Picture this, a property developer looking to put up a mixed-use real estate project, enters into an agreement with a manufacturer of construction materials, to supply them with the items they will require.
The contract they have signed has clauses on delivery schedules, pricing and quality standards, but has no clauses that address labour rights, environmental practices or ethical sourcing of raw materials.
Two years into the contract, investigative journalists expose that the manufacturer’s factories have been dumping untreated wastewater into local rivers and employing underage workers. The story goes viral, sparking outrage among consumers and civil rights groups, who accuse the developer of supporting unethical practices, even though the developer had no direct role in manufacturing.
To avoid a boycott, the developer would want to terminate the contract; however, because there were no clauses on environmental compliance and labour standards in the contract, they cannot demand immediate corrective action or terminate the contract without penalty.
Within the last two decades, there has been growing legal pressure for real estate companies to embed Environmental Social Governance (ESG) clauses into contracts to protect themselves during any transaction.
“What started as a nice-to-have kind of thing has now turned into a must-have thing. If you do not adhere to these standards, then you will face the repercussions,” says Grace Waswa, ESG Lead at MMW Advocates.
Traditionally, businesses did not have to worry much about the impact that their activities would have on the people around them, because this is not something that they would be held accountable for. Today, however, more people are evaluating how particular companies treat their employees, suppliers, customers and the broader community, before deciding whether to purchase goods or services from them.
This is particularly true if the businesses in question are operating in industries that have a huge impact on the environment, such as real estate, which contributes 40 percent of global carbon emissions.
“Back in the day, a board would sit somewhere and deliberate on how to increase company revenue. Today, boardroom conversations have shifted from the money, to how company activities affect other people,” observes Waswa.
Similarly, companies are assessing whether potential partners are accountable and transparent not only to their shareholders, but also to their stakeholders, before engaging in contractual obligations with them. That is why you may find that today, for a company to award a tender, one of their requirements will be for suppliers to demonstrate they have an anti-bribery policy, and show how they are implementing it.
The evolution of ESG risk management
In the 1980s up to the early nineties, companies would only abide by environmental regulations, health compliance requirements and safety measures for industries with high injury rates or fatalities, so as not to get in trouble. In the 1990s up to early 2000s, there was a deep awakening of conscience that saw conversations switch from ‘don’t get into trouble’, to ‘do less bad’.
Companies began to focus on reducing their environmental impact, as well as managing both natural and manmade resources well, so as to reduce reputational risk at the international level. In the 2000s all the way to 2019, as conversations around social issues started to become more prominent, the focus for companies switched from ‘do less bad’ to ‘do more good’. Beyond their impact on the environment, companies now started to think about the welfare of their employees, as well as acquire local operating licenses, so that people would want to associate with their business.
Photo credit: Shutterstock
“In 2015 the United Nations sat down and came up with the 17 sustainable development goals (SDGs), which made companies start to focus on their corporate social responsibility,” explained Waswa.
Indeed, over the last five years, ESG has become a tool that companies are leveraging to not only gain an edge over their competitors, but also to mitigate risk, in a world facing the rise of ethical sourcing laws, mandatory sustainability disclosures, investor pressure for climate accountability and digital public scrutiny.
“In the 1980s all the way to the 2000s, good boys and girls could do business with bad boys and girls and their enterprises would not be affected; however, today, if good boys and girls do business with bad boys and girls, their enterprises could be affected,” stated Waswa.
Why should businesses have this conversation now?
People support businesses which support people's issues, therefore, while businesses which focus on making money at the expense of people might do well in the short-term, in the long run, they may not do very well.
Green building adoption in Kenya has seen a significant rise, with over 100 buildings now either registered or certified.
Photo credit: Shutterstock
A case in point is the 2024 Gen-Z led nationwide demonstrations, during which time Kenyans began boycotting businesses that were closing doors to peaceful protestors seeking safety from aggressive police officers. However, businesses which adhere to ESG frameworks and its principles are able to easily attract customers, improve customer retention and influence customer’s purchase decisions.
“If today a real estate developer engages in practices that affect the lives of people negatively, clients would cease transacting with that company and switch to one that is actually taking into consideration the issues of people,” explained Waswa.
In addition, adhering to ESG frameworks enhances business financial performance through reduced energy bills, decreased operating costs, elimination of unrequired expenses and increased business sales.
ESG Lead MMW Advocates LLP Grace Waswa.
Photo credit: Pool
“There is a deep correlation between how you handle sustainability issues and your financial performance. Incorporating ESG also helps businesses adapt to changes in legal and regulatory requirements,” remarked Waswa.
While many companies seek to work with partners who adhere to ESG frameworks, the gap has consistently been that ESG promises are rarely enforceable unless built into the one thing that governs business conduct‒ contracts. Because contracts are legally binding agreements that create obligations, allocate responsibilities and provide remedies if commitments between two or more parties are not met, incorporating ESG clauses in contracts can help to move ESG commitments from policy statements into legally binding obligations. Under ESG contracts, general statements of intent such as ‘the parties will act responsibly’, are usually replaced with defined obligations and metrics.
“When ESG clauses are embedded into the contract, a developer is now safeguarded from regulatory breaches, reputational damage and operational disruptions,” noted Waswa.
Having these clauses in contracts also makes it easier to monitor whether both parties are meeting their obligations and issue penalties or resolve disputes easily if and when ESG standards are not met. In addition, incorporating ESG clauses in contracts demonstrates seriousness to investors, lenders, regulators and communities.
“Investors will scrutinise agreements that are present not just between you and them but also with third parties because if your company is sued or boycotted because of the actions of a third party, then they too could lose money,” explained Waswa.
Why is real estate ESG sensitive?
The construction industry is a major contributor to global carbon emissions, responsible for nearly 40 percent of total CO2 emissions, driven by both operational energy (heating, cooling and lighting) as well as embodied carbon from materials like cement, steel, and aluminum. For this reason, real estate companies have binding obligations under international law to protect the environment from pollution.
“If you are entering into a contract with a supplier of raw materials for a project you are working on, it would be prudent to ensure that the company is aware of its carbon footprint and has taken the necessary steps to ensure that they are dealing with that footprint,” said Waswa.
Green building adoption in Kenya has seen a significant rise, with over 100 buildings now either registered or certified.
Photo credit: Shutterstock
Even as they produce whatever it is that they sell, real estate companies must ensure that their suppliers have understood the impact of their production activities and taken the necessary steps to prevent pollution.
“You do not want a situation where the community comes up and says that while your supplier was producing their goods, they did not get the input of the community, even though their activities affect the environment,” posed Waswa.
In addition, it is important for real estate companies to incorporate clauses on money laundering in their contracts, because the real estate industry is one of the sectors most targeted by money launderers.
What strategies can real estate firms adopt to ensure that both they and their partners are ESG compliant?
Embedding ESG in contracts can be challenging because it requires foresight and alignment with a company’s broader sustainability strategy, but once incorporated, ESG can transform contracts from mere procurement or finance tools into levers for positive impact.
To effectively leverage ESG to mitigate risk and increase value, consider engaging a sustainability lawyer to help in mapping out what you deal with as a company, as well as review and assess contracts. Secondly, conduct deep stakeholder mapping and engagement to identify the people who are affected by your business or who can contribute to your business, whether positively or negatively.
These stakeholders may include employees, journalists, the government or the community living in the environment where your business, or that of your supplier, is conducting their operations.
“We have moved from the shareholder being given priority (profits driven), to what the stakeholder says (social consciousness). Ensure your engagement with stakeholders has embedded ESG,” noted Waswa.
Thereafter, integrate ESG into the strategic plan of your company for it to materialise. In addition, get the buy-in of senior management to identify how your company can do things differently. A lot of real estate companies consistently engage and enter into contracts with suppliers without doing due diligence on whether the products or services they are sourcing have been produced through actions that negatively affect the lives of people, such as child labour.
Strengthening due diligence processes across value chains is crucial to identify any gaps in engagements with third-parties.
“You have to keep your eyes open and assess the kind of contract you are entering into with a third party very critically, as this is the only way you will be able to identify any gaps in your engagement with them,” posed Waswa.
