Environmental, social and governance (“ESG”) issues have never been more important. They play into everything; increasingly driving investment decisions and commercial contracts to company strategy and culture. Real Estate is no exception and ESG will have a fundamental impact on acquisition and management of real estate assets. This in turn is likely to have an effect on how landlords and tenants respond to and resolve disputes with ESG related considerations.
Although there will no doubt still be a place for conventional litigation - we can see a rise in mediation being used by landlords and tenants. This is a more collaborative and less confrontational process that aligns more closely with ESG principles of working together for the greater good.
ESG and Real Estate
Real estate has a significant impact on the ESG landscape. For example:
Nearly 50% of all global emissions come from the property sector - real estate will need to consider its carbon footprint;
There is an increasingly tangible link between health and social isolation - real estate has the potential to improve social relationships in communities and the workplace; and
Regulations require buildings to be EPC B compliant by 2030 to be let to commercial tenants.
The ESG issues will be become increasingly important for landlords to consider as ESG commitments will have an impact on potential tenants and investors.
Additionally, Millennials and Gen Z are particularly engaged with ESG so these issues are likely to be in the forefront of this generation as they enter the workforce and develop their careers.
Changing Landscape in Disputes
A tenant’s focus has traditionally been on their relationship with their landlord. However, ESG means that landlords and tenants may need to invest more in their relationships with each other to meet green targets and social commitments within a building and across the wider community in a development.
Leases are increasingly likely to contain clauses that set out the landlord and tenant’s respective ESG commitments and the implications of failing to meet these. However, many leases will have been drafted before ESG had the prominence or significance it does now.
The ESG commitments within a property may bring to light a range of issues for landlords and tenants if the leases are based on old wording and are not fit for purpose. For example:
Nuisance – issues may arise from competing demands on the use of space by tenants and other occupiers and the nature of that use, particularly in developments which combine leisure, residential and business uses.
Service Charge Disputes – landlords may introduce various ESG related benefits to occupiers of a development. However, conventional service charge allocation based on internal floor areas or similar may not be fit for purpose or sufficiently adaptable. Will there be disputes about what is “fair and reasonable”? Should the business sector in developments where wellbeing benefits are provided to all tenants within the development bear a greater proportion of the costs?
Landlords and tenants meeting ESG targets – landlords and tenants may have reciprocal or interlinked targets such that each will want to ensure the other meets their ESG commitments.
Stakeholders – there will be a rise in stakeholder scrutiny from investors and the local community which may have a greater impact investment value than in the past.
Greenwashing – increased potential for greenwashing claims and reputational issues.
Resolving ESG Disputes
Alternative dispute resolution (“ADR”) has been around for a long time with mediation and arbitration being viewed as the main alternatives to litigation.
The former sees parties engage in a facilitated dialogue whilst the latter is a more formal quasi-court process which will lead to a binding judgment. Unlike traditional litigation, mediation and arbitration are strictly private and confidential which may be particularly important for those owning and occupying buildings and the spaces which surround them whilst navigating contractual relationships.
The Place for Mediation
Mediation is a collaborative, discussion-focused type of ADR.
A typical mediation will see the parties engage in a discussion with each other, supported by a mediator. That mediator’s role will vary depending on a case-by-case basis, but they will typically be on hand to help parties move discussions forward. In some cases, the mediator could be a subject matter expert and might play a more active role in negotiations and help parties to identify strengths and weaknesses in their positions. They can also advise on how a dispute might play out in court and guide parties towards a potential resolution.
Mediation could be an effective tool to resolve ESG related disputes between landlords and tenants:
Privacy – mediation proceedings are private and confidential; minimising the risk posed by potential reputational damage.
Creative solutions – parties can set their own agenda and arrive at more creative solutions than those available in court.
Cost effective – mediation can be comparatively quick and cost effective compared to court proceedings.
Relationships – mediation focuses on reaching a mutual resolution and this provides the parties the best chance of keeping – or restoring – a good working relationship. This will be vital in long leases.
Those factors matter because reputational considerations around ESG can be particularly sensitive. The absence of cases dealing with ESG factors and the softer, nuanced nature of many current ESG policies makes more litigious outcomes much less certain.
Collaborative action will be required to resolve these issues and the ESG landscape may change how real estate disputes are approached in the future.
This article was prepared with the assistance of Jonathan Goodyear (Trainee Solicitor)