Real estate: Where property and corruption collide

The changing face of real estate is increasing the risk of corruption for investors, writes Carol Hopper. Real estate investment involves many risks, and real estate owners and investment managers are familiar with them. The risks include those that impact at the micro level and affect individual assets such as title, environmental, property repair and maintenance, and of course those arising from tenant relationships with the possibilities of dispute and default and those that take effect at the “macro” level with risks including market changes, the availability of finance and negative demographic trends. Historically, however, real estate owners and investment managers in the UK have not had to give particular attention to the risk of economic crimes committed in relation to their investments and the implications this may have for them. This is changing and there is now a very real need to be aware of and control the risks that both owners and investment managers can face because of bribery and corruption violations, money laundering and even economic sanctions.  The risk needs to be addressed, as the consequences of getting it wrong can be costly. Fines imposed by the UK courts for failure to prevent bribery can (and have) run into the millions and the gross profit secured as a result of the act of bribery can be used as a benchmark against which a multiplier is then applied in cases of severe harm. Legislative framework In the UK, the key piece of legislation is the Bribery Act 2010 and the important point for any owner or investment manager involved in real estate to note, as alluded to above, is that it is not just the individual who engages in bribery that faces criminal prosecution, but also any commercial organisation which has failed to prevent bribery by its employees or even by companies or persons associated with it, even if located overseas. In this regard, the UK is often seen as playing catch up with the US, but that is not necessarily the case, for what the UK lacks in experience in prosecuting corporates for corruption offences, it makes up for with the sophistication of its anti-money laundering legislation and its undoubted experience in bringing criminal charges against directors caught up in alleged corporate wrongdoing. The provisions under the 2010 Act simply add to an existing arsenal. Current significance Why is this so significant now? For two reasons. First, there is an important distinction between real estate and other investment asset classes such as equities and bonds in that real estate is, by its very nature, an operational asset. Indeed, real estate as a sector for investment is increasingly one that should be looked at as an operational business. This way of viewing real estate is only accentuated by the latest development trends for experiential, serviced space, often with a high degree of comfort and convenience, which is to be found in student housing, co-working space, senior living accommodation and increasingly in the private rented sector.  In other words, owners and managers are involved in active management at all stages of any investment in real estate which can involve developing and building, maintaining and managing and of course ultimately disposing of the asset. Each stage has the potential to involve government bodies as well as a wide variety of other third parties on everything from the way in which the land is developed and used to its registration, its taxation and everyday matters such as energy efficiency and health and safety. Third-party involvement can range from refurbishing or decorating a property to collecting rents from it. The more complex the asset, the greater the likely interactions with third parties, and therefore the higher the risk of unauthorised conduct by the individuals involved, which could amount to acts of bribery and corruption.  Secondly, when placed within the global context, the ongoing economic uncertainties caused by Brexit, the point of the property cycle and the mature and highly competitive UK property market and rising inflation mean that the UK market is increasingly unlikely to promise the rates of return demanded by many investors. All of which pushes investors to consider engaging in real estate as an operational business in overseas and often emerging markets. The key here is that these emerging markets are often high risk jurisdictions for corruption purposes, which has the effect of compounding the third-party risks discussed above. Managing risk So on the one hand, the increased potential for bribery and corruption to occur is clear and on the other hand the regulatory landscape is changing and becoming more difficult to navigate. So what can be done? There is only one defence to an allegation that a commercial organisation has failed to prevent bribery. That defence is that adequate procedures were in place at the time the offence was committed, which were designed to prevent the objectionable conduct from occurring in the first place. In other words, at the core of managing this risk lies a compliance programme. A compliance programme that is designed to prevent the offending conduct from occurring. If the compliance programme fails in its desired effect, at the very least it will be critical in establishing a defence to, or at least demonstrating mitigating factors in, any enforcement action that is taken or proposed in relation to the breach. The approach in the UK is not dissimilar from that taken in the US where regulators would also look to the sufficiency of an organisation’s compliance programme in considering potential penalties in the context of actions taken under the Foreign Corrupt Practices Act 1977. It is clear from the number of actions taken in more recent times that the regulators in the UK, the US, the EU and elsewhere are serious about taking action in preventing bribery and corruption and in doing so are working alongside the activity of regulators seeking to promote greater transparency of data to prevent money laundering and violations against economic sanctions. The key question then becomes what constitutes “adequate procedures”. In our experience, an effective anti-bribery and corruption compliance programme should include four key elements – see below. What should an anti-bribery and corruption programme comprise? Enterprise-level awareness At this level, the key objective is to ensure that directors and employees are aware of the regulatory regime that applies in relation to bribery and corruption both in the home country of the owner/investment manager but also in the host country of the real estate asset (if different). This is achieved through appropriate policies, procedures and training about that regulatory regime. It should focus on demonstrable levels of awareness as well as tools that enable all relevant individuals to be vigilant in looking for red flags and identifying situations where offending conduct could arise or, less optimally, identifying where it has arisen. It needs to be cognisant of both the country where the investment is located and the nature of the investment. That is, the same compliance programme that is appropriate for a real estate asset in one jurisdiction or area (for example, the UK), will not be appropriate if the real estate is located in an emerging market or if the risk profile of the asset concerned is higher. Pre-investment asset due diligence While any asset purchase will always involve extensive due diligence, it is not always the case that a purchaser focuses on bribery and corruption as a key element. Experience has shown, however, that especially in factual circumstances where further probing may be suggested (for example an office asset located in a predominantly residential area in a higher risk city, say, in an emerging market), that such further diligence is essential. Being alert to the risk, and then understanding the provenance of the planning/consenting permissions received, would be very important in the example given. Ongoing asset due diligence As mentioned above, real estate has always been an operating asset, but the trend appears for this to be intensifying. It is vital therefore for owners and investment managers to have policies and procedures in place during the operational phase of their involvement with any asset to monitor the situations which may give rise to potential bribery and corruption. Critically, this will involve monitoring of relevant processes (just by way of example, certification/permits needed by any government authority, say in terms of energy efficiency standards) to ensure that there is no impropriety at any stage but also, and just as important, record keeping of the processes and the results. Ongoing third party due diligence For most owners and investment managers of real estate some, or indeed all, of the operational activities are likely to be contracted out to third parties. A compliance programme should also focus on the third parties involved and the tasks that they are mandated to undertake, and must ensure they are aware of the consequences of improper conduct and have their own policies and procedures in place to address these issues. Understanding what those policies and procedures are will also be important, as well as their approach to addressing any problems. Indeed, this should be a critical element of any appointment process. Carol Hopper is a partner at Ropes & Gray LLP Photo credit: Universal Images Group/REX/Shutterstock