Essential guide to the German Supply Chain Act (LkSG)

Essential guide to the German Supply Chain Act (LkSG)

Jun 14, 2024

·

Michel Hampe

Disclaimer: this article is based on information as of June 14, 2024. Updates will be made and shared as official changes are announced.

In January 2023, Germany adopted the so-called Act on Corporate Due Diligence Obligations in Supply Chains (Lieferkettensorgfaltspflichtengesetzalso, also known as Supply Chain Law or LkSG).

This legislation marks a significant step towards ensuring corporate accountability across supply chains. The LkSG mandates rigorous due diligence and reporting obligations for domestic companies, aiming to prevent human rights violations and environmental harm worldwide. It requires careful monitoring and enforcement to uphold sustainable and ethical practices in procurement and contract management.

Who is affected?

The scope of the Supply Chain Act is defined by two categories: employee count and the country of legal incorporation. 

The new law applies to companies meeting the following criteria:

  • Companies with more than 1,000 employees (as an average of the fiscal year, including employees outside of Germany), and with their central administration, principal business base, administrative headquarters, or statutory seat in Germany.

  • Additionally, it applies to any company with a branch office registered in Germany that employs at least 1,000 employees.

Temporary agency workers must be included if they work for your company for more than 6 months. In the case of affiliated enterprises, all employees based in Germany across the group are counted toward the total employee count.

The law can affect small and medium-sized enterprises (SMEs) indirectly, even if they don't meet the direct scope requirements. As suppliers of directly affected enterprises, SMEs may have to comply with the LkSG as well (e.g. through supplier codes of conduct, audits, or the disclosure of additional information).

Moreover, it explicitly considers intermediaries who attempt to bypass its obligations by converting direct suppliers into indirect ones. In such cases, these "indirect suppliers" are treated as direct suppliers under the law.

What key rights are protected?

The LkSG references international treaties to define protected human and environmental rights. These include core labor standards from the International Labor Organization (ILO), such as the abolition of child labor, forced labor, slavery, and discrimination. It also emphasizes workers’ rights, including equal remuneration and the right to organize. Environmental protections focus on preventing significant human suffering caused by environmental harm, referencing conventions like the Minamata Convention on Mercury, the Stockholm Convention on Persistent Organic Pollutants, and the Basel Convention on Hazardous Wastes.

What are the due diligence obligations?

The LkSG mandates due diligence obligations based on the stage of the supply chain. Companies must address human rights violations within their operations directly, prevent violations among direct suppliers, and take appropriate actions defined by:

  1. The nature and scope of the company's activities

  2. The severity and likelihood of a risk or violation

  3. The company's ability to influence the perpetrator

  4. The company's contribution to the risk or violation

To guide companies, the responsible regulatory body, BAFA, provides a handout with examples of questions and considerations for assessing appropriateness.

Risk management

Companies must implement or adjust risk management procedures to ensure compliance, integrating mechanisms into relevant business processes. This includes clearly defining responsibilities and allocating resources within crucial departments like procurement, compliance, and sustainability, overseen by a human rights officer.

Risk analysis

An annual risk analysis is required to assess potential human rights or environmental violations by the company's operations or direct suppliers. This involves:

  • Abstract risk analysis: General analysis based on countries/industries

  • Concrete risk analysis: Detailed analysis based on internal knowledge, research, surveys, or certifications

  • Risk assessment and prioritization: Assessing and ranking identified risks

Indirect suppliers may also be subjected to risk analyses if there is substantiated notice of violations. Risk analysis is necessary when significant changes in operations or supply chain risks are expected.

Prevention and remedial action

Identified risks must be addressed to prevent and mitigate human rights and environmental violations. This can involve updated procurement guidelines, codes of conduct, training, or audits.

Declaration of basic principles

Companies must issue a declaration of principles for human rights protection in business, outlining compliance processes, key risks, and expectations for employees and suppliers, demonstrating a commitment to uphold these standards.

Complaints procedure

A publicly available complaint mechanism is required, allowing individuals affected by the company’s operations or its suppliers to raise concerns confidentially. Responsibilities and procedures for handling complaints must be clear and publicly accessible.

Documentation and reporting

Companies must publish an annual report within four months after the fiscal year ends, detailing identified risks, preventive and remedial measures, effectiveness assessments, and future actions. These reports must be available on the company's website for seven years.

What are the consequences of non-compliance?

Penalties for violations are structured to escalate based on severity. Minor offenses, such as late or incorrect filings, incur smaller fines. For more serious breaches, fines can reach up to €8 million or 2% of average annual revenue exceeding €400 million. Additionally, companies may face exclusion from public tenders for a period of up to three years.

How can companies prepare for the LkSG?

Affected companies face challenges beyond initial transformation. Early issues often arise when defining operational activities, mapping direct and indirect suppliers, and ensuring effective communication, transparency, and data management.

With the Corporate Sustainability Due Diligence Directive (CSRD) approaching, European regulators will increase scrutiny on global supply chain transparency.

To address these challenges, we recommend establishing robust communication channels and implementing a structured data collection and validation framework within your supplier network as early as possible. Proactively adopting transparent communication throughout your value chain can lead to significant long-term benefits.

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