Restrictive Covenants: some clarity but still subject to competition law

The recent case of Peninsula Securities Ltd v Dunnes Stores (Bangor) Ltd has clarified the law around challenges to covenants which seek to limit the use of land.

The case involved an appeal by a retail anchor tenant against its landlord who had sought to challenge a restrictive covenant in the lease which prevented the landlord from letting space to businesses that competed with the tenant.

The landlord sought to argue that the covenant was unenforceable as it fell within the doctrine of restraint of trade by preventing it from undertaking development which might help to revive trade within the centre as a whole. The Supreme Court found for the tenant and upheld the restriction.

Background

The restriction was granted by the landlord in circumstances where they claimed to have had limited bargaining power and in order to secure the tenant as an anchor tenant to what was to be a new development in a rundown area. The tenant constructed its store and the landlord constructed the rest of the shopping centre and a car park. The centre opened in 1982. Ownership of the centre was transferred to the landlord company in which the original owner, and covenantor, was a director and majority shareholder.

The Decision

The Supreme Court needed to consider whether the doctrine of restraint of trade was triggered either when the covenant was granted and/or when the shopping centre was transferred to the landlord, and if so whether that restraint was unreasonable so that the covenant was unenforceable. In that regard the primary issue for the Supreme Court was to consider previous case law in light of issues of logic and public policy identified by the Court of Appeal.

In reaching its decision the court found that the term restraint of trade applied more widely than was argued for by the landlord and covered business as it was understood in its widest sense, and as such the business of the landlord as a developer and property owner. In addition, it found that the covenant did potentially restrain trade as it restrained the landlord from “causing or permitting a trade in specified goods in a retail unit of a specified size on the site”.

In previous cases relating to restrictions on use of land the focus of the court had been on whether the covenantee had or retained an interest in that land. Where such an interest was retained the doctrine of restraint was not engaged. The alternative measure was to focus on the covenantor and to consider whether they had, in entering into the covenant, restricted their freedom to deal with their property. This latter test, the “pre-existing freedom test” found favour in a number of cases despite significant criticism as to the certainty and merits of its application.

The Supreme Court considered this pre-existing freedom test in detail in this case and confirmed that it should not be applied when considering whether the restraint of trade doctrine was engaged. Rather, the Court confirmed that as the doctrine is founded in public policy it should be guided by common law which is governed by and reacts to “new events and new ideas” thus moving with the times. This has been referred to as the “trading society test” and the Court further confirmed that under this test the doctrine will not be engaged by a covenant which restrains the use of land if it is a type “which has “passed into the accepted and normal currency of commercial or contractual or conveyancing relations” and which may therefore be taken to have “assumed a form which satisfies the test of public policy”.” On the evidence before it the Court found that the covenant in this matter was in such an accepted form as it has long been accepted that the grant of such covenants in leases is commercially acceptable.

The Impact

This decision is helpful as it gives an element of certainty to those dealing with property subject to such restrictions albeit it is unlikely that a court would uphold any wider restrictions then are currently found to be commercially acceptable.

The judgment also aligns with the position under competition law, a route more commonly chosen to attack restrictive clauses. Agreements which have as their ‘object or effect’ the restriction of competition are prohibited under the Competition Act unless ‘exempted’ by creating countervailing pro-competitive benefits.

The Competition and Markets Authority’s current guidance on competition law and land agreements notes that in a case where, without such a covenant in favour of the anchor tenant, the shopping centre would not have been constructed at all, the agreement is unlikely to be found to restrict competition.

At EU level too, in a 2015 case concerning a Latvian supermarket chain, the European Court of Justice indicated that land agreements that, for example, allow an anchor tenant to restrict leasing of space to rivals are not a category of agreement that have as their very ‘object’ the restriction of competition. Instead, the current legal and economic context of the land agreement must be assessed to determine whether the restriction has the ‘effect’ of restricting competition.

Conclusion

In the circumstances the existence, or in the right circumstances and subject to being within the commercially acceptable “norm” the grant, of restrictive covenants should not be a cause for concern. However, there is a note caution to avoid trying to create novel or extended restrictions which might fall foul both of the “trading society test” and competition law.