From 6 April 2011 all land agreements, whether new or pre-existing, will be brought within the prohibition of anticompetitive agreements contained in Chapter I of the Competition Act 1998. On 24 March 2011, the Office of Fair Trading (OFT) published its long-awaited final guidance as to the application of the Chapter I prohibition to land agreements in the UK (the “Guidance”). The publication of the Guidance follows an OFT consultation on draft guidance, which was published in October 2010.

Although some aspects of competition law have always applied equally to land agreements (eg merger control, the prohibition of abuse of a dominant position), competition law has, in reality, rarely been a key concern when considering a real estate deal. For commercial real estate, that will change and competition law will need to be at the forefront of the minds of those in the industry. The Guidance is intended to assist parties to land agreements in assessing their compatibility with competition law.

In finalising the Guidance, the OFT has made considerable amendments to the draft version. In particular, the OFT has provided further advice on the types of restriction that may fall within the Chapter I prohibition (and, equally usefully, those that normally will not) and prepared additional worked examples to help illustrate the application of competition law to various scenarios.

The Guidance is a little more practical than the version on which the OFT consulted. However, there remain considerable areas of uncertainty for those in the commercial real estate sector. It is also important to note that the Guidance is not binding and, in particular, is not binding on the courts, where many of the cases on the application of competition law to land agreements are likely to be decided.

What is the Chapter I prohibition?

Chapter I of the Competition Act 1998 prohibits agreements between undertakings which contain provisions whose object or effect are the appreciable prevention, restriction or distortion of competition.

Undertakings

An “undertaking” is widely defined to include any entity that is carrying out commercial or economic activities relating to goods or services. The Guidance specifically sets out that, as well as the obvious commercial organisations, agricultural co-operatives, non profit making organisations and public bodies that offer goods or services are also included. The definition is sufficiently wide that it is likely to include all parties to commercial real estate transactions. The prohibition does not apply to individuals unless they are acting in a business capacity, so residential transactions with a private individual will not be caught.

Agreements

The Chapter I prohibition applies to both written and oral agreements as well as informal “gentlemen’s” agreements. Planning obligations, such as those contained in agreements made under section 106 of the Town and Country Planning Act 1990, are specifically excluded from the prohibition.

Appreciability

The adverse impact on competition must be “appreciable”. This will require consideration of the specific background to the agreement, the terms of the agreement and the nature of the undertakings involved. It may well require technical investigation into the market shares of each of the parties and there is an assumption that, for most agreements (but not certain “hardcore” agreements, such as those that fix prices), there will be no appreciable effect on competition if:

  • the aggregate market share of the parties does not exceed 10% on any of the relevant markets affected by the agreement where the parties are competitors; or
  • the market share of each of the parties does not exceed 15% on any of the relevant markets affected by the agreement where the parties are not actual or potential competitors on any of the markets concerned.

In the Guidance, the OFT has indicated that, in fact, it is unlikely to take action if none of the parties to the agreement has a share of the relevant market which exceeds 30%.

The fact that the thresholds are exceeded does not necessarily mean that the agreement will be caught as other factors are taken into account in determining whether or not there is an appreciable effect on competition and, as mentioned above, some agreements are likely to be caught whatever the market share of the parties (eg, a restriction in a land agreement between competitors aimed at sharing markets where the clear object of the agreement is the restriction of competition).

However where the thresholds are exceeded parties should take particular care and seek specialist advice.

In working out whether the thresholds have been met, it is necessary to ascertain the extent of the particular market that is relevant to the agreement. Generally, this requires consideration of the “related market” and the market for land that is suitable for use in the related market. The related market will depend on the sector and will involve, in particular, looking at the goods and services that are substitutable with those of the business under consideration and the geographic area over which those products compete with other businesses selling the same products. So, for example, a coffee shop may compete with other premises selling food and beverages, such as sandwich bars and cafés. The geographic area over which a coffee shop competes is, however, likely to be much smaller than for a larger product, such as a car or a computer, where consumers could be expected to travel further to view competing products.

The Guidance has provided additional assistance in working out how to define these markets. This is highly technical and a full analysis is beyond the scope of this briefing. However, the Guidance does indicate that the OFT has, in previous merger cases between retail businesses, used a catchment area to define the geographical area of the related market. In delineating catchment areas, the OFT has previously used two different methods:

  •  “proxies or rules of thumb” – in the past the OFT has considered the area from which about 80% of a store’s customers or sales are drawn; and
  • the distance or drive-time from a store – so, in earlier cases, the OFT has considered a 20 minute drive-time catchment for cinemas; a 10 or 15 minute drive-time catchment for supermarkets of 1400 square metres and over; a 5 or 10 minute drive-time catchment for supermarkets of under 1400 square metres; and a 15 minute drive-time catchment for sports equipment stores.

Present and future circumstances

The compatibility of the agreement with the Chapter I prohibition must be kept under review. If circumstances change, an agreement which, did not infringe the Chapter I prohibition at the time that it was entered into, may be found to be in breach at a later date. Given the length of many land agreements, this is a difficult concept for the real estate industry to comprehend and there is very little in the Guidance to assist.

Exemptions

Even if an agreement does exist that may appreciably prevent, restrict or distort trade, it may be exempt from the prohibition if the parties can satisfy four cumulative criteria:

  • the agreement must contribute to improving production or distribution, or to promoting technical or economic progress (ie the benefits of the agreement outweigh or match its negative impact on competition); and
  • it must allow consumers a fair share of the resulting benefits; and
  • it must not impose restrictions beyond those indispensable to achieving those objectives (ie it must not go any further than is absolutely necessary); and
  • it must not afford the parties the possibility of eliminating competition in respect of a substantial part of the products in question.

What type of agreements could be caught by the Chapter I prohibition?

The Guidance makes it clear that the OFT anticipates that a relatively small proportion of land agreements will be caught by the Chapter I prohibition. The Guidance states that “parties who own or have an interest in land are generally free to determine how that land should be used or whether the land is suitable for use for a particular purpose”. This is a useful statement although it should be borne in mind that the Guidance is just that and is not legally binding on the OFT or, indeed, the courts. It is also essential to remember that, just because an agreement is one that may be caught by the Chapter I prohibition, it is not necessarily the case that that particular agreement will be caught. Each agreement will need to be looked at on its own facts.

Exclusivity agreements

An agreement whereby a landlord agrees with a tenant not to permit a competitor of the tenant to operate from land owned by the landlord may protect the tenant from competition and has the potential to foreclose competitors in the related market. It may be prohibited under Chapter I unless it can be shown that the agreement benefits from an exemption.

To benefit from an exemption, it must, in particular, be shown that exclusivity was essential for the tenant to take the lease and that it does not extend beyond the period absolutely necessary. In other sectors, a “safe harbour” duration of five years has been adopted for exclusivity arrangements and it was hoped that the Guidance would include some clarification on this point. However, the OFT has chosen not to do so and, instead, has suggested that it will take a more flexible approach, stating that:

such a restriction would be justified only for so long as is necessary to give the parties sufficient certainty that they will be able to recoup their investment in a development … in a retail context, for example, it may be relevant to take into account the time necessary for a store to reach mature sales (at a point when its sales are projected to grow at a rate at or around inflation) that is, a stable revenue and customer base to provide the required return on investment”.

Exclusivity agreements that are limited to five years have been increasing in popularity and it is unclear whether the OFT’s statement will change this. If agreeing an exclusivity arrangement, it will be vital to record in detail why it was considered essential in order for the deal to progress and why the particular duration was agreed and considered to go no further than was absolutely necessary.

Leasehold covenants

The OFT has stated that commercial property agreements that are unlikely to give rise to competition concerns include:

  • covenants relating to the payment of service charges and meeting of certain financial criteria;
  • restrictions imposed on a tenant regarding alterations, repairs, obstructions to the premises, applications for planning permission, advertisements or hours of use;
  • provisions which relate to the use of the premises.

There is a caveat that, where landowners are active in a related market and seek to restrict the use of land, there may be a restriction on competition. An example may be where a tenant bank decides to close one of two branches in a small town and underlet the closed premises but seeks to impose a restriction on the undertenant using the premises as a bank or building society.

The OFT’s comments in the Guidance on leasehold covenants are good news as there were fears that, for example, restrictive user covenants could be seen as barriers to market entry. The OFT accepts the landowner’s right to achieve a mix of retail tenants and, interestingly, appears actually to suggest that restrictive user covenants can be used in preference to exclusivity agreements of even limited duration. This may seem counter-intuitive to many real estate practitioners and it is recommended that caution is adopted until it is seen how the OFT approach this in practice.

Freehold covenants

Restrictive covenants, imposed on freehold land, may restrict the use of that land for the benefit of another party’s land. They frequently arise where the land has, at one time, been in common ownership and the selling party wishes to restrict the activity that can take place on the land that is leaving its control. For example, if land is being sold to a housing developer, there may be a restriction on the number of properties that are constructed on the site in order to preserve the amenity of the neighbouring land.

The OFT makes it clear that, in many cases, these restrictions will not restrict competition. However, where the landowner imposes the restriction to protect its own business from competition by restricting the availability of land for its competitors, the agreement may infringe the Chapter I prohibition. For example, where a business sells off a portion of its land, which it has been using as a public car park, and seeks to impose a covenant that the land sold is not used for car parking, there may be a breach of the Chapter I prohibition as the covenant is designed to protect the business of the selling party.

What happens if an agreement infringes the Chapter I prohibition?

An agreement that infringes Chapter I will be void and unenforceable. Whether the anti-competitive clause can be severed from the remainder of the agreement will depend on the particular agreement. However, the consequences of a land agreement as a whole being held to be void and unenforceable can be extremely serious.

For example:

  • if a lease that is excluded from the business tenancy security of tenure provisions of Part II of the Landlord and Tenant Act 1954 (“1954 Act”) is held to be void and unenforceable, the tenant will have been occupying the premises and paying rent. Although there are a number of possibilities as to the status of the tenant’s occupation, it may have a periodic tenancy, which automatically has the protection of the 1954 Act. If that proved to be the case and it wished to leave the premises, the tenant could serve a notice to quit. Alternatively, if it wanted to stay, it could seek to force a renewal of its lease and, if, for example, the landlord intended to redevelop the premises, the landlord would have to pay statutory compensation to terminate the tenant’s rights.
  • in the context of a freehold transfer containing anticompetitive provisions, a significant purchase price may have been paid for the land and court action may be required to seek to recover the sum paid.

Parties to an anti-competitive agreement can also face enforcement action by the OFT, who can impose significant fines of up to 10% of the infringing parties’ global group turnover. The Guidance makes a somewhat alarming statement that:

where a party has used best endeavours to amend or remove a clause in breach of the Chapter I prohibition from an agreement (and where relevant, to remove this restriction from the relevant land register), and has not sought to enforce it, the OFT may, depending on the relevant facts of each case, consider this to be a mitigating factor when determining the appropriate amount of any financial penalty (if the OFT considers that it is in fact appropriate to impose a financial penalty)”.

A footnote adds that “best endeavours do not necessarily include an obligation to make any payment to procure that a party consents to the release of the restrictive covenant”. A “best endeavours” obligation sets an extremely high bar and, given the severity of what is implied by these comments, the references to “may” and “necessarily” in this statement are extremely unhelpful.

The directors of infringing companies can also be disqualified from acting as company directors for a period of up to 15 years if they knew, or should have known, that their company was in breach of competition law.

Third parties that have suffered loss as a result of the anticompetitive agreement can also bring claims for damages and may be able to seek an injunction.

Where are issues most likely to arise in practice?

It is likely that most action in respect of anti-competitive land agreements will result from private litigation rather than investigations by the OFT. Competition angles are likely to be raised in disputes and in negotiations by parties seeking to benefit from the change in the law. For example, if a long exclusivity has been given to one tenant, a competitor may seek to bring a claim stating that it has been excluded from the market.

Compliance with competition law will become a key area for transactional due diligence and it is likely that buyers will focus on this area to ensure that they are aware of any potentially anti-competitive agreements that they will inherit on completion. Given the risk of significant fines by the OFT and of claims by third parties, sellers may find that they have to re-negotiate anti-competitive provisions before completion. Where the provision is felt to be less likely to infringe competition law, there is still a risk of pricechipping. Given the potential valuation impact on properties of there being prohibited anti-competitive agreements, it is likely that those financing purchases or refinancing loans secured against property interests will also wish to ascertain the position on due diligence.

Although the Guidance contains some helpful comments regarding leasehold covenants, tenants may still try to raise arguments regarding user covenants and hope, by doing so, to obtain an advantage in negotiations. The attitude of the courts to such arguments has also to be tested. As has already been said, the Guidance is merely guidance and is not legally binding. There is a possibility that the courts may interpret the legislation differently.

The spotlight is likely to be on exclusivity agreements and here there is considerable uncertainty. Not all existing exclusivity agreements will be anti-competitive and it is as problematic to treat all such agreements as unenforceable as to ignore the possibility that they might be unenforceable. Acting in breach of an enforceable exclusivity agreement, could place you in breach of contract and liable to damages and/or an injunction.

What steps should you take?

Identify existing exclusivity agreements

Given the focus of the Guidance on exclusivity agreements, it is, in particular, worth identifying such arrangements now and keeping a record of them and their duration. You will then need to review them regularly. Depending on the duration of the exclusivity and its effect on competition, you may also wish to seek to renegotiate the deal to terminate the exclusivity agreement.

Is it essential to grant the exclusivity agreement?

For new agreements, it is imperative to consider whether it is indispensable to the deal for there to be an exclusivity agreement. It is also essential that you consider the breadth of the exclusivity and ensure that it is no wider than necessary to achieve the desired goal. For example, does the exclusivity need to cover an entire product line to have the necessary effect or would protection against key brands be sufficient.

Calculating the market position of the landlord and tenant may be a complex exercise. If a tenant seeks exclusivity, the landlord may wish to request that the tenant undertakes the necessary economic analysis of the relevant market and market positions. However, landlords should bear in mind that they will need to ensure that they are content with the analysis: the fact that the tenant undertook the analysis will not protect the landlord from the potential penalties if the agreement is found to breach the Chapter I prohibition.

If an exclusivity agreement is granted, it is advisable for there to be a severability clause in the agreement; in a lease, it may also be of assistance to include wording to deal with the rental position if the exclusivity agreement were held to be unenforceable.

Other agreements

The Chapter I prohibition can catch any type of property agreement and a competition law claim can arise in unexpected circumstances. However, it is important to pay particular attention to agreements where common sense indicates that there could be a substantial concern. Examples include where there are retailers with large market shares (such as any of the large supermarkets) and cases where there is little available land and/or it is easier to achieve higher rents due to the demand for property in the area. It should also be noted that there are specific rules laid down by the Competition Commission relating to agreements with supermarkets.

Other high risk areas include any form of price fixing or market sharing between property holders. These agreements would have been caught before land agreements were brought within the Chapter I prohibition. It should also be borne in mind that dishonest price fixing and market sharing can constitute a criminal offence under the Enterprise Act 2002.

Record keeping

If it is concluded that the exclusivity or restriction is not anti‑competitive or benefits from an exemption, it is vital to keep good records to show why that conclusion was reached and the analysis that was undertaken. It is a good idea for there to be evidence that both parties agree the analysis. This may make it more difficult for the counterparty to try to use competition law to escape from the agreement at a later date.

Tenant mix policies

If exclusivities or restrictions are agreed in connection with a tenant mix policy, it would be helpful if the landlord’s policy was published in such a way that all tenants were aware of its existence. This would also be beneficial for the landlord trying to withhold consent to an assignment or underletting on tenant mix grounds.

Marketing

Beware of marketing hyperbole that could be cited back at you in the context of a claim that a restriction or exclusivity agreement is anti-competitive.

Conclusion

All those involved in the commercial real estate sector need to be alert to the changes that come into effect on 6 April 2011 and should put appropriate procedures and policies in place to ensure that they do not fall foul of competition law.