How to integrate sustainability goals into German corporate practice

Out-Law Guide | 22 Oct 2020 | 1:16 pm | 5 min. read

Companies increasingly want to act in a way that is sustainable and in line with ethical and climate goals. Investors, customers and corporate leaders are all focusing more attention than ever on acting in a sustainable way.

The degree to which a company behaves in this way can affect the form the company takes, and even its long term value.

CSR, ESG

Companies tend to refer to their social efforts as 'corporate social responsibility' (CSR) and their environmental efforts as 'environment, social and governance' (ESG). CSR reflects the social responsibility of businesses to contribute to a sustainable development that balances economic, social and environmental aspects and also provides for a thoughtful interaction with employees and other members of the society.

Businesses are not generally obliged by law to include CSR in their activities. Nevertheless, CSR standards can be found in internationally recognized reference description documents about business responsibility, especially in the Tripartite Declaration of Principles concerning Multinational Enterprises and Social Policy, in regulatory framework such as the updated OECD Guidelines for Multinational Enterprises, the UN Guiding Principles on Business and Human Rights or in the UN Global Compact and ISO 26000. They describe how to protect the environment and climate, how to save resources or how to introduce fair business practices an employee-oriented staff policy.

CSR in German law

CSR commitments in Germany are voluntary. As a first step to embed CSR in German law, the duty to report was extended for some businesses with the CSR Directive Implementation Act in 2017.

This law places a duty on some businesses to report on human rights, environmental, employment and social issues, including the due diligence processes applied. Nevertheless, the development and execution of such concepts is voluntary. 

Since the passing of that law there has been confusion about whether the board of directors of stock corporations is obliged or entitled to pursue goals based on CSR. This question is also of interest for limited liability companies (Gesellschaft mit beschränkter Haftung/GmbH) – although this has been widely ignored until now.

Legal form and sustainability targets

When founding a company, more and more founders want to pursue sustainability goals alongside their business activity: the business is not only intended to follow an economic purpose, it should also serve the general public interest. Still, it is often challenging to predict what impact entrepreneurial action might have on the company and the public interest in the short, middle and long term. However, founders can integrate sustainability goals into their business by the choice of the appropriate legal form.     

A GmbH can be established for any legal permissible purpose and thus aim for economic and idealistic goals. Corporate purpose and object can be shaped individually and can include the companies sustainability goals.

In addition to the GmbH there is also the non-profit company with limited liability under German law (gemeinnützige Gesellschaft mit beschränkter Haftung/gGmbH). For the gGmbH apply tougher rules than for the GmbH – accordingly, the gGmbH is not considered by most founders.

The German entrepreneurial company with limited liability (Unternehmensgesellschaft (haftungsbeschränkt)/UG (haftungsbeschränkt)) is another alternative to the GmbH. The only difference is that the UG’s share capital may fall below the minimum capital. A non-profit UG (gUG) is also possible, but with the same limitations as for the gGmbH.

Recently, there have been increasing calls in legal literature and media for a new legal form in Germany – one that shows at first glance that the strategy of the business includes sustainable goals, for example with the introduction of a sustainable GmbH (nachhaltige GmbH/nGmbH) or with a GmbH in responsible ownership (GmbH in Verantwortungseigentum/VE-GmbH). It remains to be seen if the German legislator sees a need for action.

Sustainability in the GmbH’s articles of association

The articles of association of a GmbH usually contains a description of the company’s strategy. Thus, founders can integrate sustainability goals into their articles of association. Founders who would like to make their sustainability goals public, can include them in their corporate purpose and object. Nevertheless, the description of the corporate object should not be too detailed, otherwise it might limit the flexibility of the company’s business development.

First of all, the articles of association affect the competence of the managing director(s). If their decision-making authority is to be limited, an approval catalogue can be adopted. It can provide for the approval of shareholders or other bodies, for example for compliance and control of sustainability measures.

CSR in M&A transactions

So far, the sustainability trend has had a minor impact on mergers and acquisitions (M&A), but this could change soon: certain sectors such as retail sales, energy, textile, environment and automotive industry have to deal with sustainability issues and according risks more and more often, same as contractual partners like investors, banks and insurances. An adequate consideration of CSR and ESG aspects can reduce such risks, highlight opportunities and raise the purchase price of the target company in the long term.

Accordingly, a growing number of institutional investors believes that an investment that considers CSR and ESG adequately will probably bring less profit in the short term, but could be economically more successful in the long run.

Due diligence

The so-called due diligence review is usually executed at the beginning of an M&A-transaction. It shall help to identify and evaluate the target company’s risks – this also includes risks that result from non-compliance with CSR and ESG. For the review, the seller provides all relevant documents about the development of the company in a certain time frame, which are then checked by the purchaser. A legal due diligence review is regularly executed by the purchaser during the transaction process. Depending of the target company’s sector, the purchaser might also execute a financial, tax, commercial, compliance, technical or environmental due diligence.

The seller usually receives a so-called due diligence checklist tailored for the target company and its sector. CSR and ESG related questions are often raised within a compliance or an environmental due diligence. As more and more businesses desire to build or maintain renown for their responsible treatment of environment and society, CSR standards become more and more relevant in contracts. Therefore it is recommendable to add questions to the checklist of the legal due diligence that suit the precise situation of the businesses involved in the transaction.

If the company has concluded contracts on individual CSR standards, compliance needs to be checked within the due diligence review: If the target company cannot or will not comply with individual CSR standards of contractual partners, this might deteriorate the deal’s conditions, lead to cancellation of the deal or to other negative legal consequences.

The due diligence checklist could also focus on the question if there was any research on CSR standards carried out by advisers of the target company that could provide additional information on the company’s compliance with CSR standards.

If the target company is, for example, an industry supplier, one can expect that many key accounts demand sustainability standards and that quality, energy, environmental and social responsibility – especially with regard to supply chains – must be taken into account in the due diligence process: One key-consideration could be from where the resources that the company works with originate and under which conditions they are produced.