Intervention and regulation in the pub industry has been a long game, with the Beer Orders changing the landscape in favour of property owning pub companies. Inevitably opposition to the perceived unfairness of the tie, led to campaigning on anti-competition grounds and ultimately a series of Government enquiries. An attempt by the industry to introduce self regulation was not enough to satisfy the Government, and so was born a statutory Pubs Code in July 2016.
In the simplest terms this is supposed to introduce fairness, but rather than simplicity, the Code is weighed down in complexity. And when it comes to disputes, although the intention is to use arbitration to settle these, the reality is that they will involve a lot of time, cost and enmity.
A brief history
27 years ago, in July 1989, Lord Young of Graffham addressed the House of Lords on the contents of the Monopolies and Mergers Commission report on the supply of beer. What he said on the “central question of the size of the tied estate of national brewers” was that:
“I have decided that all brewers who own more than 2,000 on-licensed premises will be required to release from ties one half of the premises above that threshold. They must be leased free of ties to the company’s products. As these premises will now become free houses, the owning brewer will be permitted to make the new form of tied loans should the new tenants require them. At present there are some 15,000 free houses. On the basis of the data in the MMC report, these measures will add an additional 11,030 free houses. The proposals should enable a major freeing of the market without the compulsory divestment originally recommended by the MMC.”
The result of the findings of the MMC Report, echoed in support by Parliament, was the making of the Beer Orders which had the desired effect of removing the “complex monopoly” of the six dominant national brewers of the time (Allied, Bass, Courage, Grand Metropolitan, Scottish & Newcastle and Whitbread), by reducing the maximum number of tied houses they could hold. This removed the big six’s substantial vertical integration between the roles of brewer and retailer, through the sale of tied pubs. For example in 1991 Bass sold 368 pubs to an emerging Enterprise Inns.
What then happened was the growth of the pub owning companies, such as Enterprise Inns and Punch Taverns, who used their buying power to negotiate longer term beer supply contracts with brewers, at as competitive price as they could obtain, allowing them to maximise their profit margins through the wet rent obtained under trading tie. By February 2002 the brewing and pub sector had transformed sufficiently for the government to revoke the Beer Orders, which it did. This allowed unrestricted growth of the pub companies. For example in April 2002 Enterprise Inns then acquired 1,860 pubs from Laurel Pub Partnerships.
However the perceived strength of the pub companies operating the tie attracted strong criticism from some quarters, including CAMRA who launched a “super complaint” to the OFT, and coincided with structural changes in consumer behaviour towards alcohol as well as other factors, such as the introduction of the smoking ban and increasing price competiveness of on-trade alcohol sales.
Notwithstanding the Office of Fair Trading’s findings that “pub companies’ commercial interests would appear to be aligned with the interests of their lessees”, and that “consumers are benefiting from a significant degree of competition and choice between pubs” (CAMRA super-complaint –October 2010), the result of lobbying was a series of inquiries by the Business, Innovation and Skills Committee of Parliament.
Pub companies and brewers took steps to seek to address tenant disquiet by introducing their own industry framework code, in a move towards self-regulation. But this was not enough and in January 2013 the Coalition Government announced that it would consult on introducing a statutory code of practice and an adjudicator to take up a similar role to the Groceries Adjudicator. This was despite earlier warnings against doing so, because there was no justificatory competition reason for doing so and “for Government to intervene in setting the terms of commercial, contractual relationships could set a dangerous precedent” (Ed Davey, then Minister for Competition, November 2011).
The rest became recent history, with the Pubs Code scheduled for May 2016, but only coming into force on 21 July 2016. Despite being overshadowed by more recent seismic events, it may still be a game changer, and here is why.
The Pubs Code – the purpose
According to Government the 2 principles of the code are:
- fair and lawful dealing by pub-owning businesses in relation to their tied tenants; and
- tied pub tenants should be no worse off than if they were not subject to any tie.
This makes the Pubs Code sound simple. But the reality is the polar opposite, out of necessity, because of the complexity of arrangements between the large pub owning businesses (i.e. those that more than 500 tied pubs), their tenants subject to the tie, and within the sector. The result is an impressive 53 pages of Statutory Instrument containing 68 regulations and 3 schedules of information. There are complex sets of definitions, conditions for definitions (including mathematical formula, just for good measure), conditions for “trigger events”, procedures for operating the market rent only option and seeing the exercise of that option through to conclusion, transitional provisions and statutory dispute resolution mechanisms.
Compliance with the operation of the Pubs Code is then to be achieved by supervision through the office of a Pubs Code Adjudicator, Paul Newby, whose appointment has been criticised in a letter from Iain Wright, Chair of the Business, Information and Skills committee, to Greg Clark. On 13 September 2016, Greg Mulholland asked Greg Clark to sack Paul Newby. The scene is set for Paul Newby to prove that he is there to make the Pubs Code work for tied tenants. So, where do the tied pub tenants stand?
At the Pub Conference on 15 June 2016 Peter Hansen (of Sapient Corporate Finance), a seasoned professional who has been active in the pubs sector since before the creation of Enterprise Inns in 1991 (a deal in which he was involved), offered advice, based on an analysis of the remaining term length of tied tenants and the evolving nature of their interest, that whilst some tied pub tenants might be able to take advantage of the MRO option, they were in the minority and even then those that lobbied for the Pubs Code seem to have forgotten about the fact that the pub-owning businesses own the land.
Tied tenants – statutory protection
Peter Hansen’s reference to pub-owning businesses owning the land was a reference to the legal reality that even where pub tenants have security of tenure under the Landlord and Tenant Act 1954, the right for a tied tenant to exercise the MRO option might be met with either:
- hostile lease renewal proceedings to terminate the tenant’s lease without renewal, for example so that Enterprise Inns could continue to transfer pubs from its tied tenanted estate to its own managed house estate; or
- an exercise in stripping out value of the interest by the pub owning business, so that a hostile position can be adopted further down the line without the tenant having the benefit of a straightforward trigger event, such as a rent review.
The hostile approach
The hostile approach, which might avoid arguments such as the tied status of the lease and its duration, will come at a cost: namely a sum equal to either 1 x or 2 x the rateable value of the property. For a substantial pub at twice the rateable value, this could be £200,000. And it will not be devoid of risk as tenants will want to scrutinise the pub company’s business plans relating to the pub, which will be disclosable in the context of any litigation which ensues. Is the pub company really going to carry on a business at the property itself, through a manager? Or is the management agreement really just another tenancy in disguise? In the light of the Pubs Code, which is intended to see rights all flowing in the direction of tied tenants, the Court will be keen to look at the reality of who is to occupy the pub, under what terms, and to ensure that tenants do not lose their property rights only so that the large pub owning businesses can avoid regulation.
The more subtle approach – stripping out value in the lease
The more subtle approach, seeking as short a term as possible on the basis that the pub company will take up occupation in a certain period of time, is to play a waiting game, stripping out value in the lease for the tenant, inviting them to agree a surrender on unfavourable terms. But this could be even more fraught with risk for the unwary pub company, as it will give a chance to tied tenants to have the Court determine key lease terms and, the more onerous the pub company makes the lease for the tenant, the more likely it is that there will be an equal and opposite effect on the rent to be received. There may, also, be traps for the company to fall into, which could cause herd behaviour across its tied tenant estate, affecting the pub company’s business model and cash position.
Levelling the playing field?
No matter what approach the large pub owning businesses take towards their tenants at lease renewal, the Pubs Code is changing the game. From a property litigator’s perspective, the Pubs Code is a powerful tool to be deployed by a tied tenant in any lease renewal proceedings. It is a material circumstance which the Court will not ignore. It will not be attractive for the large pub owning businesses to seek to avoid the effects of regulation without having regard to the negative effects upon its tied tenants. The Court is there to do justice between the parties, and the security of tenure provisions contained in the Landlord and Tenant Act 1954 are there to protect the business interests of tenants. The large pub owning business will have to tread carefully when it comes to lease renewal. But at rent review stage there will be no Court procedure in immediate contemplation for tenants.
The Pubs Code – arbitrating the disputes
Instead the Pubs Code is all about arbitration: resolving disputes privately, in a less financially risky environment for tied tenants. If a tied tenant thinks that the large pub owning business has breached the Code, for example by refusing to provide a rent assessment proposal (which acts as the event entitling the tenant to serve an MRO notice), then the tenant can refer the matter to the Pubs Code Adjudicator for arbitration. And in circumstances where the tied tenant’s adverse costs exposure is normally limited to a maximum of £2,000, but the pub company’s costs exposure is unlimited, tied tenants would be sensible to pursue this avenue of potential redress. But the service does not come entirely free, there is a £200 fee for referring the dispute, and there may be an ongoing cost to conducting arbitration proceedings (as tied tenants would be wise to have professional advice).
Where the dispute relates to the MRO procedure, again the tied pub tenant can refer the dispute to the Adjudicator, who will arbitrate the dispute in a less financially risky environment for the tenant. There are even safeguards in place to make sure that tenants cannot be punished or prejudiced by the large pub owning businesses for choosing to go free of tie.
But doing all of this will take time, and cost money, and pit the large pub owning businesses against their tied tenants in a new adversarial environment.
Dealing with regulation is difficult, which makes it likely to change the business models impacted, by scaling down their tied businesses. Sale of the tied pubs will be difficult, because of the extended protection afforded to tied pub tenants and purchaser weariness. This could result in “lock in” of the problem for some of the large pub owning businesses.
The size of the affected pub companies ranges from a turnover of £64 million (Admiral Taverns), to over £2 billion (Greene King). The brewers (Greene King, Heineken, Marstons) have the largest turnover, and may be able to absorb loss of profit contained in the wet rent (obtained through the tie) as a consequence. For the largest of the pure pub companies, Enterprise and Punch, changing tack will be difficult and obstacles may arise in the process. Tied tenants, on the other hand, may lack the financial resources to use the best professional advisors to guide them through taking advantage of MRO.
All of these competing factors mean that opportunities will arise for new entrants and opportunists, to disrupt the pub sector as it currently stands. From an objective perspective, it seems that the coming into force of the Pubs Code might inadvertently cause more trouble for a sector which has already seen too much government interference. However there will, undoubtedly, be beneficiaries as a consequence of the Pubs Code, and one hopes that it will be those whose heart is in the industry, and not elsewhere.
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The content of this page is a summary of the law in force at the present time and is not exhaustive, nor does it contain definitive advice. Specialist legal advice should be sought in relation to any queries that may arise.