White Paper for Businesses
From January 1, 2023, Germany’s new Supply Chain Act obliges companies to protect human rights in global supply chains. However, the law does not provide the technical solution needed for the seamless monitoring of thousands of suppliers worldwide.
Implementing the requirements calls for full supply chain transparency. Thus, this topic is of enormous importance for ivault as Blockchain Technology offers one of the best solutions to this challenge, ensuring transparency, security, and LkSG compliance.
Apart from that, advanced applications based on environmentally-friendly Blockchain Supply Chain solutions like ours can boost the Circular Economy. For more insights, please see our White Paper on the new Supply Chain Act and Blockchain Technology at the end of this post. Or watch the German interview with CEO Arman Sarhaddar below.
New Supply Chain Act in Germany
10 questions and answers on the new law
1. What is the Supply Chain Act supposed to do?
Every day, we consume products manufactured all around the globe: Coffee and chocolate, clothing, sporting goods, and electronics. All of this creates prosperity for us while people in global supply chains often work under miserable conditions. Even some of our favorite brands’ suppliers frequently disregard fundamental human rights, such as the prohibition of child labor.
On January 1, 2023, the Act on Corporate Due Diligence Obligations in Supply Chains (Lieferkettensorgfaltspflichtengesetz, LkSG), often referred to as Supply Chain Act, will come into force in Germany. It intends to initiate the long-needed improvement of fundamental social standards and human rights in global supply chains, and it has enormous implications:
The new law covers large German corporations and affects small companies that act as their suppliers – SMEs both from Germany and abroad. The European Union is in the legislation process at the same time. All member states of the EU will eventually enshrine the EU supply chain directive nationally. As a result, the decisions also affect non-EU corporations, such as Swiss or American companies operating in EU countries.
High fines will soon follow if the implementation is missing or incomplete – even though the requirements for companies are tremendous and meeting the needs seems anything but easy…
2. Why do we need a Supply Chain Act in the EU?
In 2016, the German government published the National Action Plan (NAP) based on the Guiding Principles on Business and Human Rights. The expectation was that at least 50% of companies with 500+ employees would voluntarily implement the proposal.
However, only 13-17 % followed the NAP recommendations voluntarily. So, in line with the coalition agreement, the German government took legislative action. The result is the new Supply Chain Act, which ties in with the EU directive.
But why did only a few companies voluntarily commit themselves to adopting the NAP suggestions? Was it the sole pursuit of the most significant profit possible – not only at the expense of people and the environment but also at their reputation? Aren’t there any other reasons?
It can be said with some certainty that the challenge companies continue to face is no small one. For a critical review of the Supply Chain Act see our White Paper below.
3. What applies from when and which companies are affected?
The LkSG in Germany covers both companies headquartered in Germany and companies with a branch office in Germany:
- From 01.01.2023: Companies with 3,000+ employees
- From 01.01.2024: Companies with 1,000+ employees
As the LkSG is a transitional law, it is still unclear exactly how things will continue in Germany after 2025. However, it can be beneficial for smaller companies to prepare for a solution as early as possible.
EU member states must implement the new requirements imposed by the EU supply chain directive within two years of its official adoption. It will cover both EU limited liability corporations and non-EU corporations operating in states of the EU generating sales, as displayed below.
- From 2023: Companies with 500+ employees and a net sale of 150+ Mio EURO per year
- From 2025: Companies with 250+ employees and a net sale of 40+ Mio EURO per year operating in high-impact industries ( such as textiles, food, minerals, some chemicals, …)
4. How does the Supply Chain Act impact SMEs?
SMEs do not (yet) fall directly within the scope of the EU Directive and the LkSG. Nevertheless, the law can impact SMEs if they act as suppliers of the companies targeted. Corporations can, for example, require direct suppliers to implement due diligence processes. However, unlike buyers, suppliers do not have to expect sanctions imposed by the BAFA.
To assist SMEs, the Federal Ministry for Economic Cooperation and Development offers the KMU Kompass – a new online tool that is anonymous and free of charge. It helps companies better understand social and environmental risks and establish LkSG-compliant processes.
5. What does the Supply Chain Act demand?
The German government demands fully traceable steps to demonstrate corporate social responsibility and safeguard human rights. It encompasses the enterprise’s business area as well as direct suppliers and – in some cases – indirect suppliers.
The Act is also meant to ensure legal certainty for companies and fair conditions of competition in the global market. To this end, the due diligence requirements described in the LkSG, as summarized below, must be complied with.
In addition, complete documentation should enable corresponding evidence. However, documentation systems can only clearly demonstrate a company’s LkSG compliance if they can prove that data has not been manipulated or falsified.
This is one of the main arguments for using Blockchain Technology in the context of the Supply Chain Act, as it enables tamper-proof data storage while preventing irreversible data loss, as CEO Arman Sarhaddar mentioned in the interview above.
Part II of our series of articles on Blockchain and the Supply Chain Act will examine how the due diligence requirements listed below can be operationalized using Blockchain Technology.
6. What due diligence obligations are there?
Regarding their own business area, companies must comply with the following due diligence requirements:
- setting up a risk management system with clearly defined internal accountability,
- performing regular risk analyses,
- issuing a policy statement on corporate human rights strategy,
- laying down preventive measures to avert human rights violations,
- taking remedial action immediately in the event of legal violations,
- establishing a complaints procedure for people in the supply chain, and
- continuous documentation and transparent public reporting
In the case of direct suppliers who act as contractual partners to companies, companies must take care of the following matters:
- contractual assurance of suppliers to respect human rights
- annual risk analysis and agreed control mechanisms
- implementation of preventive and remedial measures
- offer training and education
Due diligence obligations only apply to indirect suppliers who act as suppliers of the contractual partner if there is a specific reason for doing so. Then companies must:
- conduct cause-related risk analyses
- introduce concepts to end or minimize risks and violations.
7. What are the penalties for non-compliance with the LkSG?
In the event of negligent or intentional violations of the LkSG, companies must expect these sanctions:
- Penalties and fines (see below)
- the exclusion from public contracts
Additionally, human rights violations identified in a company’s supply chain through a risk-based inspection can cause aggravating reputational damage. Consequences like this can be more severe, especially if breaches have gone unnoticed for a long time. Restoring a brand image built up for decades likely costs much more than the penalties listed below. Furthermore, this can also affect the public appearance of other companies in a business relationship with the perpetrator, including SMEs.
8. How much can LkSG fines be?
Fines can be up to 2% of a company’s annual turnover if it records 400+ million EURO worldwide. In addition, the amount of fines depends on the individual case, the extent and duration of the breach of duty, and other variables. Section 24 of the LkSG includes
9. Are companies liable for the conduct of their suppliers abroad?
The authority does not intend to provide a new basis for liability for the conduct of third parties in the supply chain. Companies only have to prove that they are making efforts to comply with due diligence obligations, look at risks and grievances, prevent violations, and take remedial actions. However, the LkSG does not affect or change existing liability bases. Lastly, terminating a business relationship with a direct supplier is required if there is a severe violation or remedial measures remain ineffective.
10. How can Blockchain help comply with the Supply Chain Act?
There is an enormous need for action concerning supply chain transparency: supply chains include thousands of suppliers from many different countries and are becoming increasingly complex. As a result, many companies do not know whether raw materials are actually mined under acceptable conditions, whether employees receive fair wages or whether contaminated production waste is handled correctly. Let alone how to keep track of it.
Still, the latest Supply Chain Act requires complete transparency. Hence it places high demands on the data management of the businesses affected directly and indirectly: From 2023, all data must be continuously collected, stored, analyzed, and made publicly available across all companies’ and countries’ boundaries.
Distributed ledger technology, better known as Blockchain, offers one of the best solutions to this task. More precisely, the technology can be the basis for a wide variety of applications that cover a large part of the new requirements better than any other solution. However, what does the operationalization of due diligence obligations look like using a Blockchain platform? How does it help sustainability and corporate social responsibility?
In particular, in the context of the Supply Chain Act, a blockchain platform enables:
- seamless risk monitoring and tracking of the entire supply chain on a single but decentralized platform thanks to increased transparency,
- smooth coordination and management of prevention and remediation activities and other international business operations beyond the scope of the LkSG in real-time,
- the exchange of securely encrypted data and trust between all parties involved without an intermediary while the anonymity of users is guaranteed – especially when it comes to the complaints procedure,
- tamper-proof documentation of all processes and activities with immutable time stamps, as well as protection against irreversible data loss and thus also
- providing clear evidence of a company’s full compliance with the Supply Chain Act.
Automation of the underlying processes is easy. The company does not rely on installing, operating, and maintaining multiple, incompatible programs and applications. As a result, susceptibility to errors can be drastically reduced, and the company’s legal security is increased.
To find out exactly how to implement the legal requirements based on a customized Blockchain platform, read our White Paper on the use of Blockchain Technology in the context of the Supply Chain Act below. In the upcoming blog post, you will be provided with a summary of the benefits of Blockchain regarding LkSG compliance.
Subscribe to our Newsletter to be notified about new publications and developments.
► The new Supply Chain Act & Blockchain (White Paper)
Do you need a customized Blockchain application to increase the legal security of your supply chain? We would be happy to advise you personally on the most cost-effective solution for your unique supply chain: Get in touch with us now.
*includes a Blockchain use case for the Circular Economy and a checklist for evaluating Blockchain solution providers