by Jonathan D.C. Turner, barrister, 13 Old Square Chambers

Tax is not the only thing set to change on 6 April 2011. Another change of importance to everyone concerned with commercial property will take effect on the same date: the application of Chapter I of the Competition Act 1998 to agreements which create, alter, transfer or terminate interests in land, together with associated restrictive covenants and user obligations (“land agreements”). Furthermore, the Act will apply as from that date not only to new land agreements but also to existing agreements which remain in force.

The prohibition

The Competition Act 1998 contains in its Chapter I a broad, general prohibition of agreements between undertakings which

• have as their object or effect to prevent, restrict or distort competition within the UK or part of it and
• may affect trade within the UK or part of it.

Agreements contravening this prohibition are invalid and the parties to them can be fined heavily if their contravention was intentional or negligent.

However, the impact of this prohibition on land transactions was greatly attenuated by an Order which excluded land agreements from its operation. In theory, the exclusion could be withdrawn in relation to a particular agreement by a direction of the Office of Fair Trading, but in practice that did not happen. This exclusion will now cease altogether with effect from 6 April 2011, whereupon the Chapter I prohibition will apply automatically to such agreements.

The removal of the exclusion is not retrospective in a strict sense, in that the making and operation of agreements down to 5 April 2011 will not be made retrospectively illegal. However, it is clear that as from 6 April 2011 the maintenance in force and operation of agreements which are caught by the prohibition will be illegal, even though the agreements were legal when made – indeed, even if the agreements were made before the Competition Act 1998 was promoted or enacted. This can have a serious impact on the positions of the parties to such agreements or possibly their successors, as discussed below.

The Office of Fair Trading (OFT) is preparing guidance and has issued a draft of this for consultation. The draft points out that most land transactions will not be affected by the Competition Act even after 5 April 2011. However, this is because the Competition Act does not generally affect the sale of residential property. On the other hand, it is also apparent from the draft that the OFT anticipates that many transactions relating to commercial property are liable to be caught by the Act.

In particular, the Chapter I prohibition may apply to

• restrictive covenants which restrict the type of commercial activity which may be conducted on particular premises;
• exclusivity obligations which promise tenants or licensees that no similar business will be permitted to operate in a particular centre or location; and
• transactions by which one company secures control over a substantial proportion of the sites which can be used for a particular type of business in a given catchment area (usually where the availability of suitable sites for that type of business is limited by planning considerations).

Interpreting the Competition Act

The Chapter I prohibition is modelled on what used to be Article 81 of the EC Treaty and is now Article 101 of the Treaty on the Functioning of the European Union (TFEU). The only substantive difference is that Article 101 of the Treaty applies if the agreement “may affect trade between Member States [of the EU]” whereas the Chapter I prohibition applies if the agreement“may affect trade within the United Kingdom [or part of it]”.

Furthermore, section 60 of the Competition Act explicitly provides (in summary) that questions arising under the Chapter I prohibition should be determined consistently with the determination of corresponding questions under (what is now) Article 101 of the TFEU.

It is therefore necessary to base any assessment of a situation under the Chapter I prohibition of the UK Act on the principles established by the extensive case-law under Article 101 of the TFEU. Having said that, there is virtually no EU case-law relating specifically to land transactions, since these do not usually affect trade between EU member states. Thus while many general issues of relevance to land agreements have been addressed under EU competition law, we are to a significant extent in uncharted territory when considering their specific application to land agreements.

Agreement between undertakings

The Chapter I prohibition applies to agreements or concerted practises between “undertakings”. According to the case-law of the Court of Justice of the EU (CJEU), the term “undertaking” covers any entity engaged in an economic activity. It does not cover individuals acquiring property for their own residential use, but it does cover individuals (as well as companies) engaging in land transactions as a commercial activity or for commercial or professional purposes.

Similarly, the term does not cover public authorities when they are carrying out governmental functions, but it does cover them when they are engaged in commercial activities. For example, a public authority taking a lease of property for its own offices would not be an “undertaking” for this purpose, but it would be an “undertaking” within the meaning of the provision if it sublet some of the offices to a business or a professional firm.

The Chapter I prohibition applies if there is an agreement or concerted practice between undertakings. An agreement can be written or oral, formal or informal. According to the case-law, a concerted practice is a form of co-ordination which knowingly substitutes practical co-operation between the parties for the risks of competition.

Application to existing restrictions

Difficult questions may arise as to how the Chapter I prohibition applies to land transactions which were made before 6 April 2011 but which continue to have effects from that date. The prohibition applies automatically from that date to existing land agreements which remain in force, but it does not apply to the unilateral exercise of proprietary rights created or transferred prior to this date.

Where an agreement continues in force, such as an ongoing lease, it seems clear that the Act will apply if terms which restrict competition (for example, restrictions on the type of commercial use of the demised premises) remain in force from 6 April 2011. It appears that this is so even if the interests of the original lessor and/or lessee have been assigned to other parties, since the original agreement constituting the lease effectively remains in force between the current lessor and lessee. It has been accepted that (what is now) Article 101 of the TFEU continues to apply where a commercial agreement is assigned to different parties, and it would be difficult to justify a distinction just because the agreement relates to an interest in land. Where an agreement is assigned to new parties, this may change whether and to what extent it affects competition, but that is a different point, which is discussed below.

The position is less clear where an agreement for the transfer of a freehold interest completed before 6 April 2011 contains a restrictive covenant which continues to apply after that date. The benefit and/or burden of the covenant may pass to third parties who subsequently acquire the dominant or servient tenements. On one view, there is no agreement between these third parties; the restrictive covenant is an incident of the property which they have acquired, not a term of a continuing agreement. However, it is thought that the better view is that the covenant is properly regarded as a term of an agreement which continues in force even if it has been assigned to new parties, and is therefore subject to the prohibition as from 6 April 2011.

The second view is supported by the consideration that the Act should be interpreted consistently with the corresponding provision of EU law which applies throughout the EU, including in member states where the burden as well as the benefit of contracts can be assigned in various ways, including universal succession. Where new undertakings become parties to an existing agreement through universal succession, it seems that Article 101 of the TFEU must continue to apply on the basis that the agreement remains in force between the new parties unless and until it is discharged by agreement or otherwise. Similarly, where new parties become bound by the terms of an agreement through the acquisition of an interest in land, it seems that the agreement must be regarding as continuing as between the new parties unless and until the terms are discharged.

This view is also supported by the Judgment of the CJEU in EMI v CBS, which held that the corresponding prohibition in EU law can apply even where an agreement is no longer in force if it continues to produce its effects after it has formally ceased to be in force; and that an agreement is regarded as continuing to produce its effects if the existence of elements of concerted practice and coordination peculiar to the agreement and producing the same result as that envisaged by the agreement can be inferred from the behaviour of the persons concerned. The continued operation of a restrictive covenant as between new owners of the respective tenements would appear to be, at the very least, an element of coordination producing the same result as that envisaged by the original agreement.

By contrast, where anti-competitive effects result not from a continuing restriction but from a transfer of land completed before 6 April 2011, the Chapter I prohibition would not apply in the absence of an agreement or concerted practice continuing from that date. For example, where a town has two petrol stations, and it is not possible within a short period of time to open a new one (for example, because of lack of suitable sites and/or planning issues) the sale of one of the stations to the owner of the other could restrict competition. Therefore if the sale takes place after 5 April 2011, it could contravene the Chapter I prohibition. But if the sale took place on or before that date, it would not contravene the prohibition and the new owner would remain the owner and entitled to operate both stations after that date. (If the new owner abused a dominant position, whether before or after 6 April 2011, it would contravene the Chapter II prohibition, but that is a different point.)

Prevention, restriction or distortion of competition

If there is an agreement or concerted practice between undertakings which continues after 5 April 2011, it is necessary to consider whether it has as its object or effect to prevent restrict or distort competition. According to the case-law of the CJEU, a restriction is regarded as having as its object to prevent, restrict or distort competition if it does so by its very nature; in other words, it is so likely to do so that it is not necessary to demonstrate the effect. If an agreement does not have as itsobject to prevent restrict or distort competition in this sense, it is necessary to go to consider whether it has this as its effect.

The prevention, restriction or distortion of competition can refer to the competition of one or more of the parties to the agreement (for example, where the commercial conduct of a party to the contract is restricted) or of a third party (for example, where an agreement or series of agreements makes it difficult for a third party to access a market).

In particular, restrictive covenants, controlling the type of business that can be conducted on a particular property, can prevent, restrict or distort competition in some circumstances. For example, if a shopping centre has only one coffee shop, a restrictive covenant which prevents the use of another suitable unit in the centre for a coffee shop may well restrict competition, at any rate if someone wants to open a competing coffee shop in the centre and there is no other unit available for such use.

In some circumstances the transfer of an interest in land may itself prevent, restrict or distort competition, as in the petrol station example mentioned above.

Insignificant effects

However, as the CJEU has held, the prohibition does not apply if the prevention, restriction or distortion of competition is insignificant. Thus if a shopping centre already has several competing coffee shops, a restriction preventing the opening of another coffee shop will not have a significant impact on competition and will therefore escape the prohibition.

The European Commission has issued guidance in its Notice on Agreements of Minor Importance (often called the “De Minimis Notice”), indicating circumstances in which the impact on competition will normally be regarded as insignificant and therefore not caught by Article 101 of the TFEU. The OFT’s draft guidance endorses the application of this Notice in relation to land agreements in the UK and the Chapter I prohibition.

The Notice states that, subject to certain exceptions, an agreement will not be regarded as appreciably affecting competition if

• the parties are actual or potential competitors and their combined share of any relevant market affected by the agreement is less than 10%; or
• the parties are not actual or potential competitors and the market share of each party does not exceed 15% of any relevant market affected by the agreement.

However, as indicated above, this is subject to various exceptions. One exception is where competition on a relevant market is restricted by the existence of parallel networks of agreements covering 30% of the relevant market: in this case an agreement will be regarded as having an insignificant effect on competition under the Notice only if the market shares of the parties do not exceed 5%.

More generally, this “safe harbour” is not available for agreements between competitors which have as their object to fix the prices of products sold to third parties, or to limit output or sales, or to allocate markets or customers. Nor is it available to agreements between non-competitors which have as their object to specify a fixed or minimum resale price or to restrict the territory or customers to whom a buyer may resell the contract goods or services, subject to various provisos where resale restrictions are allowed.

The Notice is only guidance and it is possible for a Court to reject its application on the facts of a particular case. It should also be noted that if an agreement is not in the “safe harbour” specified by the Notice, this does not mean that it does have a significant effect so as to be caught by the prohibition. It is still necessary to consider whether in all the circumstances it is likely to prevent, restrict or distort competition to an appreciable extent.

Market definition

Market shares are very important for the purposes of the Notice and generally when considering whether an agreement significantly prevents, restricts or distorts competition. In order to assess market shares it is necessary to define both the relevant product market (the goods or services which compete effectively with the products in question) and the relevantgeographic market (the area in which a rival must operate to have an effective competitive impact on the undertaking in question).

Goods or services are regarded as competing in the same relevant product market if they are regarded by customers as interchangeable with or substitutable for each other by reason of their characteristics, prices and intended use; or more formally and theoretically, if a small but significant non-transitory increase in price in one would lead to a shift in demand to the other so that it would not be profitable (the “SSNIP test”).

Definition of the geographical market is often particularly important in relation to land transactions. The UK Competition Commission considered this issue extensively in its recent investigation of the groceries market. Following this, the OFT considers that the catchment area of a retail store, being the area from which it draws most of its customers, may constitute a reasonable approximation to the relevant market in many cases. Catchment areas may be drawn by reference to postcodes, local authority licensing areas or “isochrone radii” (i.e. contours representing equal travel time).

It is well established that an agreement which was originally compatible with Article 101 of the TFEU and the Chapter I prohibition can later contravene the prohibition because of a change of circumstances, such as an increase in the market shares of the parties, or the assignment of the agreement by a party which does not compete with the other party to one which does. When this happens, the maintenance in force of provisions of the agreement which prevent restrict or distort competition becomes illegal and the various consequences described below may ensue.

A more controversial question is whether an agreement which contravened the prohibition when made or subsequently can later become valid because of a change of circumstances, without being expressly reaffirmed. Conflicting views have been expressed in the Court of Appeal of England and Wales on this point (Crehan v Inntrepreneur and Passmore v Morland). The better view appears to be that an agreement which was originally caught by the prohibition can indeed become valid on falling out of the prohibition due to a change of circumstances.

Necessary terms of pro-competitive agreements

The CJEU has also held that a term in an agreement which restricts the conduct of a party does not prevent, restrict or distort competition if it is a necessary term of a pro-competitive agreement, so that without the term there would be no agreement and no competing business under it at all. On this basis, where the developer of a new shopping centre offers a major department store exclusivity for a limited period in order to attract an anchor tenant, which will enable the new centre to become a viable and effective competitor to other shopping centres in or around the same town, the agreement may be regarded as not restricting competition, if the department store would not take a lease in the new centre without this protection.

However, this principle must be used with care. It only applies where the restriction is necessary for the pro-competitive agreement to be made at all, and no lesser restriction would be acceptable to reasonable parties in the position of the parties to the agreement. For example, even if a period of exclusivity is necessary to persuade a major department store to become an anchor tenant for a new shopping centre, a period in excess of, say, five years may be regarded as unnecessary and therefore liable to restrict competition. It also appears from the OFT’s draft guidance that it is unenthusiastic about applying this principle to land agreements, preferring to address this kind of issue under the express provision for exemption discussed below.

Exemption

Separately from the “necessary terms” principle just described, agreements are automatically exempted from the Chapter I prohibition if they

• contribute to improving the production or distribution of products or promoting technical or economic progress,
• allow consumers a fair share of the resulting benefit,
• do not impose restrictions which are not indispensable to attaining these objectives, and
• do not enable the parties to eliminate competition in respect of a substantial part of the products in question.

There is clearly some overlap between the exemption and the principle that a necessary term of a pro-competitive agreement does not restrict competition. The exemption can apply where competition is restricted in one respect but promoted in another respect. For example, some restrictions on competition between shops in the same shopping centre may ensure that this shopping centre has a broader range of shops and is a more effective competitor of another shopping centre in or near the same town. Indeed, as mentioned above, the OFT appears to prefer to assess pro-competitive agreements under the heading of exemption rather than the principle that a necessary term of a pro-competitive agreement does not restrict competition, even if this makes little or no difference to the end-result.

However, the exemption can also apply where competition is restricted in one respect, but the restriction is justified not because it promotes competition in a different respect, but for some other reason – for example, because it avoids wasteful duplication of resources, or preserves the character of a neighbourhood, or protects the environment, or promotes energy conservation. Agreements have been exempted under the corresponding provision in the TFEU on the basis of various public benefits which do not readily fit inside a literal interpretation of the phrase “improving the production or distribution of goods or promoting technical or economic progress”. However, there is debate as to whether agreements restricting competition can be exempted on essentially non-economic grounds.

Invalidity of infringing agreements

If an agreement contravenes the Chapter I prohibition – because it has as its object or effect to prevent restrict or distort competition and it is not exempted in accordance with the criteria discussed above – then its restrictive provisions are void. In the case of transactions prior to 6 April 2011, the restrictive provisions become void as from that date. However, the other provisions of the agreement remain valid if the invalidity of the restrictive provisions does not result in a total failure of consideration or change the agreement into one of a completely different character from that which the parties contemplated.

Where covenants restricting the use of land contravene the Chapter I prohibition, other aspects of the transaction would survive in many cases. Even if this results in some unfairness as between the parties, in that (for example) the price or rent might have been different without the restrictive covenant, the agreement as a whole will not be invalid in the absence of a total failure of consideration or a fundamental change in its nature.

Where a market rent has to be set under a rent review clause or under the Landlord and Tenant Act, a restriction on the use of the demised premises would normally be taken into account in the determination. But it can be argued that if the restriction is invalid under the Competition Act, it should be ignored, resulting in a higher rent, at any rate in a review after 5 April 2011.

Where an agreement to transfer land, made after 5 April 2011, itself contravenes the Chapter I prohibition, but is completed, in that the land is transferred and the consideration is paid, difficult questions, of the kind discussed in Tinsley v Milligan, may arise as to whether the transfer is invalid and the title is bad. However, even if the transfer is effective as a matter of property law, a party to the agreement might be able to claim restitution on the ground that it entered into the agreement in the mistaken belief that it was lawful, following the Kleinwort Benson case. Furthermore, the Office of Fair Trading has power to order remedial action, for example requiring the parties to reverse the transaction or requiring the purchaser to sell on the property to a third party competitor.

Object, means or consequence of infringing agreement

The CJEU has held that the exercise of an intellectual property right contravenes the corresponding prohibition in the TFEU whenever it is the object, the means or the consequence of an infringing agreement. It is not clear how far this principle applies to real property. It is difficult to imagine the courts allowing a defence to trespass on this basis if (for example) a trader opens a kiosk on another company’s property and submits that the owner’s acquisition of the property or its acceptance of a restrictive covenant contravened the Chapter I prohibition.

On the other hand, this principle does support the view (expressed above) that the enforcement of a restrictive covenant between successors in title to the original parties who created it does not escape the prohibition on the ground that there is no current agreement between the owners of the respective tenements.

This principle also supports a broad interpretation of the OFT’s power to make orders to bring infringements to an end, for example by reassigning or reselling property acquired under an infringing agreement, since it precludes the argument that the infringement is at an end when the agreement has been executed.

Damages

A person who is damaged by an infringement of the Chapter I prohibition can claim damages in accordance with normal principles of tort law. For example, third party competitors who were kept out of a market can claim for the loss of profits which they would have made, and customers who have been overcharged as a result of an infringement may be able to recover the excessive charges, at any rate if they did not pass on the increased costs to their customers.

A party to a contract who shares equally the blame for the infringement (“in pari delicto”) may be barred from claiming against the other party on the basis that he cannot rely on his own wrong doing (“ex turpi cause non oritur action”). However, a party who was forced to accept the restrictions because he was in a weak negotiating position – such as a tenant of a tied public house vis-à-vis the brewer who owned it – would probably be able to claim, in line with the CJEU’s decision inCourage v Crehan, and longstanding common law principles (e.g Kiri v Dewani).

Fines

Finally, where the infringement of the Chapter I prohibition is intentional or negligent, the OFT can impose fines on the parties of up to 10% of their annual turnover. However, it is thought that substantial fines are unlikely to be imposed in relation to land transactions until a track record of enforcement has established more clearly what type of transaction will be held to infringe the prohibition.

Other competition law provisions

The Chapter I prohibition of the Competition Act is not the only provision of competition law which can apply to arrangements relating to commercial property. Following a general review of the retail grocery sector, the Competition Commission made a detailed Order earlier this year under the Enterprise Act 2002. This Order requires the large grocery retailers to release existing restrictive covenants in their favour which restrict the use of land for grocery retailing by competitors in highly concentrated local markets (as defined), and not to impose any new restrictive covenants which may restrict grocery retailing. It also prohibits the enforcement by large grocery retailers of exclusivity arrangements lasting more than five years in such markets where the protected retailer has a strong local position (as defined).

The prohibition of abuses of dominant position in Chapter II of the Competition Act could also apply to arrangements relating to land in special circumstances. For example, some cases under the corresponding provision in EU law have concerned unfair charges for the use of facilities at airports and seaports.

©Jonathan D.C. Turner 2010