Deciphering the impact of the Pubs Code

In previous articles we asked if the Pubs Code could be made to work and how the MRO option should be delivered. Those articles sought to address key issues arising in the process of the exercise of the MRO option. Two years ago, in our commentary, we first anticipated that its introduction would create opportunity for new entrants and pit tied pub tenants against the pub-owning businesses in a new adversarial environment.

The question is what the Pubs Code has done for the tied pub sector, the trends and where it is leading.

Post- Pubs Code developments amongst the pubs owning businesses

There are currently six regulated pub owning businesses:

• EI Group

Even before the Pubs Code came into force, the largest tied pub owner EI Group plc announced its strategic plan to extend its managed house business, develop a commercial property portfolio (meaning free of tie pubs and retail outlets), dispose of hundreds of pubs and reinvest proceeds into its estate. On 10 May 2018 interim results for the six months ended 31 March 2018, revealed that its managed house business would stand at around 310 by September 2018, but it only anticipated having 500 free of tie sites by 2020 (half that originally anticipated). On 10 July 2018 the Times reported that EI Group has appointed Rothschild to assist it with the sale of its 351 commercial property portfolio: it hopes to achieve £300 million from that sale.

• Punch / Heineken

The largest single development in August 2017 was the £1.8 billion acquisition of Punch by Patron Capital, with Patron Capital selling “Punch A” to Heineken and retaining “Punch B” for itself, giving Patron close to 1,300 pubs and Heineken around 1,900 pubs.

Heineken’s acquisition has given it direct access to pub drinkers up and down the country, and its recent investment in the Beavertown Brewery signals its intent to continue expanding its drinks range to meet modern consumer demands.

Patron / Punch has since acquired Laine Pub Company and its 54 pubs spread across London and Brighton for £45m, showing that it is serious about growth in the sector.

• Admiral Taverns

The Patron / Heineken / Punch deal was followed shortly afterwards by the acquisition of Admiral Taverns by C&C Group plc (the maker of Magners and Bulmers) and Proprium Capital Partners, securing C&C access for its products to around 845 Admiral Taverns pubs.

• Greene King / Marston’s

For Greene king and Marstons it has been very much business as usual – neither has considered that the Code has had a material impact on trade, and the brewers’ focus has been on the other issues. Marstons has continued to open new pubs, and acquired the Charles Wells brewery for £55m in May 2017, giving it access to new markets. Whilst Greene King became subject to short selling speculation earlier this year, it appears to have largely recovered from that.

The trends

It seems the trend is towards vertical integration, so that beer producers have direct access to pub customers, and that even where pubs have remained in the hands of private equity investors such as Patron, there is strong interest in vertical integration via Laines.

The main impact of the Code appears to have been an intensification of capital interest in the tied pub market, from both private equity and brewers. Brewers are gaining on their direct access to the pub market. The proliferation of short-term tied agreements in response to the introduction of the Code aligns with private equity’s desire for a return on investment within shorter timescales. At the same time, tied operators are searching for opportunity, via the Code, to increase their share of the “profit cake” from the tied pub.

So what impact has the Code had?

The most significant elements of the Code are the regulations governing the Market Rent Only option: a consequence of a “historic victory” (as reported) when Greg Mulholland’s clause introducing the MRO option was included in the Small Business, Enterprise and Employment Bill, against the Government’s wishes.

However the recent BEIS Select Committee Inquiry revealed the following results about tied pub tenants securing Market Rent Only compliant tenancies since implementation of the Code:

It is clear from the above that the implementation of the Code has resulted in very low conversion of tied pub tenancies onto market rent only compliant tenancies, perhaps best reflected by EI Group’s announcement that it expects to have only half of the free of tie pubs that it previously expected, by 2020.

When asked by a Morning Advertiser journalist, a year ago, to comment on the PCA set-up I said it was a “system of attrition” for tied pub tenants. It should be noted that as many as 44% of full responses issued by the pub-owning businesses result in arbitration being initiated by the tied pub tenant. This is according to the PCA’s arbitration data.

Given these statistics, it would seem that tied pub tenants’ financial and managerial resources are very disproportionately (when measured against the resources of the pub owning businesses) re-directed to dispute management. However the search for opportunity by tied pub tenants, as a class, via the Code has been largely fruitless.

Deciphering the Code

The outcome of the BEIS Select Committee Enquiry into the Pubs Code was a scathing letter from Rachel Reeves MP to Richard Harrington MP, the Minister for Business and Industry in which she:

1. Relied on “substantial evidence from tenants that some companies are actively seeking to thwart the objectives of the Code … by employing tactics to deter tenants in pursuing this option”
2. Sought assurances that the confidentiality issues affecting arbitration will be overcome, so that the results of arbitration will be transparent to the tied pub sector
3. Asked the Minister to commit to commencing the review of the Code at the start of 2019, to enable the Government to bring forward the necessary enactments to the Code to ensure the pub companies cooperate with its implementation in the way that Parliament intended
4. Expressed concern that Mr Newby’s narrow interpretation of the Code as regards investigation of unfair business practices by the regulated pub owning businesses may allow pub companies to “systematically undermine operation of the Code without fear of a referral to the Secretary of State”.

Whilst regulatory action by the Pubs Code Adjudicator has been non-existent, and tied pub tenant resources have been diverted into arbitration, other key issues appear to have slipped through the net. Consider, for example:

• Our article of 22 January 2018, The Pubs Code: trigger events a red herring? , in which we suggested that even those tied pub tenants that have recently taken on tied tenancies may have access to the MRO option because of transitional provisions in the Code.
• The question of whether a pub owning business may be liable for damages because of its failure to offer a tied pub tenant an MRO-compliant tenancy. Can a tied pub tenant claim damages for its loss of chance to go free of tie as a consequence? After all, the Code creates a class of persons (tied pub tenants of pub-owning businesses) intended to be protected by the Code, which is itself directed at preserving their financial well-being by providing access to the MRO option. Given Mr Newby’s reluctance to entertain regulatory action (which, for a regulator, is odd), class action for damages against the pub owning businesses must be at least a possibility.

The pub-owning businesses have been quick to deploy significant legal resource to resisting the MRO process, and the limited number of MRO agreements entered into shows that most (but not all) tied pub tenants lack the capital and skill to explore the correct issues and access MRO compliant tenancies in any great number.

If the current status quo does not change, then to unlock the Code and access the MRO option the tied pub tenants will have to rely on political action to change the it. If that action proves ineffective in easing the current friction in the MRO procedure, then this may lead to a curbing of the tie for the regulated pub owning businesses.

Is the tie coming slowly but surely into the legislature’s sharp focus again? Next year will tell, but in the meantime the benefits of the MRO option in the Code remain largely locked, save to those most determined, efficient and well-resourced tied pub tenants.