Long-term exclusive lease agreements have always been quite controversial. Over the last few years such agreements often led to costly legal action between landlords and supermarkets. It is therefore not surprising that the impact of long-term exclusive lease agreements on local competition was also included as one of the six objectives to be investigated by the Grocery Retail Market Inquiry[1] (“Inquiry”).
In the Final Report of the Inquiry[2], one of the key findings was that long-term lease agreements lead to a distortion of competition and that “There are no compelling justifications to substantiate the continued unfettered presence of such lease agreements.”[3]
As more fully discussed below, the Inquiry recommended in its Final Report that exclusive provisions may in certain instances not be enforced, new lease agreements may not contain exclusive provisions and exclusive lease agreements have to be phased out over a period of time. If implemented, these recommendations would effectively lead to the end of the road for long-term exclusive lease agreements.
The discussion below will include a brief background on the process leading to the Final Report and the findings and controversial recommendations on exclusive lease agreements and the differential treatment by landlords in respect of rental rates between tenants.
Background and introduction
An exclusive lease agreement is generally a long term lease agreement between a landlord and a tenant, which in the present context grants the tenant exclusive rights to operate in a specific shopping mall. The tenant is usually one of the big four national retail supermarket chains and obtains “exclusivity” in a particular shopping mall. The exclusive provision could also include, for example, that no other supermarket, bakery, chemist or butchery, may do business in the same shopping mall in which the particular supermarket operates.
While excluding any direct competition for the retailer within the mall, an exclusive lease agreement also ensures the shopping mall’s financial viability and sustainability. This aspect was also acknowledged by the Inquiry[4] as a positive benefit, namely that this may lead to protection of an investment and a potentially optimal tenant mix in the shopping mall that may also benefit the consumer and the small businesses in the shopping mall.
The Commission’s first investigation into the four major supermarkets was concluded in 2011, when no evidence of anti-competitive behaviour and price fixing was found. At the time, the Commission had concerns about long-term exclusive leases and indicated that these may possibly contravene the Competition Act, particularly where supermarkets have market power.
After the Commission’s first investigation, a number of landlords thought there was an understanding that long-term exclusive lease agreements would not be enforced as they may not be legal. This led some retailers to turn to the courts to enforce their contractual rights.
In addition thereto, these concerns were being addressed in that the Competition Tribunal had imposed conditions in property related mergers where exclusivity clauses in leases existed, that they must negotiate in good faith to seek an end to the relevant exclusivity clauses upon termination of the lease agreement.
In most of these cases the retailer did not agree to the cancellation of the clause, or the lease agreement would only terminate after a long period, which led to the perpetuation of this practice. The findings and recommendations contained in the Final Report regarding the use of long-term exclusive agreements will seemingly end this conundrum.
Findings and recommendations with respect to long-term lease agreements
The Inquiry firstly found[5] that the widely prevalent use of long-term exclusive lease agreements leads to the distortion of competition. This leads to the foreclosure of competing retailers, particularly small and independent retailers as well as emerging challenger retailers, which gives rise to customer harm, as it limits consumer choice within shopping centres. It accordingly found that there are no compelling justifications to substantiate the “unfettered presence” of such lease agreements.
Secondly, the Inquiry found[6] that certain exclusive provisions are not objectionable. Clauses which simply provide a limited exclusion of certain businesses which could risk health and safety standards or brand positioning would be acceptable. However, such clauses must have an objective justification and must be reasonably related to such justifications.
The Inquiry made four main recommendations[7] with respect to the use of long-term exclusive lease agreements:
- Non-enforcement of exclusivity provisions[8]
The first main recommendation is that national supermarkets must with immediate effect cease from enforcing exclusivity provisions (or provisions that have a substantially similar effect) in their lease agreements. The targeted agreements are limited to lease agreements with SMME’s,[9] speciality stores (for example, butcheries, bakeries, liquor stores, etc.),[10] and other grocery retailers (including the emerging challenger retailers) in shopping centres located in non-urban areas.
It is notable that this recommendation is aimed at limited categories of tenants and clearly aims to protect smaller business and other grocers in non-urban areas. The reference to “immediate effect” most probably would mean with effect from the date of publication of the Final Report. It is unclear how this recommended prohibition will be enforced by the Commission however, as discussed later the intention will seemingly be to have voluntary compliance.
On a practical level it could be problematic to understand how the recommended prohibition will work. A national supermarket is usually the tenant, who would be able to enforce its rights in terms of the lease agreement against the landlord. If, for example the landlord allows a speciality store in the shopping mall and breaches the exclusivity provisions, the tenant will enforce its rights against the landlord. It is seemingly unclear what the consequences of this would be.
- The future use of exclusivity provisions[11]
The second main recommendation is that no new leases or extensions of leases by grocery retailers may incorporate exclusivity clauses. The exclusivity clauses include clauses that have substantially the same effect or clauses that may serve to restrict the product lines, store sizes and location of other stores selling grocery items within the shopping centre.
This recommendation is general and wider than the first recommendation, but still limited to grocery retailers and other stores “selling grocery stores within the shopping centre”. This would probably not preclude any other retailer than a grocery retailer (for example a clothing retailer) from including an exclusive provision in a lease agreement.
As the recommended prohibition is limited to grocery retailers in the same shopping centre, there would seemingly be no issue if the grocery retailer requires the inclusion of an exclusive provision where the landlord owns another shopping centre where another grocer could compete in the same area.
- The phasing out of exclusivity provisions[12]
The third main recommendation is that enforcement of exclusivity provisions by the national supermarket chains as against other grocery retailers must be phased out by the next extension of the lease, or five years from the publication of the Final Report, whichever is the earlier.
In order to achieve compliance with this recommendation, landlords and national supermarkets would have to review all current lease agreements and enter into an addendum to the lease agreement. This would require negotiations between the parties which could be time consuming and lead to additional costs to be incurred, especially where a party is not agreeing to such an addendum.
It is again noteworthy that this recommendation is limited to national supermarket chains as against other grocery retailers. This will seemingly not oblige any other retailer to phase out exclusivity provisions.
- Enforcement and compliance[13]
The Inquiry recommended that the Commission must seek voluntary compliance by the national supermarkets within six months from the date of publication of the Final Report. The recommendation continues: “If the national supermarket chains do not undertake to give effect to these recommendations, the Government should introduce legislation, in the form of a statute, or regulations, or Code of Practice to give effect to these recommendations”.
It is again noteworthy that the recommendation is only targeted at the national supermarket chains, in other words it seems to exclude landlords and other retailer tenants. As at the time of writing this note it is unknown what measures have been taken by the Commission or if there has been any voluntary compliance. It will in any event be interesting to see how these enforcement measures will be implemented.
It is finally interesting to note that the recommendations will not exclude the Commission from pursuing litigation in respect of any existing complaints and evidence gathered in the Inquiry.[14] The Inquiry was of the view that any evidence gathered during the Inquiry would constitute a prima facie case for a referral to the Competition Tribunal. It is unclear why it was necessary to address this aspect, as it will not be possible for a Market Inquiry to exclude the application of the provisions of the Competition Act.
Findings and recommendations with respect to differential rental rates
One of the more contentious aspects that followed from submissions made to the Inquiry is that of rental differentiation, which essentially means that landlords differentiate between tenants when rentals are negotiated. The reason for being more contentious is a concern from landlords that any interference in this regard may lead to some form of rental control, which conflicts with the principle of normal contractual freedom.
An example of rental differentiation would be where a large tenant which leases 1000 square meters will pay lower rentals per square meter than a small tenant which leases only 100 square meters. In the Preliminary Report published on 29 May 2019, it was identified that this may hinder the participation of competing small grocery retailers and specialist stores.
The Inquiry found[15] that the conduct of rental differentiation is generally widely practiced and is based on a number of compelling justifications which include, market forces; size, position and visibility of the unit to be let; the footfall to be likely created by the tenant; depth of the store; costs of installing the tenant and trading densities. The Inquiry noted “…that the bargaining dynamics between landlords and the national supermarket chains do appear to have an influence on the differential treatment accorded different customer groupings.”
It continues[16] to state that the Inquiry acknowledges “…the complexity associated with the determination of applicable rental rates to different types of customers. It is for this reason that the Inquiry does not make any recommendations in this regard.” It however, found that there is a need “…to ensure that there is a balanced treatment of tenants, premised on the principles of fairness and transparency.”
Despite stating that the Inquiry does not make any recommendations on rental differentiation, the Final Report does indeed contain the following recommendations[17], namely:
- Property owners and managers of shopping centres must:
- use fair, transparent and commercially justifiable criteria in determining differences in rental rates across tenants;
- ensure that escalation rates across tenants are uniform unless there are fair, transparent and commercially justifiable reasons for them to differ; and
- ensure that lease deposits and shop fitting allowances are based on fair, transparent and commercially justifiable criteria.
- In order to continue the work undertaken by the Inquiry, it is recommended that the Minister should appoint a facilitator to seek to secure voluntary compliance.If the facilitator is unable to secure voluntary compliance within six months, the Government “…should introduce a legislative framework to give effect to these recommendations in the form of a code of good practice and the establishment of an industry Ombudsman.”
As at the time of writing this note it is unknown what measures have been taken by the Commission or if there has been any voluntary compliance. It will in any event be interesting to see how these enforcement measures will be implemented.
General conclusion
It should be clear that after the publication of the Final Report the use of long-term exclusive lease agreements will not be ended in the near future. As indicated, there are still several aspects that are unclear, especially on the enforcement side of the recommendations.
Some clarity on the way forward can perhaps be expected once either the Commission or Minister takes any further steps to appoint a facilitator or introduce legislation to give effect to the recommendations. Nothing prevents any interested party to either consider taking any contentious issues up with either the Commission or the Minister.
[1] The Grocery Retail Market Inquiry was established in terms of Section 43B(2) of the Competition Act no 89 of 1998 (“the Competition Act”) in terms of a notice in the Government Gazette on 30 October 2015.
[2] Grocery Retail Market Inquiry Report to the Competition Commissioner by the Inquiry Panel dated 25 November 2019 (“Final Report”).
[3] See Par 1086 on page 333 of the Final Report.
[4] Paragraph 75 of Statement of Issues dated 15 July 2016.
[5] See par 1086 on page 333 of the Final Report.
[6] See par 1087 on page 333 of the Final Report.
[7] See paras 1102.1 to 1102.3 on page 337 of the Final Report.
[8] See par 1102.1 on page 337 of the Final Report.
[9] Small Medium and Micro Enterprises as defined on page xv1 of the Final Report.
[10] Defined on page 20 of the Final Report as “a retail store within the grocery retail sector that focuses on a specific product category.”
[11] See par 1102.2 on page 337 of the Final Report.
[12] See par 1102.3 on page 337 of the Final report.
[13] See paras 1102.4 and 1102.4 on pages 337 to 338 of the Final Report.
[14] See para 1102.5 on pages 337 to 338 of the Final Report.
[15] See par 1088 on page 333 of the Final Report.
[16] Para 1089 on page 334 of the Final Report.
[17] See paras 1102.6 and 1102.7 on page 338 of the Final Report.
