A few general notes about my campaign philosophy:
Experience will be awarded based on accomplishments more than methods. Kill the dragon to get the important magic item? Okay. Knock it out or poison it instead? Okay. Sneak past? Okay. (No extra XP for sneaking past going both ways, though.) Distract the dragon while having part of the party sneak past? Okay. Bargain with the dragon for the item? Okay.
Experience will also come from non-combat actions — diplomatic overtures, investigations, assorted stealth tasks, and so on.
But aside from experience, expect consequence to follow logically from your methods in all cases…
I also expect to give a reward for excellent role-playing.
Since I think it’s a nuisance to have players advance at different rates, everyone will gane XP at the same rate. (In other words, if you get XP for doing something cool, so do your party members.)
As far as conflict goes, many enemies or antagonists you encounter are likely to quit fighting when they realize they’re going to lose. The ambassador may withdraw if he realizes your arguments are swaying the crowd, and may attempt to regain face by finding a compromise. The angry wizard may teleport away if he gets hurt too badly. And so on. In some cases, a confrontation like this may also end not when the opponent flees (or dies), but when they surrender, or otherwise give up. Finally, it’s important to remember that D&D 3.5 does have non-lethal damage rules, which can be dealt by both weaponry and assorted specialized spells. There may be times when it’s useful to knock somebody out without having to worry if they’re going to bleed out. (Besides which, unnecessary deaths may be a threat to your adventuring company’s official status.)
Speaking of death: I fully expect character death to happen in this campaign. There will be some very dangerous encounters that could get very hairy. That being said, this is also a setting where death, while not cheap, is at least not too expensive. There are many friendly clerics who have a sufficient “in” with their deities to perform a resurrection spell to bring back a lost party member. Depending on the cleric and the temple, though, they may ask for compensation for their spent resources, or a favor at some later date. I expect that, in most cases, if your character dies, it will be an opportunity to choose between sticking with the current character, or building a new one if you are so inclined.
If the party is going up against something that’s way too hard, I’ll try to drop some hints that maybe you should consider a different approach. (Hint: Do not attempt to evangelize the Great Wyrm Mexorek about the Oneness of Pun-Pun. He’s probably heard it all before.)
Since your main activities lately have been pest control, especially for dire rats, as a group, the party should decide what your typical tactics have been. Do you just go in, and hack and slash? Set up baited traps? Poisoned baited traps? Knock out the rats, and release them into the wilds where they belong? Kill them and sell the corpses to the butchers in the kobold quarter? Or give the live animals to the alchemist down the street who wants them for gods-know-what purpose?
I’ll be putting up a summary of things in Moil and the ground-level operations of an officially chartered Adventuring Party next, including a map of the city, as my next thing, so you have a better sense of what things look like.