Changes to Competition Law: An end to "good estate management"?

Many thanks to Adrian Magnus, a partner in BLP's EU and Competition Law practice for his input in this blog.

From 6 April 2011, the Chapter I Prohibition under the Competition Act 1998 will apply to land agreements.  This might come as a surprise to a lot of people.  What on earth does competition law have to do with the ownership of land and why have land agreements hitherto been exempt?


Another legal tightrope for Landlords?
Photo by Donald Judge



I do not want to carry out a detailed analysis of the history of competition law and land agreements.  In summary competition law should apply to any agreement the effect (whether intended or not) of which is to be anti-competitive.  This can, for example, be by creating barriers to entry by preventing competition or by two competitors carving up markets between themselves.  Up until 6 April 2011 land agreements were exempt from the legislation.  However, the Government, in its wisdom no longer sees any justification for such differentiation and so now all land agreements will be caught.

Be warned, this change is not forward looking only and does not have any grandfathering provisions.  Even an agreement entered into 100 years ago could be in breach.

One area of particular interest for the real estate industry is the management of large retail estates especially shopping centres and retail parks.  It is not uncommon in these estates to have leases which contain different restrictions including:

• very specific user covenants limiting the use to, say, a shoe shop or a coffee shop

• allowing the landlord a right to refuse changes of use in the interests of "good estate management"
• exclusivity arrangements whereby the landlord agrees not to let other units for a specific use or to specific identified entities

Are these restrictions in breach of the law? 
Can tenants seek changes of use and threaten the landlord with reporting them to the OFT if they rely on "good estate management" as a reason for refusing the change?

Thankfully, the revised guidelines published by the OFT is an improvement on and much clearer than the first draft.  It recognises the fact that there are many legitimate reasons why a land owner might seek to impose or agree restrictions on the use of land and that only a minority of such restrictions will infringe competition law.

The OFT Guideline specifically recognises the need for user restrictions in leases in order to ensure a good mix of tenants and notes that such provisions are unlikely to be in breach of competition law.  Therefore limiting use to or prohibiting use as, for example, a shoe shop or allowing the landlord to refuse consent to a change of use in the interests of "good estate management" should not cause concern.  There are exceptions to this especially where the owner of the land is also a retailer.  For example, if Boots owned a shopping centre and in all leases for that shopping centre had an absolute restriction preventing the sale of pharmaceuticals, perfumes or personal grooming items this is much more likely to be considered an infringement.

Furthermore, exclusivity arrangements which place restrictions on the landlord's ability to let other parts of the same centre or park to a competitor carry with them bigger risks.  These can take a number of forms.  Let's take the Boots example again (nothing personal I promise).  If in a lease to Boots the landlord covenanted that it would not grant any leases within the same centre to other chemists and/or would include in all other leases of the centre a restriction on the sale of pharmaceuticals, perfumes or personal grooming items then there is a real possibility of an infringement of competition law.  The reasoning is that if no one else can sell these items in the centre this will result in reduced choose, potential for higher prices and worse service; there is no competition to encourage best practice.

Whether or not such provisions do in fact infringe competition law is not a black and white call.  This will depend on a number of things including:

• the geographical area (market) affected - for example a shopping centre such as Bluewater or the Trafford Centre may well be considered differently to the shopping arcade at Bond Street Station
• the market power of the parties concerned - for example Boots as opposed to a 5 shop franchise

There are also exemptions which may be able to be relied upon which are relevant for the shopping centre/retail park scenario.  These are applied on a case-by-case basis if the criteria is met rather than being blanket exemptions for certain types of agreement.  For example, exclusivity being granted to an anchor tenant could be justified since without the anchor tenant the proposed centre/park would not be economically viable.  Of course, this does not give a blanket exemption and the specific provisions relating to the exclusivity being granted need to be carefully considered in context to ensure that they do not go further than necessary to achieve the desired results.

In summary, the removal of the exemption from land agreements of the effects of competition law have wide ranging implications for land owners.  Shopping centre and retail park owners should carefully review and consider their agreements and developers need to consider how to operate within the rules when setting up new developments.  The good news is that "good estate management" can continue but the ability to restrict uses for the benefit of certain occupiers or the landlord is severely restricted and has become another legal tightrope for landlords to walk if they are to avoid expensive and image-damaging litigation and negative publicity.

Westfield and Stratford - JVs - the new form of financing?

Peter Bill, in his latest blog entry in the Estate Gazette (Westfield sells half of Stratford - more sales to come?) picks up on the announcement to the Sydney stock exchange that Westfield has agreed to sell a 50% interest in Stratford City, the part of the Olympic site which it is developing as its latest retail attraction in the UK.  The buyers are a Dutch fund and a Canadian pension fund.

This is yet another example of how developers have been turning to alternative sources of finance since the development finance market effectively dried up as a result of the credit crisis.  The truth is that joint ventures are not particularly new but they had gone out of fashion whilst developers were able to take out cheap development finance allowing them to keep significant profits to themselves rather than having to share them with partners.

What is clear now is that joint ventures are back with a vengeance and if you want to get in on the action you need to make sure you have a decent understanding of what you are getting into, what pitfalls to avoid and how to generally ensure that if the wheels come off you do not go over the edge of the cliff with your partners but can jump ship in an appropriate manner.

Some fundamental questions you need to consider when looking at entering into a joint venture include:

• how do I want to exercise control and be involved in the decision-making of the vehicle?  Depending on the type of vehicle decisions may be made at different levels and without the right controls in place you can lose control over important decisions; set the level of control too high and you risk paralysing the vehicle
• where should the vehicle be located? - there are likely to be significant tax implications depending on where a vehicle is located but beware of the effect decision-making can have on jurisdiction for tax purposes
• what are your long term intentions? - is it intended to hold the asset for a long time (i.e. as an investor) or is the intention to improve it and then dispose (i.e. as a trader)?  this can affect both the type of vehicle chosen and the jurisdiction
• Are there any deal specific issues? - some potential JV parties will have restrictions and/or preferences regarding the sorts of arrangement they can enter into.  REITs are a good example.
• Are there specific regulatory issues that make one type of vehicle more attractive? - bearing in mind the new Alternative Investment Fund Managers Directive this area needs special consideration and it will impact potentially on jurisdiction as well
• How will the vehicle be taxed and does this fit with your/partners' taxation? - some vehicles (e.g. partnerships) are generally tax transparent but this may not work for all investors

It is very difficult to change structure part way through agreeing a deal and so it is vital that you do your homework before jumping into bed.

Contracting with a UK REIT - does it make a difference?

REITs hit the UK landscape in January 2007 and now many of the best known names in the UK property world are REITs - Land Securities, Hammerson, Great Portland Estates, British Land to name a few.  As a matter of course there are certain questions one always considers in terms of the party with whom you are contracting.  It is important to consider whether they are executing the documentation correctly and, indeed, their power to enter into the transaction.  If it is a foreign entity the obtaining of a legal opinion is advisable.

REITs add something different to the mix and the risk to a party contracting with a REIT is that without knowledgeable legal advice one can be exposed to unnecessary risks or, indeed, lose out on potential advantages.

The rules governing REITs are complex and affect not only the REIT itself but also those with whom it contracts.  A REIT's business is split into a Property Rental Business (PRB) (which must be at least 75% of its total income) and the remainder being its Residual Business.  PRB income is effectively tax exempt (there is 20% withholding tax which exempt investors can reclaim) whereas the income from the Residual Business is taxable at 28%.

It is beyond the scope of this blog to go into detail (nor would I wish to give away trade secrets quite so easily) on the potential issues and pitfalls that can arise when dealing with a REIT but some highlights include:

• the sale of shares in an SPV property company by a REIT will be a Residual Business which may have negative tax consequences
• the base cost of a property in an SPV once owned by a REIT may be higher or lower than the SPV paid for it
• the sale by a REIT of a development within 3 years of practical completion is likely to be a Residual Business which again has negative tax consequences
• whilst the PRB part of the REIT does not pay tax it still benefits from capital allowances to reduce the dividend payments it needs to make so REITs will not simply give these up
• Joint Ventures with REITs raise all sorts of governance and tax issues and potential advantages

As mentioned the REIT legislation also provides potential opportunities as well.  Therefore it is key that when you are getting into bed with a REIT you know what those opportunities are and how to exploit them for both parties' benefit.

Commercial Lease Code - let's be radical

The news that the 2007 Commercial Lease Code has not proved any more well known than its predecessors has been met with dismay by the Government. Larger, institutional landlords did embrace to some degree the Code and did their best to publicise it. However the fact remains that much of the country's commercial estate is owned by small landlords and managed by small agents who have no interest in publicising the code as all it would do is damage their negotiating position and, in the case of agents, raison d'etre. So the prospect of legislation looms closer.
What I am about to say may shock you but . . . bring on the legislation. But not in half measures. Let's not tinker around the edges. Let's be radical.
I propose that for all leases of an area less than a certain minimum and/or a rent below a certain level (eg. £50k per annum) there should be a statutory prescribed form of lease. It could have the following:

• a minimum 2 year and maximum 10 year term
• Index-linked upwards only rent
• Security of tenure
• Repair to standard at date of first lease
• Assignment with consent not to be unreasonably withheld ("ntbuw")
• Underletting of whole with consent ntbuw
• Specific user with change permitted within same use class ntbuw subject to estate management considerations
• No alterations apart from internal non-structural with consent ntbuw
• Service charge drafting would be fixed by reference to the RICS Code

These are just suggestions but you get the idea. It may be that a few variations of the leases would be needed for different types of property and rental structures but all of this is achievable.
Why do this? Well the amount of time and money that is spent in the negotiation of heads of terms and subsequent documentation of those heads is one good reason. All landlords and tenants would need to agree would be the rent and term.
But the benefits go further. When an investor is reviewing a portfolio of properties low value leases would not need to be reviewed for consistency as the terms would be dictated by law. Certificates of Title could be reduced in size. Lawyer review time would be cut leaving more time to do the deal. Disputes would be dealt with more easily since the wording could quickly be interpreted by the courts and the number of disputes would fall. Everyone would benefit to some degree at some point.
The downside? Mainly in reduced flexibility although quite how much flexibility would be lost is questionable. Agents might need to reduce fees to reflect the lack of terms to negotiate but they would still be needed to find the tenants and get them signed up. Lawyers would lose out on fees as our services would not be required for straightforward leases but we would still be needed to negotiate agreements for lease, licences for alterations, etc.
So I say let's legislate, let's be radical, let's create the standard lease.