Supreme Court decides on restrictive covenants and “restraint of trade doctrine”

In Peninsula Securities Ltd v Dunnes Stores (Bangor) Ltd [2020] UKSC 36, the Supreme Court held that a restrictive covenant given by a landlord of a shopping centre to an anchor tenant did not engage the common law doctrine of restraint of trade. The “pre-existing freedom” test set down in Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd [1968] AC 269 was discarded in favour of the “trading society” test based on accepted practice in the market.

FACTUAL BACKGROUND

The case involved an appeal by a retail anchor tenant (that is a considerably larger tenant in a shopping mall, often a department store or retail chain. With their broad appeal, they are intended to attract a significant cross-section of the shopping public to the centre) against its landlord, who challenged a restrictive covenant in the lease which prevented the landlord from letting space to businesses that competed with the tenant.

The landlord argued that the covenant was unenforceable as it fell within the doctrine of restraint of trade by preventing it from undertaking redevelopment, which might help to revive trade within the centre as a whole.

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 for 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 CASE AT THE SUPREME COURT

The case involved the interpretation of the doctrine of restraints of trade, a common law doctrine relating to the enforceability of contractual restrictions on freedom to conduct business. This doctrine, in effect a precursor of modern competition law, is based on the principle that an individual should be free to follow his trade and use his skills without undue interference. The principle renders a contractual term purporting to restrict an individual’s freedom to work for others or carry out his trade or business, i.e. a restrictive covenant void unless it is designed to protect legitimate business interests and no wider than reasonably necessary.

The Supreme Court needed to consider whether the doctrine of restraint of trade was triggered:

  • when the covenant granted by the landlord; 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.

The primary issue for the Supreme Court was to consider previous case law, among which was Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd [1968] AC, through which it could examine the 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 in its widest sense, and as such the business of the landlord as a developer and property owner. The Court also 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 was 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 in entering into the covenant, they had 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”. 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 covenant “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.

CONCLUSION

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

The judgment also confirms 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 a land agreement that, for example, allows 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.

PRACTICAL TIPS

In the circumstances the existence, or in the right circumstances and subject to being within the commercially acceptable “norm”, granting restrictive covenants should not be a cause for concern. However, restrictive covenants are to be drafted in a way that avoids creating new or extended restrictions, which might fall foul both of the “trading society test” and competition law.

Please see this case here: Peninsula Securities Ltd v Dunnes Stores (Bangor) Ltd.

For more information, and any guidance or advice on your contracts, restrictive covenants and competition law, Cleveland & Co External in-house counselTM, your specialist outsourced legal team, are here to help.

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