Pub company tie-ins can place businesses at a competitive disadvantage to those that are run independently. In this article recently published in the Estates Gazette, Matthew Pugh examines the results of investigations into the model and asks if a new code of conduct will help.
A 2009 survey by the British Beer and Pub Association (BBPA) found that there were approximately 53,466 pubs in the UK, down from 59,000 in 2004. The smoking ban, supermarket competition and the recession have hit the sector hard and around 39 pubs are closing each week. (see Estates Gazette, 3 April, p.50)
Although some pubs are independent or managed houses, many are owned by pub companies (pubcos) that rent them to tenants, usually on tied leases; these require tenants to buy some, if not all, of their drinks and services from the pubco.
The tied model enables tenants to pay lower rent; the pub company then makes up for this with profits on beer sales, which are generally sold at above the wholesale market price. It may sound fair, but opponents argue that it forces tenants to resell their beer at an artificially high price in order to make a profit, which puts them at a competitive disadvantage to freehouses and managed pubs.
On 31 March, the Financial Times reported that the chief executive of Punch Taverns, Giles Thorley is to step down leaving Punch with a share price of less than a third of the 230p per share he floated the company at in 2002. Some suggest that Punch's misfortunes are a direct result of its reliance on the ties model
It is unclear whether beer ties comply with Article 81 of the EC Treaty, which prohibits agreements (particularly supply agreements) that have the potential to restrict trade between member states. The Competition Act 1998 disallows these agreements where trade within the UK is potentially restricted; it is void and unenforceable under European and UK law, however the Competition Commission can grant block exemptions for any category of agreements which "contribute to improving the production or distribution of goods, or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit...".
There has been a succession of block exemptions relevant to beer ties, the latest of which expires in May. It exempts vertical supply agreements of any category which "improve economic efficiency within a chain of production or distribution by facilitating better coordination between the participating undertakings; in particular, they can lead to a reduction in the transaction and distribution costs of the parties and to an optimisation of their sales and investment levels" - provided the benefit of the improved efficiency outweighs any anti-competitive element. This will be presumed where a supplier has a market share of less than 30%.
There have been a number of challenges to the legality of the beer tie in the UK and European courts, the most publicised being Crehan v Inntrepreneur Pub Co (CPC)  UKHL 38;  3 WLR 148. However the key case is the European Court of Justice ruling in Delimitris v Henninger Brau AG (C-234/89)  ECR I-935 in which it was determined that the relevant market is the on-licence market (inc. hotels, casinos and nightclubs) of the member state and that two conditions had to be satisfied for a beer tie to infringe Article 81(1), namely:
- The network of supply agreements makes it more difficult for new national and foreign competitors to enter the market or to increase market share; and
- The agreement in question must make a significant contribution to the above market foreclosure.
Under this test, small and regional brewers and pub companies would have nothing to fear.
The 2004 Trade and Industry Committee Inquiry considered whether the tied model detrimentally affected the market. The Committee concluded that no one pub company held a dominant market position and that the cost of beer ties was usually balanced by the benefits available to tenants. They did, however, identify a "strong possibility of anti-competitive consequences" in the distribution market and asked the Office of Fair Trading (OFT) to keep the market under close scrutiny. However, the OFT said there was no evidence of anti-competitive behaviour.
In June 2008, the Business and Enterprise Committee (BEC) began an investigation examining the relationship between pub companies and tenants to determine whether the conclusions in the 2004 report remain valid. Its report, published last 13 May considered the effect of ties, whether the rental system is fair, and the benefits of the tied model. The Committee concluded that:
- Pub companies are negotiating large discounts with brewers but are not sharing the benefit of the discounts with tenants.
- There is little pressure to resist increases in beer list prices as the discounts increase pro rata with brewery list prices. This results in an increasing disparity between on-license and off-licence beer prices.
- Supply ties may be anti-competitive therefore breaching Article 81.
- Pub companies may have a dominant position under Article 82.
The Committee criticised the OFT for failing to acknowledge the true position. It recommended that the Secretary of State exercise his powers under the Enterprise Act 2002 to refer beer ties to the Competition Commission, and for ties to be limited to ensure that competition is restored.
The OFT said that the sector had been examined in depth by the Competition Commission and itself and that there was no new evidence to justify further investigation.
In July 2009, CAMRA submitted a super-complaint under s.11(1) of the Enterprise Act 2002, obliging the OFT to investigate the beer ties of pubcos with 500 or more tied pubs. The test under s.11(1) considers whether there is significant harm to the interest of consumers. Last October, the OFT rejected the complaint, ruling that beer ties did not restrict competition. It said that consumers benefit from a wealth of competition and choice in the sector.
In January, CAMRA launched an appeal to the Competition Appeals Tribunal. The appeal has been stayed until 1 August, during which time the OFT has agreed to hold an open consultation and to consider further evidence of alleged anti-competitive behaviour by pubcos. Details of the consultation process are available at www.oft.gov.uk/news/press/2010/14-10.
Code of Practice
The , the British Beer & Pub Association (BBPA) has published a Framework Code of Practice intended to improve the operation of tied agreements. The code is mandatory for all BBPA members and by 30 June, all member companies will have to incorporate it in their own code of practice and seek British Institute of Innkeeping accreditation.
The code will require pubcos to increase the information made available to prospective lessees and tenants so they can make a more informed decision before entering into a tied lease. It remains to be seen whether the BBPA are able to police and enforce compliance with the code.
The UK tied model has held strong against repeated challenges to date, but will this remain the case? Whilst Crehan case could be seen as an expensive lesson to anyone wanting to challenge the beer tie, it certainly does not close the door to future challenges. The principles established in the Delimitis case are well recognised; any case will turn on the effects the supply agreements have in the relevant market and whether these agreements result in market foreclosure. This will depend upon the supplier's market share and the range of products being supplied.
Although the current block exemption is due for review in May, the likelihood is that a revised version will be introduced with only minor changes. The 30% benchmark will probably survive and there is no indication that any pub company or brewer is likely to exceed a 30% stake in the on-licensed market. Despite the BEC's recommendations, there is currently no Competition Commission investigation pending and this is unlikely until after the EC review. Whether such an investigation would unveil enough evidence to satisfy the Delimitis test is unclear.
Although CAMRA's appeal will be a continuing cause of concern, the super-complaint is not a competition case - it will not set a precedent for breach of Article 81. The test is whether there is significant harm to the interest of consumers. The effect on new and foreign brewers should not be a consideration.
The industry has taken a significant step in implementing a Code of Conduct. In theory, this should mitigate against the prospect of lessees blaming the beer tie if their businesses fail, as they are more likely to enter into the lease with their eyes open although breach of the code will not help tenants establish that their beer tie is unlawful. It remains to be seen whether the code is complied with and whether it can be effectively enforced.
Whilst the last twelve months have been a tense time for all players in the industry with some recent momentum behind those attacking the beer tie, there is in fact no real indication that the position has really changed since Delimitis. However, if the tied model is affecting pubcos' renal income and beer sales, it may be commercial and not legal factors that see them gradually move away from the tied model in future.
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