in the companies they run; and they are generally in favour of human rights. I also trust in the consumers. We can accomplish a lot without needing new rules. The state should help German companies become engaged and to do good. For example, this could be accomplished through more investment guarantees that could be issued more readily. These guarantees as well as export credits can be tied to proof of due diligence obligations. After all, companies want state funding and preferential treatment. By the way, problems of failed states are difficult to solve from outside, since their problems are mostly home-made. So what does that mean for the companies? Most of them are medium-sized, and they would be facing a bureaucratic mess if they were to guarantee the entire supply chain.

What is so complicated about that?

Freytag: Many of these medium-sized businesses produce goods with long supply chains, often involving up to 100 steps. Do you want to track them all to ensure that everything happens according to German standards?

Vasileva: Not according to German standards, but rather according to international law, such as the international human rights charter, the ILO core labour standards. As a representative of an SME, I can tell you that compliance with human and environmental rights is also possible for SMEs. I do not see any excessive demands at this point. German SMEs in particular are known for their outstanding quality, and they have a comprehensive quality management system. They know their supply chains and know exactly what happens within them. The principle of proportionality also applies here: The due diligence procedures to be implemented by companies should be proportional to their size and circumstances. In some cases, simple measures are already enough to remedy abuses in supply chains.

Freytag: It sounds as if German SMEs are violating human rights against their better judgement. That is not the case. That it why I think it is better to trust that something will be achieved through German involvement on the ground. We share the same goal.

Vasileva: I generally have a positive image of entrepreneurship and assume that companies want to do good. But the current economic setting is extremely unfair. Competition is very strong and price pressure is high. It is passed on to the weakest links along the supply chain. This setting makes it difficult for companies who want to do the right thing. It is a constant balancing act to comply with human rights and environmental standards in business, which, by the way, are not based on German law, but rather internationally defined standards. Therefore, we need legislation to motivate us and guide us in the right direction.

A law would not only motivate, but also punish in case of doubt.

Vasileva: It will not take effect overnight; the proposal by the BMAS and the BMZ stipulates a transitional period of three years. Under the Supply Chain Act, companies are only liable for their own fault and for foreseeable and avoidable damages. The risk-based approach applies. The idea is to first analyse and prioritise the most serious violations and develop proportionate measures to deal with them.

Freytag: I imagine it is very difficult for any company to track each step for each end product in that supply chain. This review process requires an incredible amount of effort.

Could companies work together on these reviews?

Freytag: They can definitely do that. But other issues are more important to me: The well-meaning state guiding people to do the right thing – that all sounds good. But does it reflect the realities of life for companies and local people? Will German companies possibly withdraw from these countries because they consider the risk to be too high? German companies are already hardly present in Africa. And if they stay away, others will come – from China, for example. The country is using its new Silk Road to exert influence: Chinese companies are spreading throughout Africa but also elsewhere, and they are not known for respecting human rights. Therefore, stricter rules in Germany would ultimately lead to more human rights violations there. It would be a law motivated by morality, but it should be rejected from the point of view of responsible ethics.

Is it likely that companies would pull out because of legal uncertainties?

Freytag: It raises concerns within the business community. I hear this argument over and over. And it is understandable.

Vasileva: Several studies show that other criteria mainly influence an investment decision, for example political instability or corruption.

Freytag: German companies motivate their direct investments primarily with market development. It is true that the willingness of German companies to take risks is lower than in other countries. A supply chain law would increase these local risks. Increasing risks means increasing marginal costs and decreasing willingness to invest.

Vasileva: How so?

Freytag: Because then there are more uncertainties in the following sense: Can I also unintentionally fail to comply with rules that I did not even know about and then get sued for it? There is a high risk for SMEs.

Vasileva: So far, there is no evidence that companies will actually withdraw completely from high-risk regions because of liability risks. Some are dependent on raw materials – e.g. cocoa and cobalt; others have already invested extensively in production sites. Large chocolate companies in particular are interested in finally restructuring their supply chains and avoiding child labour because of damage to their reputation. They are digging in their heels.  A due diligence obligation law has been in place in France since 2017. Only very few lawsuits have been filed. No one would risk filing a lawsuit if it was not legally justified. Most human rights violations happen at the beginning of the supply chain, for example during the extraction of raw materials. Therefore, the focus has to be on the entire chain.

Are there potential risks that smallholders in African countries, for example, are displaced because they have problems meeting standards?

Vasileva: The law is not about immediately avoiding risks once they have been identified. Instead, the goal is to gradually introduce reasonable and appropriate measures and initiate a dialogue. If the identified risks cannot be solved by the companies alone, they can collaborate with trade unions and state institutions, for example through sectoral collective agreements. The idea of the law is not that contracts will then be terminated.

Freytag: But the 2019 draft of the law reads like a general indictment of German companies and a carte blanche for unfair practices associations to adopt a new business model. I have an alternative proposal on how we could address human rights violations at the beginning of supply chains: We need to change our trade policy. We need to ensure that more of the value added in supply chains is shifted to resource-rich countries. We still have a trade policy with a so-called tariff escalation. Tariffs and other trade barriers increase with the level of processing. Of course, companies and consumers want to get the raw materials to Germany as cheaply as possible, but they also want to protect our own processing. By the way, farmers in Africa are regularly exploited by local middlemen – no matter how much we pay for cocoa and coffee, it will not reach the farmers. But it would be better if the coffee was roasted in Africa and the chocolate produced in Africa. If we eventually want to allow this, the trade policy of the OECD countries must change, even if it has already improved in recent years.

Vasileva: We are on the same boat. There are several levers we can use to prevent human rights abuses in global supply chains. A Supply Chain Act is one step in that direction. And there are many other approaches that need to be initiated at the same time. We should look for ways to support a corporate culture and promote the global framework for social and environmental transformation. The principle of everything having to be bigger, faster and cheaper is not sustainable. We all know that. The current coronavirus pandemic made this perfectly clear, because it reinforces developments: Resilient supply chains secure the future viability of German companies. They are the foundation. A long-term business relationship based on partnership, as in Fair Trade, is the be-all and end-all. The Supply Chain Act would support this effort. Taking human rights violations into account within their own areas of operation is not too much to ask of German companies.  Companies also bear responsibility for people and the environment in regions where they and their suppliers operate, even if they are located outside Germany.

Freytag: Resilient, sustainable supply chains are, of course, what small and medium-sized enterprises in Germany want. German SMEs are already exemplary in this respect, both at home and abroad. Therefore, I see no need for a law. I simply do not expect that such a law will only result in reasonable tests.

What is wrong with proving one’s own innocence?

Freytag: The three of us will not have to prove our innocence all the time. Are entrepreneurs generally different?

There is no evidence that anything is going wrong with us. It is different with the supply chains.

Freytag: Are you sure? Here again, it sounds like general suspicion. If there are indications of behaviour that violates human rights, action should taken. But why do I have to force someone to preventatively prove their innocence?

Because right now it is all up to the consumer to decide. Is that enough?

Freytag: I believe in responsible consumers, but they still need the necessary information. This information and consumer protection must be improved. And the public’s perception of entrepreneurs is negative – and these prejudices have made it even worse. As a society, we need to look at entrepreneurs with less prejudice.

Vasileva: Entrepreneurship is the backbone of the German economy. I do not believe that a Supply Chain Act will be passed with clauses that harm German businesses. Quite the opposite. There are already more than 70 companies in Germany that support the supply chain initiative and binding liability. Companies do not bear the responsibility alone – it is divided three ways between them, the consumers and the state. It is better to recognise that than to shift the responsibility back and forth.

Freytag: German companies that are in favour of such a law have different motives. Some want clear rules and others want higher costs for competitors: It is like the West German trade unionists who went to the East in 1990 to raise wages there so high that the East German industry lost its competitive edge for good. It protects the jobs of big companies because it puts more of a burden on their smaller competitors – the big ones already have to deal with the bureaucratic burden. “Raising rival’s costs” is the motto.

Vasileva: Speaking of shared responsibility, the big investors are also taking a close look at it. Sustainability requirements are no longer a niche topic in the financial market. Take the investment company Blackrock, for example – they invest in companies. The chairman of the board has called on the managing directors of the companies to do business ethically, socially and responsibly.

Freytag: That is good to hear. Then we really do not need legislation.

Vasileva: But there are also many companies that avoid their responsibility, rely on voluntary measures and shift the responsibility onto consumers or the state.

Freytag: If they are cut off from funding because their behaviour appears to violate human rights, they automatically assume responsibility. Ensuring that human rights are respected is first and foremost a state responsibility. With a Supply Chain Act, more and more responsibility for tasks that are actually the state’s is being delegated to companies. And governments in the failed states can sit back and relax.

Vasileva: Based on our experience as a company that has been involved in Fair Trade for decades, we understand that we will not get anywhere without commitment. Almost 3,000 companies are speaking up in favour of liability, for example the Unternehmensgrün association, which represents 350 medium-sized companies, or the European brand association AIM, which represents around 2,500 companies, including Beiersdorf, Dr. Oetker, Nestle, Nike and Puma.

Freytag: As I said, this may have to do with strategic considerations. I frequently deal with the German-African Business Association (Afrika-Verein der deutschen Wirtschaft), which advocates for investors in and exporters to Africa – and they are not screaming for a Supply Chain Act. They do not want more bureaucracy.

Will a Supply Chain Act go into effect?

Vasileva: The coalition agreement of the German government is talking about implementing a legal regulation if the voluntary approach has proven ineffective. The National Action Plan for Business and Human Rights is considering a law if less than 50 per cent of large companies do not comply by 2020. Currently, less than 20 per cent are compliant. The law must and will be implemented. The only question is: when and to what extent. The key is for it not to be an empty threat. For me, civil liability is a central element of an effective Supply Chain Act.

Freytag: I do not think it will be implemented on a national level – more likely on a European level. Civil liability, however, should not exist under any circumstances. Only affected people should be allowed to sue, not NGOs in Germany, which are sometimes more concerned with punishing companies than with respecting human rights. Then we will hopefully have a directive that most people will be able to live with.

Further Information

As long as consumers are faced with the challenge of consuming "properly", there are now plenty of options, e.g. the new website ichwillfair.de offers tips on fair consumption.