New competition rules for supermarkets

Hugh Picton Phillipps and Ilan Sherr examine how the Competition Commission's attempt to increase competition in the grocery market could limit supermarket's abilities to protect their local market position and effect real estate as a result

Following its investigation into the grocery sector, the Competition Commission is introducing a number of measures to counteract features in the grocery market that it has found to adversely affect competition. Though likely to face challenge, once implemented The Groceries (Controlled Land) Order 2009 will create great difficulties for large supermarkets’ attempts to impose and enforce restrictive arrangements that ensure a locally dominant position.

The Order will apply to any Large Grocery Retailer (LGR), defined to include Asda, The Co-operative, Marks and Spencer, Morrisons, Sainsbury’s, Somerfield, Tesco and Waitrose and any other retailer that the Office of Fair Trading (OFT) so designates. It is aimed at restrictive covenants and exclusivity arrangements which prevent or restrict grocery retailing and which benefit land owned by LGRs.

The Order requires LGRs with strong local market positions to terminate restrictive covenants and agree not to enforce existing exclusivity arrangements which restrict grocery retailing. In brief, the Order contains a list of sites which are burdened by restrictive covenants (Relevant Covenants) and exclusivity arrangements (Relevant Arrangements) that have been found by the Commission to restrict competition and which are prohibited.

The Order would require these Relevant Covenants to be released within six months and a competition test to be applied to all other restrictive covenants that restrict grocery retailing to determine whether they restrict competition. It would also prohibit LGRs from enforcing the Relevant Arrangements if they are more than five years old and requires a competition test to be applied to all other exclusivity arrangements that restrict grocery retailing to determine whether they restrict competition.

The competition test, as set out by the Order, will be failed by the particular LGR if there are three or fewer other supermarket brands within a catchment area and the supermarket retailer benefiting from the restrictive covenant or exclusivity arrangement has a market share exceeding 60 percent in the same catchment area. LGRs will also be prohibited from entering new restrictive covenants that restrict grocery retailing and new exclusivity arrangements with a duration of more than five years.

Finally, as proof that this legislation will be flexible and not present a blanket ban on such relationships, the Order contains lists of Relevant Covenants and Relevant Arrangements which have already been investigated and found not to be in breach of the competition test.

Difficulties
As with any new legislation, it is likely that there will be teething problems with the Order once it is passed. In particular, given the current state of the property market, it is questionable whether it is appropriate to impose regulations that will have the effect of making LGRs think twice about commencing new developments where they can no longer be certain that a land owner is not going to sell adjacent land to a competitor.

Similarly, as drafted, the Order may operate to prevent any LGR from acting as a developer of, for example, a retail scheme incorporating a supermarket. In such circumstances, standard forms of user clause that would typically be inserted in leases of units within the development would, technically, restrict grocery retailing, impacting on the developer’s ability to manage tenant mix and on the marketability of such a development.
There is also the danger that the Order will prevent LGRs from achieving legitimate aims through controls over land. While the Order contains a carve out so that restrictions can be imposed to ensure that adjacent land is only used as a car park, there are other good reasons why LGRs would seek to impose restrictions over adjacent land. For example, LGRs may restirct land to ensure access for servicing and goods delivery, yet could be caught by the Order.

Of course with legislation of this nature, LGRs have made representations to the Commission on the terms of the draft Order. It is hoped that from these such issues will be picked up when the Commission issues the final form of the Order.

Benefits
The Order looks to offer up good news for land owners and developers. Subject to the relevant competition test being satisfied, sites that previously were unattractive because they were burdened by Relevant Covenants or Relevant Arrangements may now become desirable for developers, investors or other retailers.
Acquisitions and disposals of land will be affected as sellers to and purchasers from LGRs will now feel in a stronger negotiating position and better able to resist requests for restrictions being placed on their use of land adjacent to that owned by the LGR.

When acquiring land (whether as prospective landlord, developer or as an LGR taking over a site from another retailer) which has the benefit of restrictive covenants or exclusivity arrangements, it will be necessary to consider enforceability from a competition law as well as a land law perspective. If unenforceable, there would appear to be a clear impact on value.

Although the Order has not yet come into force, it is open to an owner of land burdened by restrictive covenants which benefit an LGR to enter into negotiations with the LGR for a release on the basis that the covenants will fall foul of the Order once implemented.

Equally, once the Order has come into force, a land owner may agree with an LGR for the release of a covenant which the land owner considers falls foul of the competition test and negotiate with the LGR for its release. In the absence of agreement, the OFT will carry out the Competition test. Where the OFT confirms that the Relevant Covenant or Relevant Arrangement has failed the test, the LGR will have to release the affected land from the covenant or arrangement.

Implementation
The Land Registry has indicated that currently they do not have any information on how the release will work in practice. However, they expect that any releases required would be dealt with under their existing guidance and any party applying for a release would simply need to supply evidence that the Order had been complied with (it is expected that this will be in the form of a deed of release).It remains to be seen how effective this will be in practice.

The consultation period ended on 28 May 2009, and while all of the LGRs have given feedback to the Commission, there is currently no stated timetable either for the Commission to make further amendments to the Order, or for implementation of the Order.

Hugh Picton Phillips is a Real Estate Associate and Ilan Sherr is an EU and Competition Associate at Nabarro LLP.

Email: h.pictonphillipps@nabarro.com or i.sherr@nabarro.com