Examination of Witnesses (Questions 120
- 138)
TUESDAY 22 JUNE 2004
A.B. JACOBS &
CO AND
FERDINAND KELLY
SOLICITORS
Q120 Mr Hoyle: What would the benefits
be for the pub companies, not that I am too worried about pub
companies but one ought to see the analogy that you have. If they
are going to continue to trade, what would the benefits be for
them if that were to happen?
Mr Jacobs: The pub companies in
the end, if they lost the tie to their tenants, would still be
in the position of being the wholesaler. The tenants would need
to be serviced by somebody. Who are the biggest wholesalers in
the country? The answer is: Punch and Enterprise are the biggest
wholesalers in the country. Therefore, the pub companies could
actually do better by expanding their wholesale base. There would
be better competition between all the wholesalers to get the business
and therefore they would have a chance of making more or losing.
They will then be in the real commercial market.
Q121 Mr Hoyle: I cannot see the pub
companies doing that because at the moment they have guaranteed
profit and guaranteed income. I do not think they believe that
they would ever make as much money. All right, morally it makes
absolute sense but I do not think it is something they are going
to jump at. Presumably, if you did do that and ended the beer
tie, all you would actually do would put the impact on the tenants
of the dry rent?
Mr Jacobs: That is true to a degree,
which is one of the reasons why I think there should be a moratorium
of two years before you review the rents because all the leases
say is that "in the event that you are made free of tie,
we have the right to increase your rent". All the leases
say that. All I am saying is that there should be a moratorium
for a period of two years. In the event that you put all these
pubs now in a position to compete better with each other—they
can all change their prices, change their structures, change their
brands—you would be getting a different marketplace. That
different marketplace will generate different levels of profit
than what has historically been the case. It is only when you
get those different levels of profit that you can re-look at what
the rent should be. You do it on the straightforward basis of
assessment of profit and computation of rent, ignoring any impact
of time. The other interesting thing, of course, is that if you
remove the supply tie, you will probably also replace or remove
the tie relative to given AWP machines, which is a nice little
earner for the pub companies because the pub companies invariably
include within the assessment of profit machine income, whether
or not the pub has machines. That is one part of it. The other
part of it is that they assess what they believe the machine could
be making, irrespective of what the machine is actually making.
They will say, "Ah, you should have a couple of machines
on there at £5,000 a year income and therefore that is £2,500
a year rent for us, thank you very much". It does not even
stop there. They take the £2,500 and put it in their pockets;
they put the other £2,500 in as profit and take a half again.
So they take a double bat from the AWP machines. The only way
in which you are ever going to stop that is either by taking care
of that separately or just by saying, "no tie". Once
you say "no tie", they cannot tell you what you do with
AWP machines either.
Q122 Mr Hoyle: Do you feel that we
ought to have an independent rent tribunal panel that they could
turn to, which would be much cheaper, rather than going through
your good selves, people who charge by the minute? They could
then say, "We are not under agreement here but there is another
way". It would be like the rates; you can actually put an
appeal in on your rates, go to the tribunal and represent yourself
and they will make a decision that is binding on both sides. Do
you not think that would be a better way? I do not want to put
you out of business but I want to save some of these people some
money. Do you think that is an alternative?
Mr Jacobs: To a degree, that is
an alternative. How you would actually set that up, I would not
like to say. What you have said relating to rates is interesting
because rates are based upon a fair assessment of the annual rent
of these premises without tie, fully repairing and insuring. Therefore,
in theory, the dear old Inland Revenue, and you cannot be more
independent than that, actually decides what is a fair, open market
rent and they calculate the rates accordingly.
Q123 Chairman: You seem to suggest
that there would be almost a Damascene conversion of the pubcos,
that once they become wholesalers of beer, they will be changed
people; they go from being these rapacious rentiers to some kind
of benevolent owner.
Mr Jacobs: Do not run away with
that idea. They would still be seeking to extract the biggest
rent they can possibly extract.
Q124 Chairman: Why should they be
any less rapacious as wholesalers than they are as rentiers?
Mr Jacobs: Because it is a free
open market; if Enterprise is supplying a function, a pub, an
Enterprise pub, the tenant will be buying at the best possible
price he can get.
Q125 Chairman: The tenant was going
in to rent at the best possible rent he could get?
Mr Jacobs: He is already stuck
with the rent, is he not? The next issue is when that comes to
review, and the review would come either automatically on the
release of the tie or at the next term of review. All I am saying
is: stop; moratorium; release the tie; let them find a level pegging;
and, once they are on a level pegging, and it will take them two
years to do that, then review the rent.
Q126 Linda Perham: Which do you think
is the most important factor in reducing the viability of the
tenants of pubcos? Is it the higher price they pay for beer or
is it the rent situation and how that is calculated?
Mr Jacobs: You have just identified
the same thing. The reason I say that is because the higher prices
of the beer should be deducted off the open market rents to arrive
at a dry rent. Therefore you have x and x being equal. The problem
is that they do not actually deduct from the free open market
rent the true discount that the tenant is losing, ie the wet rent,
to arrive at a dry rent. The answer is that the loss of the discounts
and the wet rent affect the dry rent. All in all, it is the same
thing.
Q127 Linda Perham: So they are in
a difficult position, whatever? It is the same thing.
Mr Jacobs: Yes.
Q128 Mr Berry: I would like to know
if you think the Court of Appeal's judgment in the case of Crehan
v Inntrepreneur will have an impact and, if so, who will it
have an impact on?
Mr Jacobs: I do not think it will
have any impact whatsoever, but my colleague will probably be
able to expand more on that.
Mr Kelly: There are two Court
of Appeal judgments, and the one you are referring to I think
is the most recent one in May of this year. I should just say
that the first one is on one interpretation of support for the
proposition that Mr Jacobs puts forward which is that there should
be absolute compensation when computing the dry rent for the lack
of discounts. The recent decision does relate, from a lawyer's
point of view, to a historical problem involving the application
of Articles 81 and 82 in European law having regard to the regulations
that were in place really in the early 1990s. Inntrepreneur
was the only unlucky one compared with all the other big brewers
in that it actually was found to have been anti-competitive. Therefore,
I agree with Mr Jacobs that once we are dealing with pubcos, it
will not have much direct effect. The important implications I
would say are that for the first time a Court of Appeal certainly
has recognised that back in 1994 the OFT got it wrong. That is
relevant because it would be our contention that the OFT got it
wrong in the year 2000 when they were looking at the market. The
way the OFT got it wrong was parallel in both cases. In both cases
the OFT transparently, we would say, drew the wrong conclusions
from the facts and figures that it was relying upon, and so it
did that in 1994. The Court of Appeal has finally ruled that the
European Commission had to be upheld in finding that the OFT got
it wrong in 1994. For the current complaints that are made now
one has to refer to the OFT report of 2000 when the OFT gave the
industry a clean bill of health and said, for instance and by
way of example, that it excused the price rises which were going
way ahead of the RPI by trying to apply an argument that this
was not a sale of products but that we should look at the services
index, for instance. That was the same kind of mistake we would
say that they made when they did their report in 1994 and 1995
specifically in the Inntrepreneur case. The interesting
thing is that finally the Court of Appeal said that the OFT did
get it wrong in 1994 and we say in fact it got it wrong for very
similar reasons to the way we say it got it wrong in 2000, which
is of course the context that we are looking at now.
Q129 Chairman: Is anybody going to
do anything about the 2000 decision then?
Mr Kelly: What happened was that
Mr Jacobs and I were joint authors of a submission commissioned
by the FSB to the OFT in the first place complaining, in a sense,
about the conclusions that the OFT had reached in the year 2000.
The basis of our complaints was really to say that if you take
the basic facts and figures on which you rely, the inferences
you draw are wrong. In a sense, that was parallel to the complaints
that I think Mr Jacobs and I had both made in 1994. We were not
privy to the workings of Europe and the Commission and how it
came to its decision, but we might argue that obviously arguments
like the ones we put in were persuasive for the European Commission
in finding that the OFT had got it wrong. In a sense, what is
happening before you, sir, could be argued to be a review of what
the OFT did in the year 2000, which we would still say was wrong.
Q130 Chairman: What I was really
meaning was this. Would you anticipate someone taking legal action
against the OFT in respect of the 2000 decision in the way that
they seem to have done successfully in respect of the 1994 decision?
Mr Kelly: It is a possibility.
The most likely candidate to have done that, looking around one,
is the FSB. The FSB in a sense appears, having failed to persuade
the OFT, currently to have been lucky enough to have a hearing
before this Committee. Therefore, obviously it is a question that
could go back to the OFT. I would say that from the point of view
of individuals bringing cases, there is a bit of a cautionary
tale in the case of Mr Crehan because I think it has taken him
nearly 12 years to get justice. He has only been to the Court
of Appeal twice. I do not know how many times he has been to Europe.
About a year ago he had some pretty bad news, which was that he
failed on liability. The good news was that the judge said if
he was wrong about liability, then the damages were over £1
million. He had better news in the Court of Appeal because he
won on liability but the damages went down to £130,000. One
final thing that is relevant from Crehan and probably shows
this better than anything is that the court was concerned with
the amount of damage that one suffers when one is the victim of
anti-competitive pricing in the pub business. The circumstances
in a sense, in practical terms, are the same in Mr Crehan's case
back in 1992 as they are in effect in the year 2004 for many people
who are suffering from high rents and also high prices for beer.
Q131 Chairman: To put it simply if
I can, what you are really saying is that while Crehan
does not create a precedent, nevertheless the kind of market analysis
which is implicit within it if applied today, in the light of
the 2000 decision, may have a relevance which would render it
worth someone having a go, or certainly, and we probably will
raise this with the OFT, the OFT having a fresh look at their
decision of 2000 in the light of the Crehan case?
Mr Kelly: Yes, sir.
Q132 Chairman: As a layman, would
that be a reasonable summation of it?
Mr Kelly: Yes, sir. I wish I had
put it as succinctly as that.
Q133 Chairman: You get paid for doing
it and we do not.
Mr Kelly: We are not paid today
when we do not even get an allowance. There is one thing that
I should just raise in that context. Everybody has been talking
as though of course the beer tie is lawful at common law. It is
questionable whether in fact the beer tie, in so far as the other
party is not a brewer, is lawful at common law because it was
always held to be one of the restraints of trade, or prima
facie restraints of trade, that was always accepted. The context
always was that it was a restraint of trade by a brewer and the
law on that is a House of Lords decision that goes back about
petrol companies in 1966. The problem is: what publican is going
to take a case to the House of Lords to point out, although he
might be upheld at First Instance, that a pubco is not a brewer
and therefore the legal validity of a tie is questionable overall?
Somebody could take a test case. Again, looking at the example
of Crehan, one might hope that legislators, with help from
their legal advisors, might be able to cut through that.
Chairman: We will bear that in mind when
we are making our recommendations.
Q134 Sir Robert Smith: One of the
things the OFT gave in their letter back to the Federation of
Small Businesses after the FSB put their concerns was a general
analysis. In point 8 of their reply they talked about: The question
of market definition would only become significant if we had evidence
of a lack of competition. As it is, there is evidence which points
to the entrée sector as a whole being very competitive.
In particular, the press carries regular reports of reduction
in pubcos' margins and competition between high street pubs being
particularly fierce. The increased blurring at the edge has been
that different types of entrée licence appear also to have
brought pubs more into competition with other types of entrées.
Do you see that view that there is quite fierce competition in
the entrée sector as a fair reading of the market?
Mr Jacobs: I do not see a fierce
competition except probably in city centres. There is no major
competition when you get out into suburbia where most of the pubs
are. If you take most of those in the city centre, very few, in
actual fact a minority, of those licences suffer from this, whether
tenants or whatever. The greatest majority are owned by pub companies.
Q135 Sir Robert Smith: What is your
view of the margins that pubcos make?
Mr Jacobs: The margins that the
pub companies make in what respect?
Q136 Sir Robert Smith: It is just
that the OFT were suggesting, admittedly in talking about press
reports, reductions in pubcos' margins.
Mr Jacobs: There is no reduction
in pubcos' margins. The pubcos keep marching on and on and on
and pushing the margins higher and higher and higher. They keep
getting bigger and bigger discounts from the brewers, from the
manufacturers, and never pass those on to the tenants. If they
pass them on in any way, shape or form, even in the smallest amount,
as they do with the Punch Growth Lease, they go and whack a huge
chunk on to the rent. Therefore you finish up with a situation
where you are not really better off, unless your volumes increase
dramatically, and then they hit you with the rent next time round.
Mr Kelly: I think there is a principle
of inelastic demand here. I am thinking particularly of rural
public houses where of course there is no substitution. I am not
an economist and I realise that you are better economists, but
in a sense with certain products—and the Chancellor is well
aware of this—you can increase the price but the public
will still go on buying. That is exactly what is exploited in
the case of beer because if that were not the case, prices would
not increase ahead of the RPI year in and year out as they have
done over many years. Although there is a total drop in volume,
the person who is in fact getting the big margin is still well
ahead, so his profits increase. It is the retailer who has the
smaller margin and a smaller volume who then suffers. Looking
at it from the point of view of the public, it is people of modest
means who are used to going to their local public house who are
squeezed out, but the people behind pubcos are happy to see them
go because overall, notwithstanding the smaller volume, their
prices have increased well ahead of inflation because they are
exploiting an inelastic demand.
Q137 Sir Robert Smith: One of the
things, of course, that affects an individual pub is the local
circumstances if the factory in the community closes and the local
economic circumstances change in the area. What more do you think
the pubcos could to do aid their tenants who are struggling as
a result of external factors?
Mr Jacobs: First of all, you could
say that they should be prepared to review the rent downwards
to reflect substantial changes. I came across a case down in Devonport
when the nuclear submarine base was shifted up north. The pubcos
expected the same rent and they wanted to apply the RPI. The fact
that probably 75% of the people who were using that pub had disappeared
did not matter—oh no, you stand by your lease.
Q138 Sir Robert Smith: What was the
final outcome there?
Mr Jacobs: From memory, that particular
person went bankrupt and I think they then closed the pub actually.
There you are.
Mr Kelly: One final point on that:
the public at large of course give great rebates, particularly
in the countryside and in particular to country public houses,
and the pubcos are happy to be supporting that. You might wonder
why it is that if the public is providing that, in fact there
is not a concomitant generosity shown by the landlord in the way
he is charging rent. You might think that there should be a link,
again as we have said before, between rates and rent.
Mr Jacobs: Let us face it, one
of the prime reasons why the pub companies got behind the lower
rateable values and lower rates for the rural pubs was because
the lower rates meant higher profits and higher profits meant
more rent for them. It was self-serving.
Chairman: That is very helpful, gentlemen.
We are very grateful to you for these insights. Certainly I think
some of the points you have made will be raised not only with
the pubcos but with the OFT as well when they come. Thank you
very much for your information and your forbearance because we
realise this session has gone later than we anticipated.
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