The EU Corporate Sustainability Due Diligence Directive (CSDDD) imposes a duty upon companies to identify, prevent, bring to an end, mitigate and account for potential and actual adverse human rights and environmental impacts arising from their business activities, as well as those of their subsidiaries and value chains. 

The final text of the CSDDD is only expected in early 2024 and Member States will have a further two years to implement it into national law. However, as the saying goes, you cannot outrun a bad diet (or in this case, poor governance and ESG hygiene), and companies should not expect to be able to wait until the last minute to review their ESG health, hoping for “crash diet” success, particularly in the context of M&A.

M&A due diligence

Whilst its implementation is still a few years away, it is advisable for buyers, sellers, and target boards to factor CSDDD considerations into M&A due diligence processes and valuation discussions now. Unlike the various regulations regarding disclosure which mostly required internal systems to be put in place to capture the data, CSDDD imposes a positive obligation to take measures to prevent or cease actual adverse impacts. 

The timeframes involved to undertake a review and then execute the contractual and operational changes needed, including with third parties, should not be underestimated. In addition, the CSDDD currently outlines a right to sue for damage flowing from a company’s failure to comply.

Until the CSDDD comes into force, the answers to these questions may not have an immediate impact on a target business. However, they may become very relevant and potentially very costly to remediate, by the time a buyer is operating the business or wishes to sell the target in the future.

What buyers need to consider

A prospective buyer may wish to ascertain the following, either as a preliminary scoping matter or as part of a formal due diligence exercise.

1. The likelihood that a target or its group will be in direct scope of the CSDDD, and to what extent it might be affected indirectly if it is in the supply or value chain of an in scope company.
2. The status of a target’s “readiness to comply” with the CSDDD, including whether it has carried out a review of its policies and procedures; any related dialogue the target board may have had with stakeholders, shareholders and employees; and any plans to implement changes as a result.
3. Existing jurisdictional CSDDD (super) equivalent measures (such as the German Supply Chain Due Diligence Act or the French Corporate Duty of Vigilance Law) to which a target’s operations may be subject, including: (i) its compliance with those measures; (ii) exposure to fines, sanctions, claims, litigation or disputes relative to such regimes (including directors’ liabilities and availability of indemnities); and (iii) the extent to which a restructure of a target operational in unduly onerous or costly ESG regulatory regimes may be possible or necessary.
4. The ESG health of the relationship between a target and its business partners in its supply or value chain, including whether existing contractual provisions need to be amended to give the target further assurance of compliance with CSDDD within its value chain, or failing that, identifying which business relationships may need to be terminated and how that might affect the target’s business or its enterprise value.

Until the CSDDD comes into force, the answers to these questions may not have an immediate impact on a target business. However, they may become very relevant and potentially very costly to remediate by the time a buyer is operating the business or wishes to sell the target in the future.

Therefore, depending on a buyer’s findings during a due diligence process now, it may wish to factor in such future risk in its deal valuation and consider what, if any, consideration adjustments or deal protection measures (such as bespoke W&I (warranty and indemnity) coverage for ESG matters) may be desirable or available before progressing a potential acquisition.

In anticipation of buyers factoring CSDDD considerations into their M&A due diligence processes, sellers and target boards should work towards ensuring they are prepared to demonstrate the steps they are taking towards getting into tip-top “ESG shape”, including CSDDD (if applicable).