Real estate may not be your business; even so, it will almost certainly be an asset used by your business. Competition issues in the real estate context may not previously have featured particularly prominently. This is changing with recent changes to competition legislation.
What competition issues can arise in real estate transactions?
Consider:
- Merger: this can arise in a real estate acquisition, perhaps a portfolio acquisition, or in the real estate joint venture context.
- Grocery market: large grocery retailers are now subject to special rules imposed last year by the Competition Commission, following its previous investigation into perceived anti-competitive practices.
- Anti-competitive real estate agreements: these might include restrictive covenants that operate to restrain trade, or exclusivities and other restrictions imposed in leases. An exemption from competition law for real estate agreements has meant the real estate sector may have ignored elements within a real estate agreement that may be potentially anti-competitive. This will change. Going forward, parties will need to consider anti-competitive provisions contained within real estate agreements as they would any other commercial contract.
This article outlines:
- what is changing for real estate agreements that are anti-competitive;
- what steps to take now; and
- what to factor into internal procedures and negotiations.
What is changing?
Real estate agreements will cease to enjoy special exemption from competition law.
Therefore, if an agreement (essentially, any agreement that deals with the transfer or disposal of a land interest, or rights granted over land) between undertakings (this could apply to a sole trader, partnership, company or group of companies), which may affect trade in the UK and has, as its effect, the prevention, restriction or distortion of competition in any part of the UK, it may be anti-competitive. The only exception will be if it provides some overriding economic benefit (or qualifies for exemption).
Which real estate agreements may be affected?
- Transfers and conveyances;
- leases;
- assignments;
- surrenders;
- licences; and
- deeds of grant.
The rules catch oral as well as written agreements.
Draft guidance published by the Office of Fair Trading (OFT) suggests few real estate agreements are likely to breach competition law. This is reassuring. However, bringing real estate agreements within the scope of the rules, which now apply to other commercial agreements, may offer another avenue for disaffected counterparties or competitors to exploit in future. The changes cannot be ignored and may actually offer opportunities.
What is the risk if an agreement is anti-competitive?
- The agreement or relevant provision may be unenforceable;
- fines (up to 10% of turnover) may be imposed;
- potential third-party claims for damages or injunctive relief;
- complaints to the OFT; and
- directors’ disqualification (up to 15 years).
(It appears the OFT is increasingly focusing on directors’ liability.)
How to assess whether an agreement is anti-competitive
Assessment is done on a case-by-case basis. So what should assessors be looking for? In short, a restriction of some kind. Restrictions typically imposed by real estate agreements include:
- restrictions on the sale of surplus land;
- exclusivity covenants given to tenants, common in certain types of real estate lettings; and
- restrictions on tenants in leases.
The OFT considers that restrictions aimed at sharing markets or making it more difficult for other businesses to compete effectively in a particular market are most likely to be anti-competitive. Examples given by the OFT in its draft guidance offer some clarity. For example: a coffee shop operator takes a lease in a shopping centre and pays a higher rent in return for exclusivity in the shopping centre; demand in the shopping centre could easily support more coffee shops.
The OFT’s view is the ‘market’ here is the shopping centre, and the barrier to new entrants will have an adverse effect on competition. Since the exclusivity does not produce an efficiency gain or other consumer benefit, the restriction will not qualify for exemption and is therefore unlawful.
Even if a real estate agreement is anti-competitive, there may be a ‘get out of jail free’ card, if the agreement is exempted. That is if it:
- contributes to improving production or distribution, or to promoting technical or economic progress (eg creation of one or more retail outlets);
- allows consumers a fair share of the resulting benefits (ie the economic benefits must outweigh or balance the negative effect on competition);
- does not impose restrictions beyond those indispensable to achieving those objectives; and
- does not afford the parties the possibility of eliminating competition for a substantial part of the products in question.
In the real estate context, the third limb – indispensability – has particular significance. Is the restriction time limited? If so, is the time limit imposed reasonable in all circumstances? What is the scope of the restriction imposed? Is it broadly or narrowly defined?
The draft OFT guidance offers the example of an anchor tenant letting, in a new shopping centre, ten minutes from the nearest town (which has no department store). To ensure viability the developer offers the store tenant exclusivity in the shopping centre for the life of the lease (ten years plus renewals). The nearest rival shopping centre with a department store is 20 minutes away. The OFT considers that this may appreciably affect competition but, to fall within the exemption, and so not be unlawful, the exclusivity would need to be time limited.
The concession offered to grocery retailers, which took effect last year, allows certain exclusivity arrangements a permitted five-year duration. The OFT makes no mention of a similar concession in its draft guidance on real estate agreements generally. Again, industry representation has raised this issue with the OFT. It remains to be seen if the same approach will be applied to exclusivity arrangements in real estate agreements generally as currently applies to certain arrangements concluded by large grocery retailers.
A self-assessment flowchart, based on advice from the OFT in their current consultation on guidance for real estate agreements (to be issued in the spring), works through what should be considered (see p46).
What constitutes the market in an assessment is probably the most complex aspect of the rules. It requires specialist assessment, but in part would involve assessing the location and product offering. For example, the ‘relevant product’ market (eg how far would a consumer deterred by rising prices have to go to buy an alternative?) and the ‘relevant geographic’ market (the geographic area is important for land agreements, eg what is the drive time to the nearest competitor?).
The other point to consider is when to make that assessment.
Initially, when an agreement is entered into. However, consider:
- real estate agreements may continue for many years, contrasting with other commercial contracts; and
- the competition landscape may change over time.
This combination dictates that real estate agreements will need to be reassessed over time. What may have been a justifiable restriction when originally imposed may no longer be, in light of external factors. Equally, the converse may be true.
Does the change affect existing agreements?
Yes, if they continue on or after 6 April 2011. So, for example, an exclusivity agreed in a ten-year lease concluded in 2006 might be an issue, going forward.
The change will therefore operate retrospectively, for agreements in place on or after 6 April.
Unlike the competition changes introduced last year for large grocery retailers, there is currently no transitional period proposed for real estate agreements.
Existing arrangements should therefore be reviewed now to assess whether they contain any potentially anti-competitive provision. For real estate and other companies this is a mammoth task. For many, even identifying agreements to consider them further may be a challenge.
The real estate industry is lobbying for concession on the forthcoming change to the rules, to seek some transitional period to offer a breathing space in which to operate. It remains to be seen whether this will happen.
Considerations, going forward
- Can or should a particular provision be included in a lease or other agreement?
- Could the other party or third party challenge the enforceability of a proposed or existing provision?
- Can existing provisions be relied on against the other party?
- Can an existing obligation be broken?
- Can this point be raised as an issue at rent review, or if seeking change of use on assignment or underletting?
- Is there a ‘paper trail’ to analyse and justify potentially anti-competitive restrictions? They may be subject to greater scrutiny than has previously been the case.
- Due diligence exercises: these will now need to consider any potentially unlawful restrictions. What analysis is available on potential competition issues? Consider also warranties against liabilities for breaches of competition law.
- What compliance training is in place for staff who are involved in negotiation? For example, to keep a record of restrictive provisions that may have an appreciable effect on competition, and the reasoning to justify them. Is there a process in place, if needed, to review existing restrictions periodically where circumstances change?
An increased focus is already being seen on potential competition issues in the real estate context, which has been caused by this change in competition law. This is a trend that looks set to continue.
By Anne-Marie Lusty, principal knowledge development lawyer, Berwin Leighton Paisner LLP.
E-mail: anne-marie.lusty@blplaw.com.
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