Legal briefing | Real Estate, Retail Funds, Competition |

Restrictive covenants favouring anchor tenants: are they in restraint of trade?

Overview

The Supreme Court has ruled that a restrictive covenant in favour of an anchor tenant was not subject to the doctrine of restraint of trade. But does this mean that anchor tenants now have a free hand to negotiate whatever protection from competition they can get from a landlord?  And that landlords can't use the law to push back against such demands?

Anchor tenants and restrictive covenants

An anchor tenant can play an important role in the initial development and the ongoing success of a shopping centre, in that they are often among the first shops to open, usually occupy a central space and draw in both shoppers and other retailers.  They are therefore in a better negotiating position than other prospective tenants and can usually obtain favourable terms from the landlord, ranging from financial incentives such as rent-free periods or contributions to fit-out works through to commercial benefits such as exclusivity agreements in which the landlord agrees not to lease other units to the tenant's competitors. 

In Peninsula Securities Ltd (Respondent) v Dunnes Stores (Bangor) Ltd (Appellant) (Northern Ireland) [2020] UKSC 36, the Supreme Court had to consider whether one such agreement fell within the common law doctrine against restraint of trade.  A covenant which engages the doctrine would be unenforceable unless it is deemed to be reasonable. 

What happened in this case?

The case concerned the development of a shopping centre in Springtown, Londonderry. When it was initially constructed in 1980 the developer, Mr Shortall, persuaded Dunnes Stores to take a long lease as anchor tenant of the scheme. As part of the deal, to assuage Dunnes' concerns about the viability of their new store in a location which was described as being an "economic and political wasteland" at that time, Mr Shortall agreed that he would not grant a lease of more than 3,000 square feet in the shopping centre to another tenant which also sold groceries or textile goods for the duration of the lease (999 years).

In recent years, the shopping centre has declined. Mr Shortall argues that the restrictive covenant is partly to blame for this situation as it hampered his ability to agree other leases of substantial stores to major retailers.  Since 2010, he has been trying to obtain a release of the restrictive covenant, through both the Lands Tribunal and the Courts. 

What is the basis for the challenge to the restriction?

There are several strands to Mr Shortall's argument but his main three lines of attack are as follows:

1. The restriction is void under section 2 of the Competition Act 1998. This prohibits agreements which prevent, restrict or distort competition.  A covenant of this nature may be prohibited if it has the effect of restricting competition by raising barriers to entry (or expansion) in a particular market and one or more of the parties to the agreement possesses 'market power' in the relevant market.  This is unlikely to arise where there is sufficient competition from existing competitors in the related market, or where other suitable land is available for use in the related market by other competitors.

Mr Shortall's claim under this argument was withdrawn in response to expert evidence from Dunnes.  This may have been because Dunnes were able to show that the covenant does not have any appreciable effect on competition in the local area, or (perhaps less plausibly from a competition law perspective – see further below) that it enabled market entry because without it the shopping centre may not have been built in the first place.

2. The restriction should be declared void or modified by the Lands Tribunal: Mr Shortall argued that under article 4 of the Property (Northern Ireland) Order 1978 (SI 1978/459) (“the 1978 Order"), the restriction amounted to an impediment to his enjoyment of the land and should therefore be extinguished or modified by increasing the cap from 3,000 square feet to 55,000 square feet. 

WHAT DOES THE LANDS TRIBUNAL HAVE TO CONSIDER?

Much like section 84 of the Law of Property Act 1925 which applies in England and Wales, the 1978 Order requires the Tribunal to consider the period at, the circumstances in, and the purposes for which the impediment was created or imposed; any change in the character of the land or neighbourhood; any public interest in the land; any trend shown by planning permissions granted or refused in the vicinity of the land; whether the impediment secures any practical benefit to any person and, if it does so, the nature and extent of that benefit; whether the obligation has become unduly onerous in comparison with the benefit to be derived from it; whether the person entitled to the benefit of the impediment has agreed either expressly or by implication to the impediment being modified or extinguished; and any other material circumstances.

In the Lands Tribunal, where this claim was made, Mr Shortall had included in his claims some aspects of his third line of argument, and had to accept that the Tribunal lacked jurisdiction to determine this common law claim, which could only be decided by the High Court. 

3. The restriction is unenforceable by Dunnes because it is in restraint of trade: in particular, Mr Shortall argued that the scope of the restriction is unreasonable in that it prevents him from revitalising the shopping centre by granting new lease of large units to other key retailers.  This was the focus of the case in the High Court, given that the Lands Tribunal did not have jurisdiction. 

What happened in the High Court and the Court of Appeal?

In the High Court, the judge held that, following the House of Lords decision in Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd [1968] AC 269, the first question that must be answered is whether Mr Shortall had surrendered a pre-existing freedom to use the land when it entered into the restrictive covenant. In her view, Mr Shortall had done so whereas the company to which he assigned the shopping centre in 1983 did not, even though he owns that company. She therefore decided that the doctrine ceased to be engaged in 1983. Mr Shortall appealed to the Court of Appeal, which decided in his favour.  The tenant then appealed to the Supreme Court, which had to consider part of this line of argument: does the restrictive covenant engage the doctrine against restraint of trade? Until that was decided, the courts could not consider whether or not the restraint is unreasonable and therefore unenforceable.

What did the Supreme Court decide?

The Supreme Court decided to depart from the Esso decision on the basis that it has been heavily criticised, does not reflect commercial reality or any public policy rationale and has been rejected in several overseas jurisdictions such as those in Australia and parts of Canada.

Furthermore, they recognised that the covenant was not unusual in leases to anchor tenants in shopping centres, and as such it could be seen as encouraging trade rather than engaging the doctrine of restraint of trade.  The Court preferred to follow the criterion favoured by Lord Wilberforce in the Esso case, known as the “trading society” test, which asks whether the agreement in issue has become acceptable and necessary as part of the structure of a trading society (rather than whether a pre-existing freedom was given up).  It was satisfied that "it has long been accepted and normal for the grant of a long lease in part of a shopping centre to include a restrictive covenant on the part of the lessor in relation to the use of other parts of the centre."

The Court emphasised that when Mr Shortall entered into the restrictive covenant he "was faced with a free but limited choice: to take Dunnes on the terms offered, or not to have an anchor tenant at all."  When he accepted those terms it was an intrinsic part of his business as developer.  Far from acting as a constraint, the lease with Dunnes containing the covenant had facilitated the development of Mr Shortall's wider business, namely the shopping centre.  In view of this, he should not be excused from honouring his contract based on the doctrine of restraint of trade.

WHAT ABOUT THE LANDS TRIBUNAL CLAIM?

Although it found against Mr Shortall on restraint of trade, the Supreme Court noted that he still had the possibility of relief in the Lands Tribunal pursuant to the 1978 Order. It viewed this as a more appropriate forum for raising any challenge to the restriction based on its effect having become disproportionate over time. 

Given the Supreme Court's emphasis that restrictions of this nature are prima facie acceptable, it may be difficult for Mr Shortall to persuade the Tribunal to simply discharge the restriction in full.  However, he may still be able to persuade the Tribunal to modify it if he can show that there has been a relevant change in circumstances, as compared with when he entered into the lease.  For  example, he may seek to argue that Derry is no longer an "economic and political wasteland" and that consequently the relatively broad scope of the restriction (preventing leases of units of 3000 sq ft for groceries or textiles for the entire 999 year duration of the lease) is disproportionate and should be adjusted.

What does this judgment mean for developers and landlords?

The message this judgment sends to other shopping centre landlords is that it is likely to be difficult to challenge restrictive covenants favouring anchor tenants based on the doctrine of restraint of trade.  Landlords will, however, be interested to follow the progress of the case in the Lands Tribunal to see if the covenant is released or reduced in scope.  On a practical note, landlords considering seeking a release or modification from the Tribunal should bear in mind that contested applications still take 12 months plus to be heard and often this is too long for the deal that a covenantor is hoping to do.  They should also bear in mind the possibility of arguing that such a covenant breaches the Competition Act 1998 (see discussion below under "What does this judgment mean for anchor tenants?").  Both these legal constraints are worth bearing in mind in negotiations with anchor tenants over the scope of restrictive covenants. 

What does this judgment mean for anchor tenants?

Although the case only considered one aspect of the developer's case, and did not discuss whether the covenant itself was reasonable, its departure from the Esso principle in favour of a recognition of market norms is significant. The case therefore provides some reassurance for retail tenants in this turbulent time to know that their landlords will find it difficult to use restraint of trade to argue that exclusivity agreements are void and unenforceable. However, this does not mean that restrictions of this type cannot be challenged. As noted above, there is still the possibility of modification or release under section 84 of the Law of Property Act 1925 for England and Wales and the 1978 Order for Northern Ireland. And although arguments based on the Competition Act 1998 were abandoned in this particular case, it does not necessarily follow that they will always fail, as much depends on how the local market is defined.

THE COMPETITION ACT: KEY POINTS TO WATCH

A key point for anchor tenants to note is that although one can argue successfully that a restriction is justified on the basis that without it, the lease would never have been entered into, the Competition Act requires that restriction to go no further than is necessary to achieve that arguably pro-competitive effect. If it goes further, it is likely to be open to challenge – and could be held unenforceable in its entirety (a far worse outcome from the tenant's perspective than the Lands Tribunal deciding to modify the restriction by reducing its scope). For example, if an anchor tenant sells a limited range of food, a restriction that prevents the landlord leasing to any other retailer selling food, regardless of whether that retailer can realistically be said to compete with the anchor tenant, may well be viewed as going further than necessary – and therefore potentially unenforceable under the Competition Act. Given that it is often difficult to say with certainty whether the Act will apply (such advice is likely to require complex market analysis), it would nonetheless be prudent for parties to consider the extent to which the relevant restrictions are genuinely necessary, and in practice it may be safer to err on the side of caution when in doubt.

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