In February the Competition and Markets Authority (CMA) called for Britain’s biggest supermarket chains to review thousands of land agreements and prove they are lawful. This came to light after the CMA openly wrote to Tesco Chief Executive calling the retailer out on unlawfully preventing landlords from letting properties to its rivals at 23 sites across the UK.
We asked Richard Curry, our food retail expert, for his opinion, specifically asking how permeated is this practice in the industry and do you predict more agreements of this nature will be uncovered? He commented:
The CMA’s ruling will come as no surprise to anyone who has observed the food retail market over the years, as restriction covenants have been a known feature of supermarkets’ strategies for decades.
In the period prior to the rise of discounters and ecommerce, when the race for space still dominated the food retail sector, supermarket operators would often purchase an old industrial site, occupy one of the smaller lots, with a view to establishing a larger-format store in one of the other lots once trading had increased. Restrictive covenants were a crucial part of this strategy. In order to prevent loss of trade to competitors in the meantime, they would sell the other lots with a restriction of use clause, ensuring the subsequent owners could not sell on to another food retailer.
Even when the race for space ended, the covenants continued to protect retailers from loss of trade to competitors and were waiting patiently for another bullish market when rollout of larger stores was back on the agenda.
Restrictive covenants do have their uses – if a food retailer takes a gamble by investing in a new location, such as within a new urban extension or trading estate, they should be able to benefit from their initial financial commitment to an unestablished trading location without competitors coming along and building next door as soon as trade increases.
However, most convenience stores should be up to maturity within five years so they should not need protection further than that. It may even be the case that a food retail store enjoying an unrivalled position on a retail park by for over five years by virtue of a covenant, could have been overtrading, as their levels of traffic were being artificially raised by covenants now deemed unlawful.
In 2010 the CMA limited the length of restrictive covenants to 5 years, after which food retailers must allow competitors to occupy nearby locations. The fact that the CMA claims 20 different agreements by Tesco violated this rule could be seen as evidence of the high-risk strategy the retailer has taken when choosing new locations.
Another point to consider is that the terms of restrictive clauses only prevent nearby spaces being occupied by major competitors, which essentially comprises the other members of the big four food retailers. Up-market food stores such as Waitrose or M&S, and more significantly the discount food retailers such as Aldi or Lidl, were permitted to establish, with the latter taking full advantage. Restrictive covenants may therefore have been one of the factors contributing to the dramatic expansion of discount food retailers in recent years.
The smart money would say that this ruling will not necessarily result in any significant increase in the number of store openings in the retail sector, as this is tied to many other factors, not least the general health of the sector and its main actors, some of which are actively downsizing. However, if the market picks up, and space once again becomes a priority, this ruling could open-up new opportunities for expansion.
It has not generally been possible to assess just how significant an impact restrictive covenants have had on the marketability of key retail sites. That is until now. With the release of these spaces from extended covenants, their performance on the market should indicate just how much of a lead weight these kinds of clauses have been.
Further expert commentary alongside Richard’s can be found in this article from Property Week, published on 28 February 2020.