New law applies Competition Act to restrictions in property contracts

A new law, taking effect in April 2011, will for the first time apply the full force of competition law to restrictive covenants and clauses in UK property contracts – including shopping mall leases and property sales. Covenants and clauses which breach the rules will be void and unenforceable, and the parties may face other sanctions too. The new rules will apply to existing contracts which were signed before April 2011, as well as to new contracts.

The new rules will affect landlords, tenants, vendors, purchasers, property developers, property investors and property financiers. Not every restrictive covenant will be prohibited – but they will all need to be assessed by the parties and their advisers. This briefing, prepared by the international legal practice Norton Rose Group, explains the practical implications of the new rules, and the steps which businesses can take to minimise risk.

What is the new law?

The UK Government has announced that a statutory instrument, The Competition Act 1998 (Land Agreements Exclusion and Revocation) Order 2004, is being revoked in April 2010. The revocation will come into force on 6 April 2011.

In plain terms, this means that, as of 6 April 2011, the UK’s Competition Act 1998 will for the first time apply fully to “land agreements” – that is, contracts and other commercial arrangements (including leases and property sales) in the property sector.

Until now, certain “land agreements” enjoyed the benefit of an “exclusion” which protected them from the Competition Act’s prohibition on agreements restrictive of competition – the so-called “Chapter I prohibition”. This exclusion was in the statutory instrument which is now being revoked. Its revocation, taking effect from 6 April 2011, means that from that date land agreements will no longer enjoy the benefit of the exclusion, and will be subject to the full force of the Competition Act.

The provisions of all land agreements will therefore be subject to scrutiny under the Chapter I prohibition. For the first time, restrictions on competition in all land agreements risk being held unlawful under UK competition law.

Crucially, once the revocation comes into force, on 6 April 2011, land agreements will be subject to scrutiny under the Chapter I prohibition whether they were entered into before or after 6 April 2011. The new legislation will therefore apply retroactively to pre-existing contracts. It is for this reason that there is a “transitional period” of a year until April 2011 for businesses to assess their existing contracts.

What kinds of provision are affected?

Not every restrictive covenant or provision will be caught. The Chapter I prohibition applies only to those provisions which are restrictive of competition in the production or sale of goods or services.

It is important to understand that competition law has regard not so much to the legal form or wording of a provision, as to its actual economic and commercial effect on competition.

This means that a clause which is restrictive in wording will not necessarily breach the prohibition, as its actual effects will not necessarily be restrictive of competition. (This point is explained more fully below, in the section headed “Assessing the restrictive provisions”.)

At the same time, however, where there is a restrictive effect on competition, the Chapter I prohibition will apply regardless of the legal form of a clause – it is not possible to “draft around” the rule while maintaining an anti-competitive effect, and the prohibition applies to non-legally binding commercial arrangements no less than to formal contracts.

The kinds of provision in property agreements which are most likely to be affected by the new legal development include:

  • restrictions and restrictive covenants in a shop, office or factory lease which limit the type of commercial activity which the tenant may undertake, especially if this is intended to protect the landlord or other tenants from competition
  • restrictions in a lease limiting the freedom of the landlord to let other premises to competitors of the tenant – for example, in a shopping centre where a landlord agrees with a retail tenant not to let other retail outlets to competitors of that tenant
  • restrictions on competition affecting retail outlets, restaurants or refreshment kiosks at sporting venues, events sites, exhibition halls, conference centres, and so on – including in connection with the London Olympics
  • restrictions accepted by a vendor of property not to sell adjacent property to a competitor of the buyer
  • restrictions in a lease requiring the tenant to obtain certain goods or services – for example, insurance or cleaning services – exclusively from one supplier, and not from competitors, may also be caught. (Indeed, this last category of restrictions never benefited from the protection of the exclusion in the first place, as they are not restrictions on the use of land.)

Exclusivity periods in property deals – where the seller agrees with a potential buyer not to negotiate with anyone else for a certain period – will generally not be caught, provided that the period is only a few months maximum.

Restrictions on development in planning agreements will be outside the prohibition if the only parties are the landowner and a local authority.

Consequences of breaching the prohibition

Provisions in a contract (restrictive covenants, clauses, and so on) which breach the Chapter I prohibition are automatically void and unenforceable in the courts1. In addition, third parties who are adversely affected by the unlawful provision – for example, a retailer excluded from a shopping mall by restrictions on competition in the shopping mall’s leases – may take legal proceedings in the courts to obtain an injunction or declaration against the restrictive provision, and/or to obtain compensatory damages from the parties for any losses they have sustained as a result.

The UK’s competition authority, the Office of Fair Trading (the OFT), may investigate alleged breaches of the Chapter I prohibition, either on its own initiative or following a complaint by a third party. If the OFT decides that a restrictive provision does breach the Chapter I prohibition, it may make a legally-binding order for termination or modification of the provision. The OFT also has powers to impose substantial fines on the parties to the agreement concerned, although fines are usually imposed only for the most seriously anti-competitive practices (and in practice it is unlikely that fines will be imposed for provisions in land agreements newly subject to the prohibition, at least in the initial aftermath of the exclusion being revoked).

Assessing the restrictive provisions - what will be permitted?

Restrictive provisions in property contracts and arrangements will now need to be assessed by the parties, and their advisers, to see whether or not they comply with the rules. This is a matter of self-assessment; there is no possibility of notifying or otherwise approaching the OFT or another competition authority to obtain authorisation for a contract or arrangement – it is incumbent on the parties to ensure that they are compliant, or take the risk of their agreement being challenged in the courts or by a competition authority.

There are three main grounds on which an apparently restrictive provision may, nevertheless, be permissible:

First - is competition really affected?

A restriction only breaches the Chapter I prohibition if it has an appreciable effect on competition in relevant markets. This requires proper assessment of its actual effect on competition in the particular circumstances of the arrangement, taking into account the goods or services concerned and the locality. The assessment will be based on competition case law and precedent, and economic analysis. For example, if the tenancy arrangements in a shopping mall provide that only one department store will be allowed in the mall, and competitors will be excluded from the mall, the assessment of whether that has a restrictive effect on competition may depend on whether that department store in fact faces competition from other department stores outside the shopping mall within, say, a 10-mile radius.

Second - de minimis

Agreements where the parties are below certain market share thresholds (10 to 15 per cent) will generally be regarded as de minimis and therefore outside the ambit of the Chapter I prohibition. The calculation of market share depends on defining the relevant market – for example, in measuring the market share of a retailer in a shopping mall, does one regard the shopping mall as the relevant market, or is the relevant market wider encompassing other retail outlets in the area? Again, that will depend on the particular circumstances of the case in question.

Third - exemption

Even if a restrictive provision comes within the ambit of the Chapter I prohibition, it can be treated as “exempt” from the prohibition if the parties can demonstrate (in broad terms) that it brings economic and consumer benefits, that the restrictive effects are no wider than is indispensable to achieving those benefits, and that it does not substantially eliminate competition.

An example of the kind of arrangement which might benefit from exemption is where a shopping mall developer might seek to justify provisions restricting competition against the department store that is the “anchor tenant” in the mall. The argument for exemption for such exclusivity would be that the establishment of the shopping mall brings economic and consumer benefits, and that the restriction is indispensable in that the shopping mall would not be able to attract enough tenants or rental to justify the investment in its establishment without an anchor tenant, and would not be able to attract an anchor tenant without the restriction. As always in competition law, this argument would need to be tested against the actual economic and commercial realities of the case in question.

In the Netherlands, where the Dutch national equivalent of the Chapter I prohibition has applied to land agreements for many years, the competition authorities have ruled that such exclusivity restrictions may merit exemption – but only if the restriction is no longer in duration than six years from the start of the first tenancy in the shopping mall; exclusivity going beyond six years is considered to be wider than indispensable to the economic benefits, and is prohibited under Dutch law. It remains to be seen whether the competition authorities and courts in Britain will take a similar view.

Another kind of restriction on user which might be exempt is where a tenant is required to operate a certain kind of store in order to have an appropriate “tenant mix” in a shopping centre – that is, to help ensure that the centre offers a wide range of shops and not just one type.

Managing risk - how should businesses in the property sector deal with the new laws?

The Government has granted a one-year period until 6 April 2011 for businesses in the property sector to comply with the new law. It may be that the OFT will issue guidance on how the law will be applied to property contracts, and some regard can be had to treatment of such restrictions under the competition law of other European countries. In any event, as explained above, each case will need to be assessed by companies and their advisers in the light of its actual economic and commercial circumstances.

For property owners, landlords and tenants:

  • restrictive provisions in existing agreements (purchase agreements, leases, and so on) will need to be reviewed to ensure compliance – and, if necessary, modified. It is probably sensible to conduct a full audit, aided by professional legal advisers specialising in competition law
  • the standard terms of new agreements should be examined, to ensure that they are compliant
  • it is sensible to have competition compliance training for staff involved in negotiating commercial terms.

For prospective investors and acquirers of property portfolios:

  • due diligence should include checking for potentially unlawful restrictive provisions, to see whether there might be exposure and liabilities for breach (or possible breach) of competition law
  • it may be sensible to secure warranties against such liabilities, as is common practice for acquisition agreements in other commercial sectors outside the property industry.

Retailers will wish to check the protections which they may enjoy contractually against competition – eg, exclusivity – to see whether these are in fact enforceable.

Competition and property law specialists at Norton Rose are able to assist you in these matters.