As from 6 April 2011, property transactions will be subject to the prohibition on anti-competitive agreements in Chapter I of the Competition Act 1998. Developers, investors and business occupiers all need to understand the scope of the prohibition and to review their existing and intended arrangements to ensure compatibility with the Act.
What has changed?
Chapter I of the Competition Act 1998 prohibits anti-competitive agreements whilst Chapter II prohibits the abuse of a dominant market position. Chapter II has always applied to property transactions and so is not dealt with in this bulletin, but “land agreements” were expressly excluded from the Chapter I prohibition. That exclusion has now been revoked with effect from 6 April 2011.
The revocation of the exclusion will bring all commercial property transactions within the ambit of Chapter I of the Act, including those entered into before the revocation takes effect; informal arrangements are also affected. As a result, businesses now need to review their property transactions to consider whether they might infringe the Act.
It is worth putting the changes into context. When the Act was introduced, there was a right to notify agreements for a ruling by the Office of Fair Trading (“OFT”) as to whether they infringed the prohibition. The OFT took the view that the vast majority of land agreements were innocuous and did not want to be swamped by thousands of “failsafe” notifications. The right to notify was subsequently abolished. Following an investigation into the grocery market, certain land restrictions affecting major grocery retailers were expressly prohibited to prevent “land banking1” and, almost as an afterthought, the OFT decided to revoke the exemption.
Parties to land agreements will now have to self-assess their agreements (as is the case with all other types of agreement) but
- only commercial rather than domestic transactions are covered;
- planning restrictions are still outside competition law; and
- the vast majority of agreements will still not be caught.
What are the risks?
The consequences of infringing the prohibition are potentially severe. The major risk is that an agreement which falls foul of the prohibition, and does not meet the criteria for exemption, is unenforceable. It may be possible to sever the offending provision from the document leaving the remainder in force. It is therefore sensible, going forward, to place provisions which might infringe the Act in a separate clause or schedule so that, if necessary, they can be deleted without damage to the remainder of the document. The OFT has power to order parties to cease or to modify conduct which breaches the prohibition and can impose a fine of up to 10 per cent of turnover. However, unless there are major consequences of the restriction or a clear abuse, this type of agreement is unlikely to be high priority. Third parties who suffer loss as a result of the offending agreement may claim damages or an injunction. In practice, however, such litigation remains rare.
The OFT has issued draft guidance to help businesses assess whether land agreements are compatible with competition law. The guidance is available at http://www.oft.gov.uk/news-and-updates/press/2010/108-10. What is an anti-competitive agreement?
An agreement is anti-competitive if:
- it has as its object or effect the prevention, restriction or distortion of competition;
- its effect on competition and trade within the UK is “appreciable”; and
- it does not qualify for exemption on the basis that its benefits outweigh its anti-competitive effect.
The OFT draft guidance identifies the following as the types of land agreement most likely to fall within the prohibition:
- an agreement that gives one party exclusivity or protection from competition, for example a landlord of a shopping centre guarantees one tenant the exclusive right to operate a sweet shop in that centre. This may have an appreciable impact on competition depending on the scope of the relevant market;
- an agreement between competitors which restricts their ability to behave independently in the market, for example an agreement to share markets by territory or by type or size of customer;
- an agreement which hampers or prevents access by competitors to supplies or sites (this is called “foreclosing” competitors from the market);
- an agreement which restricts the commercial freedom of a trading partner such as a distributor or supplier — for example, beer ties on a pub;
- an agreement where one or more of the parties has market power, that is the ability profitably to keep prices above competitive levels or restrict output or quality below competitive levels. For example, a company which owns all or substantially all of the land suitable for a particular use in a related market has market power over that market; and
- an agreement which raises barriers to entry for potential competitors in the related market — for example where there are a limited number of other suitable sites in the related market because of planning restrictions or because they are tied up in long term leases or because suitable sites need certain special qualities or must be in a particular location such as near a transport network.
A series of similar agreements may need to be considered together. For example, leases of shops within a centre might each permit use for the sale of different types of goods. A series of such covenants affecting the whole or a significant proportion of the centre might have the effect of preventing each tenant from facing competition within the centre even though none of the covenants alone has that effect. Whether that would amount to an appreciable impact on competition would depend on the scope of the relevant markets.
Defining the relevant market
In order to assess an agreement’s effect on competition it is necessary to define the relevant market in which the restriction operates. The market has two elements—the relevant product market and the relevant geographic market. The relevant product market means all the products (i.e., goods or services) which customers consider substitutable. The OFT would take the products subject to the restriction—say a coffee shop—and assume that someone has a monopoly of that product and tries to put the price up by a “small but significant” amount, generally 5-10%. If the customer would move to a different product—say a pub—that will also be included in the product market. The geographic market looks at how far the customer would reasonably travel to find a substitute faced with such a price rise—for example, for groceries, they tend to use a 10-minute drive time.
What is appreciable?
Usually an agreement will not be regarded as having an appreciable effect on competition in the following situations:
- where the agreement is between competitors and their aggregate market share is not more than 10 per cent on any of the relevant markets;
- where the parties are not competitors and the market share of each of them is not more than 15 per cent on any of the relevant markets; and
- the thresholds are reduced to 5 per cent where there is a cumulative effect of a network of similar agreements.
Market shares above these levels are not necessarily appreciable but will be analysed on the individual facts. The greater the market share, the greater the risk.
However, price fixing and other serious restrictions on competition will be capable of having an appreciable impact on competition regardless of the parties’ market shares.
An agreement is exempt from the prohibition if all of the following four conditions apply:
- the agreement contributes to improving production or distribution, or to promoting technical or economic progress;
- it allows consumers a fair share of the resulting benefits;
- it does not impose restrictions beyond those indispensable to achieving those objectives; and
- it does not afford the parties the possibility of eliminating competition in respect of a substantial part of the products in question.
Examples of the first condition (efficiency gains) are:
- establishing new retail outlets;
- more efficient distribution of products;
- a greater range of products available to consumers; and
- preserving the character of a building.
For example, an agreement for the development of a new shopping centre might give exclusivity rights to a department store. The restriction has a negative impact on competition but it makes the development economically viable and thereby contributes to the economic benefits which the development provides. Other examples are lease covenants which ensure a good tenant mix or a logical layout to the centre (for example by putting all food outlets in a food hall). Although they affect competition, they might also improve the centre for customers.
However, restrictions granting exclusivity to each retailer in the centre (rather than just restricting the use of each unit) would go further than is necessary to achieve those benefits and so would not satisfy the third of the four conditions. Similarly, it may be indispensable to give an anchor tenant a period of exclusivity to make it commercially viable for the tenant to invest in the centre, but if the period is longer than necessary then it might not satisfy the third condition for exemption.
For the second condition to be satisfied, the benefits to consumers must at least equal the negative effects. Benefits to the parties or wider social benefits are not sufficient. So, in the example above, the exemption would only apply if the benefits to consumers from the development of the centre equal or outweigh the negative effect of the lack of competition for the department store. The negative effects might include higher prices, a narrower range of goods or a lower quality of service. The greater the restriction, the greater must be the efficiencies and benefits to consumers to justify it.
In considering the fourth condition, potential as well as actual competition must be taken into account by looking at barriers to entry into the market.
The following examples are based on scenarios included in the draft OFT guidance. They illustrate the process necessary to assess whether the prohibition is infringed.
Scenario 1 – Anchor store
Facts: An anchor tenant takes a 10-year lease of a large unit in a new shopping centre. It is the only retailer prepared to make the level of commitment needed to ensure the success of the centre. To persuade the tenant to take the lease, the landlord agrees not to have any other department store in the centre for the term of the lease and any renewals. The centre is 10 minutes by car from the nearest town. There are no department stores in the town but there is one in another centre 20 minutes away by car and 10 minutes from the town.
Analysis: The agreement prevents competition from other department stores in the centre. There may be competition from the department store in the other centre, depending on the scope of the relevant market, and from other stores in the centre or the town. However, it is likely that the agreement would restrict competition. Does the exemption apply? The first condition is satisfied because the agreement facilitates the development of the centre which improves distribution. Consumers benefit from the new centre and competition is not eliminated so the second and fourth conditions are satisfied. However, the benefits could probably have been achieved by giving a restriction of limited duration, so the third condition for exemption is not satisfied and therefore the agreement would infringe the prohibition.
Scenario 2 – Coffee shop
Facts: The tenant of a coffee shop in a shopping centre agrees to pay a higher rent in return for the landlord agreeing not to have any other coffee shops or cafes in the centre. There is likely to be enough demand for several coffee shops to operate profitably in the centre.
Analysis: The relevant market is probably confined to the centre because a small but significant price rise at the coffee shop would be unlikely to make customers go outside the centre for a coffee or a snack., although the possibility of customers simply deciding not to buy a drink at all must also be taken into account. The agreement will have an adverse effect on competition because it raises a barrier to new competitors. There is no evidence of any benefits for consumers so the exemption would not apply. Therefore the agreement would infringe the prohibition.
Scenario 3 – Petrol station site
Facts: An oil company operates the only two petrol stations in a town. They are within 10 minutes of each other by car. The company closes one station and sells the site subject to a covenant not to use it as a petrol station. Another oil company was interested in buying the site.
Analysis: If there are other suitable sites which the other oil company or other operators could buy within the relevant market, then it is unlikely that the covenant would have a negative effect on competition. If there are no other suitable sites, then the covenant is more likely to infringe the prohibition. However, the covenant might still not breach the prohibition if there is sufficient competition from existing operators within the relevant market so that raising barriers to entry to a new competitor would not have an appreciable effect on competition. There is no evidence of any benefits which would bring the exemption into play.
Scenario 4 - Office block
Facts: Leases of units in an office block prevent use except as offices and prevent the landlord from letting units except for office use. There are plenty of other offices and retail premises available to let in the area. Can the landlord refuse to let a unit for retail use?
Analysis: The lease restrictions are unlikely to affect competition in the retail sector or competition between tenants in the block,nor are they likely to raise barriers to entry in any related market because there are plenty of other premises available in the area for office and retail use. Therefore the restrictions would not infringe the Act.
Scenario 5 – Betting office
Facts: There are two betting offices in the High Street of a small town; the nearest other town is 20 miles away. The owner of one of the betting offices sells a vacant retail unit next door subject to a covenant not to use it as a betting office.
Analysis: The relevant market is likely to include only the two betting offices in the High Street because customers are unlikely to travel to the next town to bet in response to a small but significant sustained price increase. The covenant is intended to make it more difficult to compete with the betting office, so it is likely to infringe the prohibition. Whether the impact is likely to be appreciable will depend on whether there could be potential entrants to the market who are foreclosed from doing so by the covenant. That will depend on whether there are other betting offices wanting to open in the town or might be in the future and whether there are other suitable sites. Future changes in circumstances must also be considered. There is no evidence of benefits which would bring the exemption into play.