Are exclusivity clauses in leases sustainable?

The Competition Act 1998 prohibits any agreement between undertakings who seek to effect the prevention, restriction or distortion of competition in UK markets. This is commonly known as the “Chapter I Prohibition”. The Exclusion Order protected certain “land agreements” from the remit of the Act. The rationale behind this was a commonly held view that land agreements do not have a significant effect on competition. Furthermore, there was also a desire to prevent the Office of Fair Trading (OFT” from being bombarded with requests.

Following an investigation by the Competition Commission into the groceries market, it was found that grocery retailers were using land agreements in order to reduce competition, for example by buying and selling strategic parcels of land and imposing restrictive covenants that prevented competitors from opening up stores in certain areas. The Competition Commission believed that such restrictions (together with other considerations, such as the operation of the planning regime) were capable of having an adverse effect on competition. This, coupled with the fact that there is no longer an ability to notify agreements to the OFT to assess their potential anti-competitive effect, prompted a full review of the position. The Department for Business Industries and Skill (BIS) consulted on the possible options available and its initial view was that the most appropriate course of action was to repeal the Exclusion Order in its entirety. The then Labour government endorsed this view, resulting in the draft statute; “The Competition Act 1998 (Land Agreements Exclusion Revocation) Order 2010, which was finally enacted on 29 June 2010.

What will be caught?
The repeal of the Exclusion Order means that a variety of provisions in land agreements may be caught. These include:
- Restrictive covenants in leases which prohibit a landlord from letting other premises to a named competitor or a specific type of operator (for example in a shopping centre or business park)
- Restrictive covenants in leases that prevent the tenant from using the property for certain specified uses (for example in a high quality shopping centre, a landlord may well wish to prevent a tenant from selling discount goods so as to maintain the quality of goods sold in the centre); and
- Restrictive covenants in sale agreements preventing the sale of adjacent property by the seller to a competitor of the buyer.

Effects on leases
Land agreements will now have to be self-assessed by the parties for any anti-competitive effect. There is no mechanism to get advance clearance from the OFT. This could potentially mean that restrictive covenants and exclusivity clauses in leases could no longer be viable.

Pending any guidance from the OFT (which is due to be issued ‘as soon as practicable’), it is difficult to say exactly how the new legislation will operate. It is clear that restrictive provisions in leases that breach the anti-competition legislation and do not fall within one of the potential exemptions will be void and unenforceable. Parties will be forced to rely on the drafting of the rest of the agreement to see whether these restrictive provisions can be severed from it.

There are however some circumstances where restrictive provisions will continue to be acceptable. The considerations will to a large degree depend on the facts of each individual case. The pertinent questions to be asked are as follows:
1. What will be the effect on competition? A common sense approach should be taken to ascertain whether the restriction will have an appreciable effect on competition. For example, a covenant in a lease that provides that only one department store will be permitted in a shopping centre is unlikely to distort competition if there are other department stores within a sensible radius of the shopping centre. The question is whether consumers have a realistic alternative choice and whether there is effective competition from outside the shopping centre. Putting in place a sensible retail policy for the centre would also help.
2. Does the restriction bring consumer and economic benefits? Are there wider ranging advantages that outweigh the anti competitive effects of the restriction? An example of this would be a landlord looking to attract an anchor tenant in a shopping centre, and that tenant insisting on protecting its position via the application of a covenant on the landlord preventing a named operator in the scheme. If the restriction is indispensible to attracting a particular tenant, it is likely to be upheld as the benefit for the landlord in securing a particular anchor tenant may well bring greater economic and commercial benefits to the community as a whole.
3. What is the market share of the parties to the agreement? In cases where the parties to the restrictive agreement have only a slight market share (10-15%) they will generally seem to fall outside the ambit of the competition regime.

Conclusions
There is mixed commentary about the effects that the Revocation Order might have on property transactions. The BIS consultation suggests the repeal of the Exclusion Order should not have as dramatic an effect on the property industry as people are anticipating. The Exclusion Order never meant that land agreements were incapable of infringing competition law. The intention was not to provide a safe harbour for anti competitive land agreements and so to a degree the repeal should not have a material effect in terms of cost or the content of property agreements.

Until any guidance is received from the OFT, a cautious approach should be advised. Clients should start the process of reviewing existing agreements for their potential anti-competitive effects now. The penalties for breach of the competition regime are not insignificant. These range from the striking out of restrictive clauses, huge fines of up to 10 percent of world wide turnover and also the further threat of third party legal action by the excluded third party that has been adversely affected by the restriction. However, we still strongly believe that in the vast majority of situations with the right protection some exclusivity clauses in leases will be sustainable, most particularly for retailers who do not have a coverted widespread share within the market.