INDEPENDENT PUB CONFEDERATION
Representing lessee, licensee and consumer interests
As representatives of multiple and individual lessees and consumers within the pub industry, the organisations and groups listed at the end of this document support and endorse the analysis and conclusions reached by the Business and Enterprise Select Committee. Since the publication of the report, we have been working collectively and individually to determine how best to address the problems it identified.
As part of this process, we have entered formal mediation with landlord representatives, the British Beer and Pub Association (BBPA). We have also engaged in the formal review conducted by the Royal Institute of Chartered Surveyors (RICS) in order to discuss their internal guidelines and the principles upon which pub valuations and the rental calculation model are based. We hope that these two initiatives will go some way to addressing those specific parts of the BESC Report.
In and of themselves, however, these two initiatives cannot deliver a complete solution to all of the problems facing the industry. A satisfactory resolution of all the issues raised by the BESC report appears to be outside the hands of the industry and remains a matter for further consideration by government and the competition authorities.
This paper, therefore, represents the collective position of all lessee and consumer representative groups in the industry and sets out what changes we believe are necessary to address all the concerns raised by BESC. In each case we set out our position in response to BESC, recommend actions to be taken and commitments we as lessees will offer to address the general concerns raised by BESC and to assist individual lessees and pub operators.
The IPC will work with landlord representatives, individual pub companies, industry stakeholders, other audiences, government and regulatory authorities where necessary to progress this position.
1. Rental Valuation method (para 41, 58)
The BESC Report concluded that the current method of pub valuations, used in the initial setting and reviewing of rents was subjective and argued that it should be abandoned unless it could be significantly improved. It also noted that “neither the pubcos nor RICS has taken any serious action to make sure the rental system is not unfairly biased against the lessee”.
We believe that the rental valuation method currently in use (the Profits Method) is – in itself – appropriate for the pub industry. Although significantly different to the method used by other commercial landlords, the assessment of a fair net profit before rent based on a maintainable trade (FMT) established on the assumptions of the turnover and costs of an average competent tenant will, we believe, deliver the right results if properly applied.
The problem arises in the way in which it is applied in practice and the over-reliance upon guidelines produced ostensibly by the RICS but drafted by surveyors who are working for, and on behalf of, the major pub owning companies. There has never been an opportunity for lessee groups to influence the content of these guidelines. This has resulted in a standard or blanket application, rather than an individual case-by-case assessment, along with a perception and real risk of bias.
The RICS guidelines are currently the subject of an internal review within that institution. We have the following recommendations for action:
- The RICS should establish a working group comprising appropriately qualified and experienced lessee and landlord representatives, as well as independent RICS members to formulate new valuation guidelines. The guidelines should be independent and equal in their application and should cover, as a minimum: the criteria for determining FMT; running costs; how an average competent tenant should be defined; as well as measures to improve the level of disclosure surrounding the income earned from the site by the landlord.
- The tied tenant should be no financially worse off than a tenant who is free of tie, and all parties should agree on how to determine and implement this principle. A mechanism for quantifying countervailing benefit must be developed by lessee and landlord representatives collectively as a matter of urgency. Proper implementation of this principle is imperative to ensure tie arrangements deliver a benefit to consumers and are compatible with basic competition and free market principles.
- The key change we would wish to see made to the current model is an acceptance that that the lessee is entitled to recompense for the time spent in the day-to-day running of the business as a valid cost of operating the premises. It remains a matter of concern that many lessees are earning a very low return from their business investment, and are therefore unable to invest as much as they would wish in improving consumer amenity and expanding community activity . This is as a direct result of imbalances in the valuation model which do not allow for lessees time to be taken into account before a divisible profit is determined. The valuation model and guidelines for its application must be amended to make allowance for this.
- The guidelines should also set out how tenants’ goodwill and the effects of their alterations and improvements are to be properly disregarded. They should also set out how relevant statute and common law is to be applied to the sector.
In order to deliver these changes, lessees and their representatives will draw up a panel of experts to help develop and implement new guidelines and to assist lessees in rent negotiations. We will work collectively to develop robust benchmarks for quantifying the benefit of a lessee’s time to the business in order to calculate an appropriate level of remuneration.
2. Rent setting and review (para 12, 45, 54, 47, 60, 70, 75)
Noting the significant imbalance in bargaining power between lessees and landlords, the BESC Report argued that improvements in the level of transparency about the assumptions used in setting rents and information on the way in which they were calculated was vital. We concur with this, and believe that the benefits avaiable to the landlord from the ‘tie’ confer a duty of care and a responsibility to make sure the assumptions on which the rent is based are accurate, justifiable and sustainable.
- There should be industry agreed minimum standards of disclosure, transparency and fairness in the handling of rent negotiations. In particular the cost and turnover assumptions used in the rental calculation model should be explained, justified and agreed before lease negotiations are commenced. This is one of the issues being addressed by the current mediation between landlord and lessee representatives. This process is still ongoing and both the discussions and topics included within it are bound by confidentiality.
Lessee representatives commit to working together to develop robust and reliable industry benchmarks for operating costs, which will be made freely available to lessees and their advisers, pro forma templates for business plans and P&L statements, standard questions and information requests to present to a prospective landlord.
3. The way in which leases are issued – Individual company codes of practice
There are limits as to what may be covered by such a pan-industry agreement and we acknowledge that the BBPA believes itself to be constrained by the Competition Act from discussing pricing or the operation of purchase obligations. We do not necessarily agree with their interpretation of the law and continue to believe that it would be possible to collectively debate all the substantive issues set out in this paper. Nevertheless, in light of the BBPA’s position, we would expect companies to draft their own codes – outside the mediation process – setting out how they intend to implement and exceed this.
Individually, and in public, the majority of pub companies have acknowledged that the current division of profits between landlord and lessee is imbalanced and needs adjusting. We accept that this may not be capable of being delivered collectively but have, to date, seen nothing setting out in detail how the current imbalance may be addressed. In the absence of detailed proposals to deliver that adjustment, we have set out below how we believe the necessary redistributive effect may be achieved.
We believe the following issues should be included in such a company code and we will be recommending them to our members as standards of best practice:
- Lessee Representation: the earliest property owning pub companies, Unique and Inntrepreneur, established an internal lessee forum comprising nominated representatives. The forum met with the Board and discussed issues such as discount formula and other trade related matters. These internal forums have been largely abandoned and there is now no conduit for lessee concerns to be raised and addressed. It is this, arguably, which has led lessee groups to look outside the industry for a solution to their problems. We believe that there would be merit in treating the pub companies and their lessees as if the Works Council Directive applied to their relationship and requiring companies with sufficient lessees to establish a consultative body with lessee and landlord representatives. Such a body should meet the minimum standards set out in the Works Council Directive and would require the pub company to meet with a representative, elected forum of their lessees to inform and consult them on issues material to the company and their contractual relationship. We would expect the forum to be consulted on changes to the company code of practice, standard lease terms, pricing and discount policy and negotiate with them on these matters with a view to reaching agreement. The code of practice should make clear that these matters and related policy cannot be determined unilaterally.
7. Pricing: an individual company code of practice should make clear the company’s policy on beer pricing and should set out the formula for calculating discounts. We will be advising our members that, as a matter of best practice, we believe that the formula should be set in consultation with an established lessee forum or council; be published openly and shared with new and existing lessees; provide for volume related discounts, set by reference to the national wholesale price; and should give a clear commitment to margin maintenance.
8. RPI: the use of RPI for the annual indexation of rent is wholly inappropriate. The index bears no relation to the commercial environment within which pubs are operating and in particular the operating costs which are being borne. The use of annual RPI increases often takes place in addition to normal periodic rent reviews. The effect of the annual increases is to increase the passing rent so as to influence the outcome of the rent review further in favour of the landlord. The net effect is to replicate an upward only rent review clause of the type which has been criticised by BESC, DCLG and others over the past decade. Long leases within the industry are already subject to a regular rent review which allows rent to be adjusted according to market conditions and further annual adjustment should be unnecessary.
As a matter of best practice, pub companies should abandon the use of RPI in rent setting for leases which are more than 3 years’ in duration. If they wish to retain an annual indexation method for these short leases, another property-based index should be used. The company code of practice should make clear which method is being used to review rent and provide justification for it. We will be advising our members not to accept RPI clauses in their leases and will be asking pub companies to issue Deeds of Variation to remove such clauses from existing leases longer than 3 years in duration.
Where companies make a range of lease terms available, lessees should be offered the ability to remove an RPI clause from an existing contract by Deed of Variation at nominal cost.
9. Upward Only Rent Reviews: despite being criticised in the TISC Report in 2004, many existing leases still contain UORR provisions. Some pub companies have given undertakings not to apply them, but these are not binding and it would be therefore open to a subsequent landlord to enforce the terms of the lease in full. Others have offered lessees the option of a Deed of Variation to remove the clause, but at a cost of £500. We believe that all lessees should be offered the option of removing an UORR clause from their lease on request at nominal cost. In addition, a company’s code of practice should make clear that any undertakings offered in respect of UORR clauses will be made binding on their successors in title.
Moreover, those companies which have undertaken not to enforce upward only clauses have interpreted this strictly and have not allowed rents to fall, even where circumstances suggest they should have. For the avoidance of doubt, it should be made clear by pub companies that all rent review clauses should be capable of upwards and downwards reviews.
10. Insurance: the BESC Report clearly states (para 108) that lessees should not pay through their insurance premiums for a measure which benefits the pub company. Whilst it is acceptable for the landlord to recharge the cost of insurance for property damage of their loss of rent in the premium paid by the lessee, it is not appropriate for the lessee to bear the cost of insuring the landlord for other income risks that they face. We would expect the best codes of practice to make clear that the pub company will not seek to make a profit from the provision of insurance and to make clear that the insurance premium does not cover the cost of insuring the landlord’s loss of income from wet rent and other income streams.
11. Enforceability: we remain concerned to ensure that any revised BBPA Code and individual company codes produced in response to it are legally binding. There are many examples of existing codes being ignored or the provisions changed. We believe that a company’s commitments offered through its code of practice should be translated into standard lease terms to be applied to new and existing agreements. As a group of lessee representatives, we are working to draft these clauses and accompanying deed of variation
In the past, company codes have been dramatically altered on a unilateral basis and imposed upon lessees without consultation or notice. For the avoidance of doubt, we believe that any company code should be explicit that changes cannot be imposed unilaterally, must be developed in consultation with lessee representatives and provide for a guaranteed minimum notice period before any such changes take effect.
As a collective group representing lessee interests, we will be advising our members to be extremely cautious about signing leases with companies whose codes of practice do not make these matters clear or meet these standards of best practice. We will also be providing model examples of leases which contain the correct clauses and rent review structure to advise them on which leases meet best practice.
In addition, we will work to support the BII’s current process of code accreditation to ensure that it scrutinises the content of the codes as well as their clarity. We commit to placing our expertise at the BII’s disposal to ensure that compliance with company codes is assessed on an annual basis and to develop a mechanism for dealing with complaints.
4. Exclusive Purchase Obligations – the Beer Tie (84,87,92, 125, 129, 138, 139, 191)
The BESC Report expressed concern about the operation of an exclusive purchasing clause or tie in long pub leases. It stated that “the tying of beers, other drinks and ancillary products should be severely limited to ensure competition in the retail market”. We would concur with this.
When the pub company model was developed in the 1990s, the lease agreements typically only included one exclusive purchasing obligation – the beer tie. Over time, the phrase ‘the tie’ has been expanded and now many lessees are bound by five separate exclusive purchase obligations. For the avoidance of doubt and to aid understanding these are set out below:
- Beer tie – originally bottled and draught lager, ale and recently cider
- Wines, spirits and minerals (WSM)– all other wet products
- Machines – originally just Amusement With Prizes (AWPs) but recently other skills based machines (we have dealt with this separately below because it raises separate concerns)
- Insurance – requirement to buy buildings cover
- Ancillary products
In so far as they are made to meet with the objectives of competition legislation, the existence or legality of an exclusive purchasing agreement in and of itself is not the issue in question. As lessees, the focus of our concern is on the cumulative economic effect of this clause on the agreement as a whole and in particular the distortive effect it can have on the rental calculation model. At present, the income earned by pub owning companies from the sale of beer is not adequately taken into account in the determination of rent and a fair share of the divisible profits earned by the lessee. This is a particular matter of concern where the company has no production capacity.
We would therefore put forward the following proposals to address lessees’ concerns about the economic effect of the tie:
12. Choice: BESC suggested that the only way of determining the fairness or otherwise of the tie would be to open it to genuine market pressures and urged the Government to undertake an urgent consultation to introduce a phased programme offering all lessees the choice of whether to be free or tied. This would force pub companies to compete and demonstrate the clear, quantifiable benefits arising from any exclusive purchasing agreements. Ahead of any Government intervention, we believe that industry best practice would be for companies issuing leases to provide a free and fair choice to all existing and future lessees whether to be tied for beer or not and a menu of options of the degree of partial tie for other ancillary products – either at the start of new lease negotiations, at the next planned rent review, at renewal of the lease or on receipt of a code of practice review request.
As a lessees body, we would be recommending to our members that they do not contract with a company which does not offer this degree of choice and flexibility.
13. Extent of tie: whilst we can understand the justification put forward for tying beer, as the principal product or service provided by the pub, we believe that all other ties are ancillary to this and believe they should be severely restricted in line with the BESC Recommendations. Where exclusive purchasing agreements continue to exist they should be for beer (draught and bottled beer and lager) only and other wet products should not be ‘tied’ at all.
Exclusive purchasing obligations should be separately considered and negotiated and the cumulative effect of each restriction should be fully reflected in the rental valuation and share of the divisible profit.
We note that the European Commission has recently expressed concern at the bundling of buying obligations. The greater the number products subject to an exclusive purchase obligation, the less likely it is that the benefits of them will outweigh the anti-competitive restrictions. For this reason, we support the removal of the Competition Act 1998 (Land Agreements Exclusion and Revocation) Order 2004 to require pub companies to carefully assess the cumulative effect of a number of product ties on an ongoing basis and justify that the benefits outweigh the restrictions. In our view, the greater the number of product ties, the less likely it will be that the agreement will satisfy the criteria for automatic exemption and the greater the need for individual scrutiny.
14. Guest Beer: Leases which continue to include a beer tie must allow lessees to purchase one draught and one bottled beer outside the scope of the exclusive purchase obligation, provided this is sourced direct from a small brewer (less than 200,000 hl capacity). This limited relaxation of the beer tie would reduce barriers to market access for small brewers and increase competition and consumer choice.
15. De Minimis: nevertheless, we accept that for some small businesses, the beer tie is an integral part of their business model and they may not be able to offer this degree of choice. We would therefore suggest that a de minimis threshold, consistent with that applied under EU law, be adopted to restrict the application of the above to companies with a market share of more than 1%. Within the UK pub market, this would equate to companies operating fewer than 500 pubs.
As a collective group representing lessee interests, we will be advising our members to be extremely cautious about signing leases with companies whose codes of practice do not make these matters clear, meet these standards of best practice or which do not contain the correct clauses.
We will also work to develop learning programmes and tools to explain the economics of the tie and to equip lessees with an understanding of its impact on the rent calculation and FMT model.
5. AWP tie (103)
TISC Report in 2004 and BESC Report both concluded that the “benefits of the AWP machine tie outweigh the income tenants forego and recommend that the AWP machine tie be removed”. It also noted the requirement on machine suppliers to make up front access payments to many pub companies. This results in above-market rents being charged to lessees.
We wholeheartedly concur with the BESC Report and are disappointed that the pub companies have taken no steps to address this issue over the past 5 years. We understand that the BBPA believes that it is precluded by competition law from requiring its members to act in this area, therefore we recommend the following as best practice to be adopted as a matter of urgency by individual companies:
16. The AWP tie should be removed from all long leases either at the end of the machine supply contract or the next rent review whichever is earliest. In the meantime, and until this is fully achieved, the nominated supplier list and practice of upfront access payments should cease immediately. No new leases should be issued which include a machine tie.
As lessee representatives, we would be willing to discuss collectively with the BBPA and others a new system for dealing with gaming machine income. We would also work to develop an approved supplier list for use by lessees.
The BESC report has already been a catalyst for change within the pub industry but the problems it identifies are wide ranging, multi-faceted and inter-linked. We as lessees, endorsed by consumer organisation CAMRA, believe that there are five key elements of the pub company model which must be addressed as a matter of urgency to ensure that competition in the market is not further distorted to the detriment of small businesses and consumers alike.
Those five elements are set out in detail in this paper:
- the rental valuation model
- the way in which rents are calculated
- the way in which leases are issued by pub companies
- exclusive purchasing obligations (tying agreements)
- the AWP tie.
Some of these require structural adjustment or regulatory intervention, but many can be delivered through the promotion and adoption of best practice and a willingness by the pub companies to change the way in which they operate.
As a collective body of lessee and consumer representatives, we have already begun work to address these issues individually and the discretion of the competition authorities has been engaged in considering the beer tie. However, it is clear that these five issues are intricately inter-linked and a successful resolution of one element on its own cannot and will not resolve the problem as a whole. There is no one solution or lever to be applied, and any solution must address all five issues.
We are committed to working with all stakeholders to deliver a workable and pragmatic solution in each of these five areas and will not consider the problems identified in the BESC Report fully resolved until that is achieved.
12 October 2009
PREPARED AND ENDORSED BY
- Association of Licensed Multiple Retailers
- Campaign for Real Ale
- Fair Pint Campaign
- Guild of Master Victuallers
- Justice for Licensees
- Federation of Small Businesses
- Society of Independent Brewers
- Unite the Union
SUPPORTED IN PRINCIPLE BY
- BII – in light of its charitable status and training remit, the BII has offered its full support but is unable formally to endorse the document itself.
This principle was recently confirmed in the Brooker judgement
 This process was started by Whitbread in its application to the European Commission for individual exemption from Article 85(3) in 1994
 Research carried out by BESC identified that the majority of lessees earn less than £15,000 pa and many would be in breach of the NMW and Working Time Regulations if they were employed as staff as a result.
 Research carried out by BESC identified that the majority of lessees earn less than £15,000 pa and many would be in breach of the NMW and Working Time Regulations if they were employed as staff as a result.