House of Commons - Trade and Industry

Select Committee on Trade and Industry Second Report

8 THE BENEFIT OF THE TIE TO TENANTS

133. Pubcos do not deny that their tied tenants pay higher wholesale beer prices than other public house operators. The offset, or 'countervailing benefit', to the tenant is in the form of a lower than commercial, or free of tie, dry rent (rent) and special commercial or financial advantages (SCORFA).[170] Under EU competition law, contracts containing an exclusive purchasing obligation, such as the beer tie, have only ever been permitted if they provide such 'countervailing benefits'. The theory is that the net cost of the beer tie to the tenants makes them no worse off than if they were free of tie.[171]

Dry rent - the profit assessment method

134. For new leases, pubcos calculate the rent on the basis of a projection of the fair maintainable level of trade (FMT) a competent hypothetical untied tenant would be expected to achieve. This includes total 'wet' sales and an estimate of additional income from food sales, room rentals and AWP machines. Similar projections are made relating to the likely costs of the public house in the hands of the same hypothetical tenant, excluding the tenant's salary, which are subtracted from the FMT. The rent valuation is assessed on the basis of a percentage of the remaining profit, known as the 'divisible balance'. Pubcos suggested to us that their share of these 'profits', the rent, reflected the market demand and specific agreement terms for a particular public house but were typically around 50 percent.[172]

135. If a pubco believes the share is inequitable for either side, they adjust the required rent to the requisite level. Expected AWP income is then deducted to arrive at the rent offer they present to an ingoing tenant. It was accepted by all parties that this was an imprecise science but was the standard industry method for the valuation of onlicensed premises, as supported by the Royal Institution of Chartered Surveyors (RICS).[173]

136. Once the required rent has been decided by a pubco, the rent an ingoing tenant actually pays follows further negotiation with the pubco through agreement of an appropriate assessment of FMT. Once the rent has been agreed it is indexed, increasing annually by the increase in the retail price index (inflation). Rents are also subject to review at prescribed intervals, usually three to five years, when the calculation is repeated.[174]

Fair maintainable rent (FMT)

137. The determination of rent levels has been a major source of concern among tenants, particularly the evaluation of a fair maintainable trade (FMT) by pubcos' valuers. A lack of transparency and accuracy in calculating FMT has given rise to complaints that rent levels bear no relation to the actual level of business being done in tenants' public houses.[175]

TRANSPARENCY

138. There is a lack of transparency about the way pubcos' valuers decide what a fair FMT for a particular public house is. The valuation of FMT is made on the basis of the public house, trade fixtures and fittings and the future trading potential that would be achieved by a competent operator.[176] Valuers are required to ignore the actual trade of an incumbent tenant, whether they are under-performing or are achieving above average trade. In effect, valuers are required to value the property and not its occupier.[177]

139. Pubcos' valuers 'adjust' FMT for differences in the public house business being assessed; this might include differences in the agreement terms, which include the discounts available and repairing obligations, as well as the date the rent was assessed. They also have regard to the views of the tenant, knowledge of the past performance of the public house concerned and the quality of past tenants.[178]

140. The larger pubcos told us that "every effort is made at the outset to agree the rent on a transparent and consistent basis"[179] and that they always provided tenants with a copy of their analysis of the rent calculation. However, tenants are provided with basic information only on the expected level of sales, estimated costs and level of rent required for the public house. The tenant is not in a position to see how their pubco decided their rent as pubcos consider the supporting detail of profit assessment and rent computation on how they were constructed confidential.[180] For example, the FSB provided evidence of a pubco tenant in South East England who was advised by an accountant to ask for a written explanation of how his rent was calculated. He was refused both a written explanation and even a breakdown of the possible factors which could influence rent levels.[181] Pubcos maintained that for tenants to make a decision on whether to sign an agreement they only needed to know the quantity of product they were likely to sell, the cost of the beer they would purchase and the rent they would have to pay.[182]

ACCURACY

141. The FMT of any particular public house is a matter of opinion and where the FMT of a public house has been set too high, or the associated costs too low, it can lead to serious problems of over estimating the rent. A.B. Jacobs told us that in recent cases he knew of, the costs that had been underestimated by valuers included the buildings insurance the pubco should charge, the gas usage for beer raising, and the water rates based on usage. The magnitude of error he found in these cases was between 50 and 200 percent.[183]

142. The effect of such underestimation of costs on the divisible balance, and therefore the rent, could be expensive for tenants as any miscalculation here means "for every £1,000 of legitimate cost left out of the profit assessment by valuers, the landlord gains £500 in rent and the tenant bears the burden of that £1,000 out of their income".[184] Mr Jacobs believed such errors were made because valuers "generally have no operational, managerial or marketing experience relative to a pub, let alone knowledge of accounting practice and in particular the disciplines for profit assessment".[185]

143. One witness suggested to us that the performance of the hypothetical tenant of a public house, in its then current condition, should use the historic profit and loss accounts of the business to form the basis of the profit assessment.[186] Unfortunately, the precise profitability of each retailer is not known by pubcos as there has never been a requirement in their agreements to share such information and tenants generally keep these details confidential.[187]

144. The industry could and should establish clear guidelines for the valuation process. Where they do not already exist, new national guidance for rent calculation should be compiled, and disclosure rules clarified. The profit assessment method of calculating rent should be carried out in accordance with national accounting standards and with knowledge, prudence and due diligence.

145. Pubcos should provide their tenants with a comprehensive breakdown of how their rent was calculated. This should reveal the whole detail of the profit assessment and how the specific requirements of the lease conditions had been interpreted by valuers. The profit assessment should form an addendum to leases, with any subsequent review, to ensure transparency.

Rent reviews

146. Tenants were also concerned about the use of upward only rent review (UORR) clauses in their agreements which meant rents had to increase, even when trade could be falling.[188]

UPWARD ONLY RENT REVIEW (UORR)

147. At the outset of our inquiry we did not intend to specifically examine UORR clauses as we were aware that the ODPM was undertaking public consultation on commercial property leases generally, which included options for deterring or outlawing the use of UORR clauses in all such leases.[189] However, we could not ignore the concerns about such clauses expressed to us by tenants and their representatives.[190]

148. The majority of pubcos' agreements provide for the rent to increase each year in line with the rate of inflation. Pubcos told us these clauses were included so that when a full review of the rent took place the increase did not create a sudden unexpected burden on their tenant.[191] However, many tenants said when their rent reviews took place proposed increases were still unexpectedly high. Many believed that their rents should be reduced because of falling trade, but as their agreements contained UORR clauses this was not possible.[192]

149. We asked the ALMR to undertake a survey of its members to gauge the use of UORR clauses in pubcos' leases and whether there were any differences between true pubcos and brewers.[193] The survey found the use of UORR clauses by pubcos was more common in long leases than traditional short term tenancies. Three quarters of pubcos (19 companies) did not include an UORR clause in some or all of their agreements. In terms of public house numbers, this figure increased slightly to 76 percent, with just over 17,000 public houses not being governed by such a clause. Of the 19 companies, 84 percent had never included an UORR clause in their contracts. Three companies, representing over 9,000 public houses, stated that they had recently abolished UORR clauses for some or all of their agreements. Several respondents (28%) noted that while their agreements included UORR clauses, these were not applied automatically and discretion was always exercised, with rents being frozen or reduced in exceptional circumstances. Others said that in practice the clauses were often ignored or unenforced.[194]

150. We were also told by our pubco witnesses that their new 'preferred' leases did not contain UORR clauses and in the case of old leases they did not exercise these clauses. Of the larger pubcos, Mr Harrison, Operations Manager for Enterprise, told us that Enterprise had removed UORR clauses from all their current agreements with tenants, except those of a company they had recently acquired. They were currently in negotiations to remove such UORR clauses from these agreements.[195] Of the Punch estate, 31 percent of tenants had agreements which included UORR clauses.[196] These were mainly 'legacy' leases they had inherited when they took over other companies' estates and in these cases they did not exercise them. The Chief Executive of Punch told us that none of their current leases contained UORR clauses and they told us they would look at removing these clauses from all legacy agreements.[197] W&DB also confirmed they had no UORR clauses in any of their agreements.[198]

151. We commend pubcos which have already removed upward only rent review (UORR) clauses from their agreements. We consider this best practice within the industry and we call upon those pubcos which have not already done so to remove such clauses as soon as is practicable.

GRIEVANCE PROCEDURES

152. If tenants believe the rent offer is unfair they have different options depending on whether they are prospective tenants or incumbent tenants undergoing lease renewal or rent review.

153. Prospective tenants have the option to decline signing a proposed lease without penalty. However, incumbent tenants rarely have this option as the public house is their business and often their only accommodation. If they are trying to negotiate a lease renewal and choose to walk away they receive payment from their pubco for only the fixtures and fittings. Under the terms of their original agreement the leased premises, the public house, reverts to its pubco owner. Such tenants have the choice of court action but this is expensive. Incumbent tenants undergoing rent reviews often have the further possibility of independent review by rent panel, third party arbitration or mediation.[199]

154. M&W told us that the level of pubco/tenant litigation was currently low due mainly to the introduction of tenant discounts and 'fair dealing' measures taken by the more responsible pubcos to ensure prospective tenants were better informed before taking on a lease.[200] However, they were aware of instances where tenants had entered into leases on unsustainably high rents or had accepted or had had imposed upon them inappropriate rent increases on review.[201] They provided evidence from one valuer which showed in fifteen cases where a court decision was required the settled rent was substantially below the pubcos' opening offer. M&W suggested that while this was a small sample of settlements, they appeared to "confirm our experience that current pubco leases are often over rented".[202]

155. Pubcos provided us with information about the nature and extent of arbitration in their estates. All Enterprise's agreements provided for either party to refer a rent assessment to a third party arbitrator, who is charged with determining the 'correct' rent and whose decision is binding on both parties.[203] In the year to September 2003 they had completed 718 rent reviews, of which two were referred to arbitration for settlement. Up to March 2004, a further 410 rent reviews were completed; none of them were referred to arbitration.[204] Since August 2001, Punch had agreed 648 rent reviews with their tenants, with nine arbitrations and two court determinations,[205] while InnSpired told us that although they had a provision for tenants to appeal on rent reviews they had never gone to arbitration.[206]

156. Court or third party arbitration is expensive and unaffordable for many tenants. Many pubcos have introduced alternative methods of dispute resolution, such as rent review panels and mediation, where tenants can challenge the decision of the valuers.[207] At W&DB, rents were proposed by tenants' business development managers (BDM) but they were all reviewed by an independent rent panel, irrespective of whether they were in dispute or not. W&DB told us that in the time the panel had been in existence; only one rent had gone to arbitration.[208] Punch told us they had introduced a charter under which they were committed to the opportunity of an independent mediation service at no cost to the tenant. They suggested they had found: "provided our retailers are prepared to be open and honest about their business, we have always been able to reach agreement through the mediation service".[209] Since the launch of its charter in September 2003, three cases had been mediated with a further four cases pending.[210]

157. We believe it would be preferable for the industry to develop a nationwide register of rent reviews, accessible by professional valuers representing both sides of the industry. Although we believe the proportion of rent reviews not resolved amicably is small, such a register would increase transparency and reduce contested reviews.

158. The pubcos have argued that if tenants do not agree with their rent assessment, they should not have entered into the lease or accepted the rent review.[211] We do not share this view. In the relationship between pubco and tenant, the tenant is in the weaker bargaining position. Pubcos should recognise that they have a responsibility to ensure they do not exploit their position of economic strength. All tenants should be treated fairly and rents should be reasonable and sustainable.

RENT CONCESSIONS

159. The larger pubcos suggested to us that they offered support to tenants should the level of trade be "materially short of a fair maintainable level".[212] Punch told us in such cases action was taken to "energise the business".[213] This included promotional activity, the introduction of new amenities such as food, alteration to trading hours and tenant training. On these occasions they also offered rent concessions for a period of time while the action took effect.Punch's agreements allowed rents to be reduced through temporary rent concessions or a formal rent review but only if they believed the rent was untenable through no fault of the tenant. They had 167 active concessions and 140 'stepped' rents in place to allow tenants to return their business back to an agreed level.[214]

160. Enterprise suggested to us that they would informally review rents if the trading performance of the public house was such that the established rent was unsustainable due to circumstances outside the tenant or lessee's control. In these cases, rent concessions would be awarded on a temporary basis until such time as the trading performance could sustain the established rent. They had 19 rent concessions in place, averaging £9,000 per public house.[215]

161. In M&W's experience the offering of rent concessions by pubcos in response to a tenant in trading difficulties was rare, although pubcos' attitudes had improved in comparison with the stance adopted in the early 1990s. They believed pubcos could do more to assist tenants in such circumstances.[216]

162. Some pubcos are willing to offer rent concessions in cases where tenants are experiencing financial difficulty through no fault of their own, for example because of demographic changes or because the public house is closed for repairs. We recognise this as good practice and commend it to the industry as a whole.

Special commercial or financial advantages (SCORFA)

163. Pubcos suggested to us that the higher wholesale prices they charged their tenants enabled pubcos to offer tenants support functions, which were unavailable to free house operators. These included: business development assistance, such as training and legal support through a business development manager (BDM); investment; centralised technical and complaint services; and financial benefits through pubcos' increased purchasing power.[217]

TRAINING

164. Many tenants enter public houses with little or no direct business experience of the sector or of running a business generally. Pubcos told us that they made a variety of training courses available to assist new and incumbent tenants to run their business.[218] Enterprise's new 'Retail Partnership Agreement' will require tenants who do not already hold an appropriate qualification to attend Enterprise's training course. This covers the British Institute of Innkeeping (BII) Induction Certificate, the National Licensee's certificate, and the Food Hygiene Certificate. The course also provides information to enable tenants to gain further qualifications in licensed premises management.[219] Punch told us that they offered a comprehensive training package, all accredited by the BII, to both existing tenants and prospective applicants whether they took a public house with Punch or not. As part of their agreements an introductory training course was compulsory for all tenants.[220]

165. It is clearly to the benefit of both pubcos and their tenants that pubcos should encourage appropriate business training for prospective and incumbent tenants alike to improve their business knowledge and performance through courses such as those run by the British Institute of Innkeeping (BII). Some tenants who would benefit might be deterred by the cost. We suggest that as they would benefit from better trained and more competent tenants, pubcos should consider providing support to their tenants to attend these courses through the payment of course fees or grants to enable them to employ cover for the period when they are absent from the public house.

LEGAL AND PROFESSIONAL SUPPORT

166. Legal and professional support provided by pubcos includes advising tenants on issues such as rating revaluation and appeals, licensing law reform and applications for licences, and employment regulations. For example, following the introduction of new licensing legislation, Punch have offered tenants a package service at cost price to assist them in the new licensing process. This will include: a survey of their properties; the preproduction of the core elements of tenants' business plans, as per the guidelines outlined by the Government; copies of applications for personal licences; and support in the application process.[221]

BUSINESS DEVELOPMENT MANAGERS (BDM)

167. Pubcos told us that they offer their tenants support functions through a business development manager (BDM) or similar.[222] Some tenants complained to us that they did not receive the necessary support from their pubcos. They rarely saw their BDM[223] and when they did, the BDM appeared to be uninterested in solving tenants' problems but was more interested in increasing the profits of the pubco.[224] Tenants complained that their BDM changed frequently and the "majority have no operational or business experience, the few that do are often failed managers".[225] A study by Morgan Stanley found that around one-third of tenants saw their BDM once a month but nearly half did so only once every six months, and 15 percent did so only once a year or less often.[226]

168. A.B. Jacobs in particular has been very critical of the attitude of some BDMs towards tenants, telling us one of the "business manager's prime tasks is to reduce or eliminate late payments for goods supplied, rent and insurance".[227]He also suggested "it is not uncommon for business managers of pubcos to apply harassment to tenants who do not match up to trading and cash flow expectations".[228] On the other hand, Morgan Stanley found that tenants generally rated their personal relationship with their BDM between satisfactory and good, well above their relationship with their pubco.[229]

169. We were interested in finding out more about the background, business skills and remuneration of BDMs. The Managing Director of the Union Pub Company, Mr Oliver, told us that Wolverhampton & Dudley Breweries' BDMs had been employed by the company for an average of 15 years. They came from a range of backgrounds, with many having previously worked in free and managed houses and a number having previously been tenants. They were given between 10 and 15 days formal and informal training a year. The majority were members of the BII and had achieved other qualifications. The informal training they were given covered "the whole gamut of issues that affect the licensed trade"[230] such as property management, legal issues and marketing. Mr Patton, Customer Relations Director for Punch, also told us that Punch's BDMs went through a training programme starting with a 10 day induction to the company and continuing onto their licence retailing course, which was compulsory for new tenants. Most of their BDMs had a brewing background with a few having been tenants.[231]

170. Punch also told us that part of their BDMs salary was based on a bonus scheme and within the bonus scheme part reflected the profit of the area they ran.[232] An important element of the bonus scheme was related to their 'Retailer Satisfaction Survey', which asked tenants how they rated their BDM. Punch suggested this ensured: "our employees' potential bonus is thereby directly linked to the service and support they provide".[233]

171. It would appear that the performance of business development managers (BDMs) varies across the industry from excellent to dire. We found no consensus within the industry as to their role and function. Some seem to be more concerned with the policing of operations in the public houses under their supervision rather than the provision of genuine assistance to tenants. We recommend that the industry should review the support offered to tenants to ensure the application of best practice in the provision of support to individual businesses.

INVESTMENT

172. Many pubcos invest capital in their public house estates. In some cases this is done through joint investment with their tenants.[234] Pubcos invest primarily in buildings and landlords in fixtures and fittings under their repair and maintenance obligations. Punch told us that they repaired or upgraded 10 to 12 percent of their estate each year, with an average spend of £60,000 per investment site and an additional tenant investment of £12,000 per site. They estimated the financial returns varied from project to project but in general they earned a payback on their investment after three to four years, the tenant faster.[235]

CENTRALISED PURCHASING AND TECHNICAL SERVICES

173. Pubcos derive scale benefits, such as purchasing, which they suggested are passed onto tenants. Benefits for tenants included buying group discounts on electricity, contents and building insurance, capital equipment, and food products.[236] Enterprise utilised their purchasing power to secure beneficial terms for their tenants on a range of non-tied non-drinks goods and services. These were made available without charge to any of their tenants. Sales of these goods and services were made by a range of suppliers to 2,500 Enterprise public houses in the 12 months to March 2004, generating an estimated saving of £1,600 per participating tenant.[237]

174. Pubcos offer their tenants centralised problem solving and complaint procedures which allow them to manage suppliers against specified service criteria to ensure that a higher level of sales support and technical service is provided to tenants than they might achieve on their own. Specific examples quoted by the pubcos have included arranging replacement products for tenants should there be a delivery or product quality failure, organising an emergency delivery for tenants who did not order enough stock, and arranging emergency repairs to drink-dispensing equipment.[238]

175. Punch's 'Frontline Customers Queries & Complaints Procedure' offers that if a service provided by Punch or its nominees fails to meet the published service standards, the issue can be raised with Punch through Frontline. Complaints or general problems are acknowledged within three working days of receipt and a reply sent or discussed by telephone within 10 working days. All complaints are logged, tracked and given an estimated time for resolution of the problem. If the complaint is not resolved within the agreed timescale it is passed to the appropriate senior manager. Any unresolved complaint is escalated within the business until it becomes the responsibility of the Chief Executive.[239]

176. M&W praised this approach to customer complaints and suggested all pubcos should adopted similar procedures and ensure they are fully implemented in practice. However, they stressed that: "it is important that pubcos do more than simply establish complaints handling procedures. In a significant number of cases in which we have been involved, tenants facing financial difficulty are treated unsympathetically by their pubco and do not receive constructive advice as to how best to deal with the trading difficulties that they have".[240]

177. Dealing with tenants' complaints quickly and efficiently is good business practice for all companies. Pubcos should ensure that a higher level of sales support and technical service is provided to tenants than they might achieve on their own. The terms of these procedures and details of the consequences should complaints and problems not be dealt with to the satisfaction of both parties should form part of tenants' agreements or a binding code of practice.

170 Appendix 8, para 2.12 (iii) Back

171 For example see European Commission Decision 1999/474/EC, Case IV/35.992/F3, Scottish & Newcastle, 16 June 1999 (OJEC (L) 1999 186/28) Back

172 Appendix 23, para 142 Back

173 RICS, The Capital and Rental Valuation of Restaurants, Bars, Public Houses and Nightclubs in England, Wales and Scotland, Valuation Paper 2, 2003 Back

174 For example see Appendix 23, para 40 and Appendix 12, paras 5.4 -5.5 Back

175 Appendix 12, paras 6.1-6.10 Back

176 RICS, The Capital and Rental Valuation of Restaurants, Bars, Public Houses and Nightclubs in England, Wales and Scotland, Valuation Paper 2, 2003, page 2 Back

177 Appendix 3, para 6.1 Back

178 Appendix 23, para 145 Back

179 Ibid., para 39 Back

180 Appendix 17, para 3.7 Back

181 Appendix 12, para 6.4 Back