In the second of a series on the Pubs Code, we analyse the hot topic of how the MRO option should be delivered. Ten months ago we asked the question (see our commentary) of whether the MRO Option should be delivered by:

“… the pointlessly expensive mechanism of a new lease proposed by the pub-owning business, or the clean and simple deed of variation.”

Together with others we also called upon the Pubs Code Adjudicator, Paul Newby, to publish guidance on the point. Since then the Adjudicator has published an Advice Note on MRO compliant proposals (March 2018), and been subjected to threats of judicial review by EI Group and Greene King as a consequence of the contents of that guidance (Morning Advertiser – 22 May 2018).

Background to the problem

When the Small Business, Enterprise and Employment Bill was being debated in Parliament the method of delivery of the MRO option was discussed in Grand Committee on 28 January 2015, but it was decided to leave the detail of the process for exercising and delivering the MRO option to secondary legislation, i.e. the Pubs Code.

Unhelpfully however the Pubs Code is essentially silent on the method of delivery.

Under the Small Business, Enterprise and Employment Act 2015 the terms of a proposed tenancy are only MRO-compliant if they do “not contain any unreasonable terms or conditions”. This is echoed by the Pubs Code which adopts the definition of “MRO rent” as being rent paid under an MRO-compliant tenancy.

This begs the questions:

  • What is the starting point for considering the reasonableness of the terms presented to the tied pub tenant?
  • What other factors should be considered when assessing the reasonableness of terms presented to the tied pub tenant?
  • Are there any other pointers as to when it will be unreasonable to present a proposed tenancy in the form of a new lease?

What is the starting point for considering the reasonableness of the terms presented to the tied pub tenant?

Examples set by the Court are a good guide for considering the starting point, especially given that many proposed tenancies will be presented to tied pub tenants prior to lease renewal under the Landlord and Tenant Act 1954. In that context, in O’May –v- City of London Real Property Co Limited  the House of Lords held that:

The terms of an existing lease should not be frozen and incapable of change at lease renewal, but the burden of persuading a Court to impose change to those terms against the will of either party must fall on the party proposing the change, and that change must be fair and reasonable and should take into account the comparatively weak bargaining position of a sitting tenant.

In the case of the Pubs Code, it was introduced to provide procedures and guidance which must be consistent with the two core principles of, firstly, fair and lawful dealing between pub owning businesses and their tied pub tenants, and secondly tied pub tenants should be no worse off than their free of tie counterparts.

So both the Act and Code are concerned with:

  • The financial well being of tied pub tenants; and
  • Their negotiating position.

In that context, it is madness to ignore the existing terms of the tied pub tenancy when considering those changes sought to be imposed by the pub owning business against the will of the tied pub tenant, or indeed vice versa. Changes must be justifiable.

Some of those changes might be obviously justifiable by a pub owning business, for example the removal of “special commercial or financial arrangements” which were given to the tied pub tenant as a benefit in return for working in partnership with the brewer or pub company under a tie. Others less so, such as an increase in a rent deposit where the wet rent actually results in a decrease in the pub owning business’s financial exposure to the tenant (because the new fixed or dry market rent amounts to less than both the fixed and variable, or dry and wet rent).

Similarly for the tied pub tenant changes sought will often be obviously justifiable, such as the removal of terms associated with the tie (rights to inspect the cellar for foreign products etc.).

This should not be rocket science. If the tied pub tenant challenges the terms of the proposed tenancy put forward, seeking minimal interference with the existing tied tenancy by way of variation to the existing relationship (for example just removing the tie), but the pub owning business wants to impose a completely new set of terms to suit its business purposes, then an MRO-dispute about the proposed tenancy should only lead to one result.

What other factors should be considered when assessing the reasonableness of terms presented to the tied pub tenant?

The PCA’s advice note suggests the following are considered when assessing reasonableness:

  • The terms of existing tenancies in the relevant market sector, bearing in mind matters such as the location of the pub and nature of trade.
  • Whether there is an effective choice between staying tied and going free of tie available to the tied pub tenant.
  • Where the pub owning businesses’ choice to offer the MRO proposal by way of a new tenancy adversely impacts the tied pub tenant, whether the tenancy terms should be drafted to reduce or remove that impact.

This is helpful guidance and, rather than the regulated pub owning businesses threatening to sue the Adjudicator’s office, they should be asking for updated Advice Notes to be issued as and when contentious cases are determined. The only proper criticism to be made of the Advice Note is that it took so long to be published.

We also think it would be helpful for the Adjudicator’s office to consider the following further factors:

  • Whether the terms proposed, if accepted, would cause the tied pub tenant financial or operational detriment, and whether having regard to its circumstances it is fair for the tied pub tenant to suffer that detriment.
  • The bargaining position of the tied pub tenant in relation to the pub-owning business, having regard to the financial circumstances of each party and, in particular, the financial consequences, if any, of the operation of the tie upon the tenant.
  • Whether the terms proposed would transfer any risk or financial burden to the tied pub tenant, and whether it is reasonable for the risk or financial burden to be transferred to the tied pub tenant having regard to the financial circumstances of each party and their existing interest in the tied pub.

An express need for the pub-owning business to consider these factors should, when preparing its proposed tenancy, help to level the playing field and enable this disruptive period of structural change to end sooner, rather than later.

Are there any other pointers as to when it will be unreasonable to present a proposed tenancy in the form of a new lease?

The short answer is that yes, there are. Consider this scenario.

A tied pub tenant has invested tens of thousands of pounds into the tied pub by building an extension to accommodate diners and/or events. The works are of a permanent nature. The pub owning business granted consent to those works and it was expressly agreed that they be disregarded at rent review, together with any effect on rent.

If the MRO option takes effect as a new lease, then the demise granted will include the extension, with the effect that the improvements will be rentalised. This is because the definition of “market rent” contained in the Small Business, Enterprise and Employment Act does not exclude improvements made to the premises by the tenant, unlike the 1954 Act.

Our recommendation

Failing to deal head on with the vexed deed of variation / grant of new lease issue was an unfortunate oversight in the drafting of the Code.

We recommend that the Code is amended so that unless the tied pub tenant is being offered a minimum amount of more time in the pub beyond the residue of its existing term, then the MRO-compliant lease takes the form of variation to the terms of the pre-existing tied tenancy, with the burden being on the pub owning business to justify departures from the existing tied tenancy.

This will alleviate friction during the MRO procedure, reduce the current period of delay and disruption to structural change in the sector, and help mitigate the risk of further political interference by extending regulation to include currently unregulated businesses.

To see our previous commentary on the Pubs Code, please see
The Pubs Code; can it be made to work?

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.