In our previous analysis, "Competition law and land agreements: safe as houses?" we analysed how, from 6 April 2011, all land agreements will become subject to competition law. Following a consultation which ran from October 2010 to January 2011, the Office of Fair Trading (OFT) has now released the final form of its guidance.
The principles of competition law do not in themselves distinguish between land agreements and other types of agreement. The guidance is intended to assist in applying these general principles to land agreements. It concentrates on restrictions which affect the way in which land may be used, or how a right over land may be exercised.
The guidance sets out the relevant principles of competition law, along with examples of activities the OFT is likely to consider anticompetitive. Perhaps more importantly, the guidance also gives examples of how exemption criteria can be used in certain circumstances to save agreements or aspects of agreements that would otherwise be deemed unenforceable. In an addition from the draft guidance published in October 2010, the final form guidance also gives an indication of the types of agreements which would be unlikely to be the subject of action by the OFT.
What sort of agreements are affected?
The guidance defines land agreements as agreements which create, alter, transfer or terminate an interest in land. Examples of restrictions which could be affected include:
- freehold restrictive covenants
- a landlord covenant not to let another unit in its development to a competitor of an existing tenant
- use clauses in leases.
Agreements which are entered into before, as well as after, 6 April 2011 are affected. Planning agreements entered into under section 106 of the Town and Country Planning Act 1990 are, however, excluded from the prohibition.
How competition law will apply
The prohibition on anti-competitive agreements (the prohibition) is contained in Chapter I of the Competition Act 1998. To assess whether a land agreement is caught by the prohibition, it is necessary to consider:
- whether the agreement has an appreciable effect on competition; and, if it does,
- whether it benefits from exemption.
In order to determine whether a land agreement has an appreciable effect on competition, it is necessary to define the relevant market within which the effect is felt. For example, where a restriction affects the use to which premises can be put, the availability of other land for the purpose in question within the defined market will affect whether or not the restriction is anti-competitive.
Sites suitable for use in the relevant market may have special qualities whereby a restriction is all the more likely to be appreciable. For example, a restriction which prevents land from being used as a superstore is more likely to have an appreciable effect on competition than a restriction which prevents a unit on the high street from being used for a particular kind of retail. This is because there are likely to be more sites which are suitable for a small high street store than for a superstore.
Planning restrictions may also be a factor. Where the number of other sites suitable for a particular use is limited by planning laws, a restriction on that use in a land agreement is more likely to breach the prohibition. It is important to bear in mind however that planning policies can change, thus affecting the assessment of the agreement (see "What happens if a restriction is found to be anti-competitive?", below).
In assessing the effect of a restriction in a land agreement, it can be helpful to consider what the competitive situation would be in the absence of the restriction in question. The share of the relevant market which each of the parties to the agreement has will also affect whether or not the effect of a restriction is "appreciable" (see "What sort of restrictions are unlikely to fall foul of the prohibition?", below).
As noted above, even if a restriction falls within the prohibition, it may qualify for exemption from that prohibition. The guidance sets out the criteria which have to be met for exemption from the prohibition to apply. The criteria are cumulative and it may not always be easy to meet them.
In order to be exempt, the benefits of the agreement must outweigh (or at least match) its negative effect on competition. Benefits which may be taken into account include the creation of a new retail outlet, or a greater range of products being made available to consumers.
In addition, in order to qualify for exemption, a restriction must be "indispensable". The question is not whether in the absence of the restriction the agreement would not have been concluded, but whether the benefits could have been achieved by means of a less restrictive agreement. Restrictions of a shorter duration are more likely to be considered indispensable.
Agreements entered into by individuals
The prohibition applies to agreements between "undertakings". An undertaking is an entity which is carrying out commercial or economic activities, and will include companies, partnerships and sole traders. Importantly, an agreement which is entered into by an individual (whether with another individual, or with an undertaking) will not be caught, provided that the individual is not acting as a business.
This means that most sales and lettings of residential property will not be caught by the rules.
There is no exhaustive list of types of restriction which do or do not infringe the prohibition. Whether a particular land agreement infringes the prohibition will depend on the context in which it operates. The guidance does however give a number of examples:
Tenant granted exclusivity
A landlord of a shopping centre grants a lease to a coffee shop. The lease contains an exclusivity clause, by which the landlord agrees that there will be no other coffee shops in the centre. Demand estimates for refreshments in the centre suggest that it could support more than one coffee shop. The only other retailer selling hot beverages is a fast food outlet.
The guidance states that this type of restriction could appreciably restrict competition, depending on the scope of the relevant market and the extent of competition that the coffee shop faces in that market. It is unlikely that the relevant geographic market will extend beyond the shopping centre itself, because most customers of the shopping centre are not prepared to go very far to buy alternative drinks. It might be difficult to argue that the exclusivity clause is indispensable to facilitate investment in the coffee shop. The agreement is unlikely to meet the exemption criteria and the restriction would probably be unenforceable.
Tenant use covenant in a lease
The guidance acknowledges that a landlord will usually specify a permitted use in a lease. The OFT states that, in most cases, use clauses are unlikely to restrict competition. This includes where the owner of a shopping centre or retail park restricts the specific line of business that may be carried on by the tenant in order to achieve a particular tenant mix. Where the tenant benefits from an exclusivity covenant however, it will be necessary to consider whether the agreement may appreciably restrict competition.
Another example of where a use covenant may have the potential to restrict competition is where a landowner seeks to limit the availability of land to its competitors in a market in which it is active. For example, a land-owner who operates a number of convenience stores in a particular area may limit how a lessee of a particular site may use the property, by stipulating that the lessee may not use the site as a convenience store (or conversely by stipulating that it must be used for a particular purpose other than as a convenience store). This has the potential to restrict competition in the market for convenience stores.
This example relates to the construction of a new shopping centre, ten minutes' drive from the nearest town centre. Most of the customers for the new shopping centre will come from within a drive-time of 25 minutes.
The new shopping centre is about 15 minutes by car from another shopping centre. This shopping centre is on the other side of the town and contains one department store, operated by a retailer called Buy More.
The developer of the new centre offers a 25-year lease to Buy & Buy, a rival of Buy More, to be the anchor tenant of the centre. The financial commitment of Buy & Buy is key for the developer to obtain finance for the project.
The lease to Buy & Buy contains a covenant by the landlord that it will not allow any other department store in the centre which would compete with Buy & Buy. There will be around 20 small and medium size retail units in the centre, which will compete with Buy & Buy to a certain extent on some products.
The guidance states that it is possible that this restriction may not fall within the prohibition if it could be demonstrated that the agreement facilitates market entry as a result of the building of the shopping centre, which would not have occurred at all without the existence of the agreement.
If it cannot be shown that the agreement enables market entry, whether the restriction has an appreciable effect on competition will depend on the scope of the market in which Buy & Buy competes for customers. Based on the 25 minute drive-time from which Buy & Buy's customers are derived, Buy & Buy may face competition from the department store in the other shopping centre, and from other stores in the town. On the basis that Buy & Buy competes in a sufficiently wide and competitive market, it may be that the exclusivity clause does not have an appreciable effect on competition. The guidance notes that there may also be other land available for other potential department stores.
If the exclusivity clause was found to appreciably restrict competition, it would be necessary to consider whether it would benefit from exemption. It facilitates the development of a new shopping centre, which increases overall choice and competition in the town. Investment in the shopping centre could not have taken place without a period of guaranteed exclusivity, and therefore the exclusivity provision is "indispensable" to the benefits produced by the agreement.
However, an exclusivity provision of unlimited duration is unlikely to be necessary in order to protect Buy & Buy's investment, or ensure the overall profitability of the centre. An exclusivity period of limited duration could benefit from exemption. The appropriate duration of the exclusivity provision needs to be determined taking into account the economic and commercial conditions in which the agreement will be implemented. In particular, it may be relevant to take into account the time necessary for a store to reach a stable revenue and customer base to provide the required return on investment.
It is important to note that the courts will not step in to re-write an offending clause by inserting what they consider a reasonable period to be. It may therefore be better for the parties to agree a time limit from the outset.
Covenants restricting the use of freehold land
The guidance states that, in most cases, restrictive covenants restricting the use of freehold land will not restrict competition. However, where a landowner stipulates how a property should be used in order to limit the availability of land to its competitors, this has the potential to restrict competition.
An example is given relating to the sale of a petrol station. The seller owns another petrol station in the same town, ten minutes' drive away, which it is retaining. There are no other petrol stations within a ten minute drive-time.
The seller wants to prevent the land being sold in the future to potential rival petrol stations, and so includes a covenant in the transfer that the land cannot be used as a petrol station.
Whether this restriction appreciably restricts competition depends on the scope of the market for the sale of petrol and the extent of competition in that market. The scope of the market can be determined by the distance that the majority of customers are prepared to travel to fill their tanks at the seller's retained petrol station.
It is unlikely that the covenant will have an effect on competition if there are many other suitable sites for use as petrol stations, as this would mean that new entrants could establish a petrol station in future.
If there are no other suitable sites, it is more likely that the covenant will be held to restrict competition to an appreciable degree. However, it is still necessary to consider the extent to which the seller faces competition from other sources. In this example, it is assumed that the time which customers would be prepared to drive to buy petrol is ten minutes. The seller does not face any competition within this market, and so the restrictive covenant is likely to appreciably restrict competition.
It is clear from this example that the analysis of the covenant may change over time. Even though the agreement may not have an appreciable effect on competition when it is entered into, it may do subsequently as a result of a change in circumstances such as the availability of other suitable sites (see "What happens if a restriction is found to be anti-competitive?", below).
A second example is given in the guidance of a restrictive covenant which prevents land adjacent to a theatre from being used for certain industrial purposes for so long as the theatre remains in place. The guidance states that this restriction is unlikely to infringe the prohibition. It does not prevent competitors of the party which owns the theatre from entering the market. The restriction lasts only so long as the theatre remains in place, and so is no wider than is necessary to achieve its objective of avoiding interferences with use of the theatre.
The guidance states that, for the purposes of the prohibition, the OFT considers that the parties to an agreement will be the original contracting parties. However, restrictive covenants can bind successors in title to the burdened land, and can be enforced by purchasers of the benefited land. The guidance states that the OFT will consider on a case-by-case basis whether a restrictive covenant is an "agreement" between successors. The OFT considers that it may be relevant to take into account whether a party is aware of a restriction and whether a party is seeking to enforce a restriction. This is curious, as it suggests that the validity of a restrictive covenant depends not only on market conditions, but on whether the undertakings concerned are aware of it, which produces an unwelcome lack of certainty.
Planning permission allocation between residential developers
One of the examples which has been introduced since the draft guidance was originally published relates to the development of a large site by a residential developer. If the developer chooses to develop part only of its site and sells the rest of the site to two of its competitors, the developer is likely to impose a restriction on the number of houses that may be built on the parts which are sold. This is to avoid more houses being built than is permitted under the planning permission for the site.
The guidance states that this arrangement is unlikely to infringe the prohibition. A restriction which is subordinate to the main transaction and inseparably linked to it may fall outside the scope of the prohibition altogether. The restriction must be objectively necessary for the implementation of the main transaction and be proportionate to it.
In this case, the restriction is necessary for all parties to know with a sufficient degree of certainty how the terms of the planning permission apply to each part of the site. None of the parties would have been able to enter into the agreement without this knowledge.
What sort of restrictions are unlikely to fall foul of the prohibition?
The guidance states that obligations or restrictions in land agreements are unlikely to be deemed to appreciably affect competition where the agreement does not dampen competition in the market for the economic activity for which the land is being used, or prevent potential competitors from entering that market.
This should be contrasted with a situation where the parties to a land agreement are competitors in a relevant market and a restriction regarding the use of land is aimed at sharing the market between them. This is likely to constitute a serious infringement of competition law. (See however the example above relating to the allocation of planning permission between residential developers).
Other types of restriction may be prohibited if they raise barriers to entry in a particular market. However, this sort of restriction is unlikely to appreciably restrict competition unless one of the parties to the agreement possesses "market power". Market power arises where an entity does not face effective competitive pressure, so that it can (for example) maintain prices above competitive levels, or reduce quality below those levels. There is unlikely to be a breach of the prohibition where there is sufficient competition from existing competitors in the market, or other suitable land is available for use by other competitors.
Unless the agreement contains a "hardcore" restriction of competition (for example, an agreement to fix prices), the OFT considers that an agreement will not appreciably restrict competition:
- where the agreement is between competing undertakings, if the aggregate market share of the parties to the agreement does not exceed 10%
- where the agreement is not between competing undertakings, if the market share of each of the parties to the agreement does not exceed 15%.
In addition, the guidance states that the OFT is generally unlikely to take further action in respect of a land agreement where none of the parties to the agreement has a market share exceeding 30%.
This does not mean that agreements where the parties have smaller market shares will not breach competition law. It is also important to bear in mind that the "market" for these purposes could be relatively small (for example, the market for hot drinks in a particular shopping centre). The market share will usually be calculated according to value of sales. However, in retail markets, if there are four or more independent fascias in the relevant market the OFT is likely to take the view that the 30% market share threshold is not exceeded.
The OFT has listed provisions which it considers are unlikely to give rise to competition concerns:
- covenants relating to payment of service charges, and meeting of certain financial criteria
- tenant covenants relating to repairs, alterations, obstructions to the premises, applications for planning permission, advertisements, or hours of use
- covenants which restrict activities that may be carried out on an adjacent property which could interfere with enjoyment of the benefited property.
What happens if a restriction is found to be anti-competitive?
A restriction which offends competition law will be void and unenforceable. Since land agreements are often difficult to unwind, it will usually be desirable for an agreement to provide for potentially offending clauses to be struck out without affecting the entire agreement. Alternatively, if the anti-competitive restriction is a major consideration in the commercial terms of the contract, the parties may wish to provide for what is to happen in the event that the restriction becomes unenforceable.
The position is complicated by the fact that the competition law assessment of a restriction may change, depending on when it is carried out. We noted above that an agreement which does not restrict competition within present market conditions may become anticompetitive if market conditions change. Similarly, an agreement which infringes the prohibition at the time when it is entered into may cease to be void and become enforceable at a later stage because of a change in circumstances. The factors which bring about the relevant changes in the economic context may be entirely outside the parties' control; such as a nearby competitor going out of business.
The guidance refers to this as "transient voidness". This is a difficult concept to apply, particularly to an agreement which creates or transfers an interest in land. As mentioned above, it is therefore even more important to ensure that any provision which could potentially infringe the prohibition is capable of being severed from the rest of the agreement.
There are other possible sanctions if an agreement is found to be anti-competitive, such as fines, or damages claims - see our earlier alert.
What does this mean for my business?
Negotiating new restrictions
Any new covenants imposed on the sale of a freehold will have to be assessed in light of the prohibition. Will it be possible to enforce the benefit, or alternatively challenge the burden, of the new covenants? The same issues will apply with regard to covenants imposed on the grant of new leases. Traditionally accepted methods of ensuring a new store's profitability (for example, exclusivity agreements within a shopping centre) may no longer be enforceable, so any new agreements will have to be drafted to avoid anticompetitive effects, or to ensure that they qualify for exemption.
From 6 April, competition law will apply to all land agreements - even those entered into before that date. Existing covenants for both freehold and leasehold properties may cease to be enforceable, and become subject to challenge. If a covenant appears to breach the prohibition, it is worth examining whether the exemption criteria may apply. If not, the parties may be able to re-negotiate the provision to ensure that it remains enforceable.
The guidance states that the OFT expects that only a minority of restrictions in land agreements will be anticompetitive. However, the need to define the relevant market when assessing the enforceability of a particular restriction means that each agreement will need to be considered individually, in its own context.