Pub companies: follow-up - Business, Innovation and Skills Committee Contents

Supplementary memorandum submitted by Simon Clarke


  As requested I have prepared an additional submission to address a few specific issues raised.

The Committee are aware there are two main financial issues which, above all else, are considered to be the main roots of the problem facing tied tenants;

    (A) Rents

    (B) Tied products prices.

 (A)   RENTS

  1.  With fairly recent activity in rental valuation over the past six months there have been some developments that I believe warrant the Committee's attention, which will have a bearing on the issue of rents.

  2.  It has long been considered by tenant groups, now all under the umbrella of the Independent Pub Confederation (IPC), that tied rents have been artificially high, thereby allowing pub owning companies, operating tied pub estates, to charge inflated rents whilst at the same time sometimes extortionate tied product prices. The Committee will have received copious submissions indicating, beyond all reasonable doubt, that tied tenants are paying considerably more than free of tie tenants for the same products, in many cases double. The principle "that the tied tenant should be no worse off than the free of tied tenant", put simply, means that if a pub owning company wishes to charge extra for the supply of tied products then, in return, the rent should be lowered to compensate for the financial loss suffered by the tenant.

  3.  The Royal Institution of Chartered Surveyors (RICS) has guidance which was believed to encompass this principle and ensure fairness prevails. Unfortunately, the valuation guidance has been misinterpreted by some and as a result tied tenants have been disadvantaged financially often leading to financial ruin and bankruptcy.

  4.  In an attempt to arrest this misinterpretation, the RICS held a "Pubco Forum" after which they offered a report which importantly stated:

    "4. Valuation Guidance

    The content of Valuation Information Paper No.2 (The capital and rental valuation of restaurants, bars, public houses and nightclubs in England and Wales) was the subject of much debate during the Forum hearings. It is clear that the guidance within the paper is relied upon within the industry in calculating rents. The Forum heard that there was some confusion in the interpretation of the guidance with the paper. For example in the treatment of the valuation of the wet rent, where it is clear to us that most lease agreements require a valuation largely on the terms of the lease. This follows the principle of the tied tenant being no worse off than the non tied tenant; a position which is arrived at with a correct interpretation of RICS guidance."

  5.  The importance of this statement alone is significant. The RICS have not indicated that their guidance was wrong but rather, if interpreted correctly, the tied tenant should be no worse off than if they were free of tie, a principle previously denied, or ignored, by many of the pubcos and their surveyors.

  6.  Another fundamental development was the "Brooker case", a High Court case, which, amongst many other things, extinguished the myth that the net profit before rent (divisible balance) should be split 50:50 between landlord and tenant. It has long been maintained by some surveyors and pubcos that the 50:50 split is set in stone. The RICS confirmed in its report that the RICS does not and has never endorsed any particular split.

  7.  Importantly, in their report the RICS expressly indicated that they believed the Brooker case was "significant" and David Rusholme reiterated their view during the BISC witness hearings. The case highlights the historic manipulation of the RICS guidance so it should come as no surprise that the pubcos, and their surveyors, are still attempting to belittle the judgement as insignificant in the trade press and courts.

  8.  Judge Hughes concluded that the reasonably competent tenant (be they tied of free of tie) would consider a number of facts and matters before making an offer, eg state of the market, smoking ban etc. Importantly, given the tenant in the case was tied, they would consider one additional fact, "…the hypothetical tenant would have regard to the fact that free houses are available on the market and the tenant could expect, other things being equal, to make a much greater profit from being able to buy beer on the open market and not at the nominated suppliers prices. The fact of the partial tie provides a second level of profit for the landlord and this wet rent provides the tenant with an additional margin for negotiation."

  9.   Judge Hughes, in "Brooker", concluded the net profit before rent was £51,000 and that given the facts and matters that a reasonably competent tenant would consider, the rental bid would be £18,000, a split of the net profit before rent of 65:35 in the tied tenants favour.

  10.  Had the property been free of tie, the tenant would have received the discounts available in the open market leading to a higher gross profit and the free of tie rent would have been higher to reflect the absence of the onerous tied lease terms. There would have been no second level of profit for the pubco from tied products.

  11.  The RICS report said that the recent Brooker case had provided "timely guidance". A "select" few have sought to befuddle the judgement, an Enterprise Inns spokesman was quoted in the Morning Advertiser saying "This is a matter of fact and is not a decision of principle or law and, as such, does not bind the outcome of any other lease renewal or rent review.", implying it is a one off and should not be relied upon. It seems the majority, surveyors, lawyers, tenants representation bodies, have universally accepted that Judge Hughes interpreted the RICS guidance correctly, and effectively penalised the pubco for over charging on tied products, by reducing the rent, to redress the balance. Given this was a High Court case, there is no escaping the fact that the principles of the judgement will be relied upon in future.

  12.  The problem that remains is for the RICS to effectively incorporate this timely case law into their revised guidance to ensure the ambiguity can no longer be abused to over inflate tied rents.

  13.  Those who might seek to continue the practice of "misinterpreting" guidance will have to rely on other means to overcome the hurdle of clarity, offered by the RICS and, indeed, those surveyors acting for tenants (like David Morgan) have already seen attempts to muddy the water once again from some pubco surveyors and valuers.

  14.  It seems the pubco surveyors wishing to maintain business as usual are seeking to rely on the following, and I consider you will have received submissions from those parties ;

  15.   "COUNTERVAILING BENEFITS"—It will be claimed that these benefits outweigh the detriment of the tie. As the Committee hopefully have already understood, only terms, be they beneficial or onerous, that are contained within the lease can be included in the valuation process. I would dispute that some of the benefits claimed by pubcos are indeed "benefits", many are time-consuming and of no real benefit at all to the tenant. However, let us assume there are some benefits, as they are described by pubcos, essentially they are discretionary, if the pubco sells their freehold interest then the new owner may not continue those purported benefits and therefore they should not be quantified in the rental valuation process. The issue of countervailing benefits is that if they are not contractual, they are not in the lease—then they are not a matter for rent review at all. RICS confirms that the review should be strictly based upon the terms of the lease.

  16.  The pubcos attitude towards this issue was effectively demonstrated in the Punch Taverns v George Scott case (which I have already submitted but append herein for ease of reference Appendix 1) (not printed here). Benefits are no different to the codes of practice, they cannot be "legally" expected. Punch's lawyer stated "Punch Retail Charter sets out standards that Punch applies in relation to its business. It does not have contractual effect or amending the lease. Rent review provisions are in the lease. Punch's code (or charter as they call it) is not part of the lease, the same applies to so-called benefits. A property contract such as a lease—a deed—cannot contain implied terms, such as the pubcos Area Manager being a benefit at review. Pubcos rely on the Law of Property (Miscellaneous Provisions) Act to exclude anything other than the terms of the contract when it suits them, tenants should be able to rely on the same legislation in the context of "benefits". The lease contracts usually contain an "entire agreement clause" to this effect, effectively excluding any other informal agreements be they written or verbal. Pubcos tend to rely on this clause to prevent tenants, who may have been gullible at the outset, from seeking to use pre-contract oral representations at a later date. A pubco may renege on benefits or their code with no fear of legal repercussion.

  17.  I have read once again the BESC evidence Volume II and it seems to me that, on the issue of countervailing benefits, the pubcos have said a number of contradictory statements in this regard. On the one hand we are told that tied rents are similar to free of tie rents because of countervailing benefits counterbalancing detriment of tie, then we are told that a lower tied rent is a countervailing benefit and last but probably not least we are told that tied product prices are higher than those available to free of tie to counterbalance countervailing benefits.

  18.  Basically, it looks like double/treble counting of "countervailing benefits" if indeed any exist at all. The so-called countervailing benefits are in exchange for a higher rent (even though a lower rent is supposed to be one of the benefits) and, at the same time, pubcos explain that product prices are higher to pay for the countervailing benefits. Surely if the higher product prices are paying for the countervailing benefits then they should not then be used again in the argument to increase rents.

  19.   "OPEN MARKET"—this will be the last refuge for those abusing the guidelines. Much effort will go into convincing the Committee, and RICS, that despite the profits method valuation, surveyors must adhere to the terms of the lease which require the surveyor to consider what happens in the open market. What the lease actually requires is that we consider the open market position assuming an "average competent tenant", or as the RICS guidance outlines, a reasonably efficient operator. Clearly, there has been much inflated bidding in this industry from ill informed tenants and that evidence is not indicative of an open market, with competent tenants. The important point to make is that a competent tenant would not over estimate turnover and gross profit and would not under estimate costs. Inflated bids for new lettings demonstrate incompetence and should not be relied upon as open market evidence.

  20.  The Brooker judge made reference to this and was not prepared to accept that high bids ultimately leading to business failure were appropriate for valuation purposes.

  21.  The RICS are forming a panel of surveyors and propose more discussion on this area to ensure one door is not closed and another opened as an unintended consequence.

  22.  In paragraph 76 of the judgement in "Brooker" the Judge Hughes stated "Mr Wonnacott (the lawyer for Enterprise Inns) suggested that if the market generated over—optimistic bids, then that would represent a true reflection of the market for present purposes, even if such bids would end in business failure and surrender prior to expiry of the term. That submission may be correct when economic circumstances are favourable but it is certainly not the present position. There is no such optimism in the market at present."


  23.  Herein lies the age old problem that we seem to be revisiting time after time, committee after committee.

  24.  If the RICS are able to close the loopholes of abuse of the valuation model the problem remains that the pubco may simply increase the price of tied products to ensure the same "overall" income is received.

  25.  The rent is capable of regulation by contracts and the law, the tied product prices remain utterly unregulated.

  26.  From my BISC submission 1;

    "As we have seen, in the MMC report 1969, the difference between tied and free of tie product pricing was diminimus, in some cases there was no difference at all. Many factors affect the pub industry but the operation of tie agreements remains the fundamental influential factor contributing to business failure. The BESC 2009 heard evidence demonstrating that tied products are in many cases around twice as much as the same product free of tie. The MMC 1969 report (Appendix 6: demonstrates clearly that historically there was practically no difference between tied and free of tie prices. The purpose of the tie was to ensure the distribution of a brewers particular product, not as a source of additional revenue, the reverse now applies."

  27  The RICS can resolve the misinterpretation of their rental valuation guidance but there remains no control what so ever over the price that pubcos can dictate on tied products, what they lose on the swings they will gain on the roundabouts.

  28.  In order to genuinely overcome all the efforts to bypass the law or abuse the RICS guidance the Committee's original recommendation, to offer a free of tie option to tied tenants at review, renewal or on taking a new lease, remains by far the most influential. The option is not complex, does not require abolition of the tie and should be relatively inexpensive for a tenant to instigate as compared with legal action.

  29.  A fair tied rent is something that the BBPA may try to accommodate in their codes of practice, however, in reality rent is, or should be, controlled by the law and terms contained within a legally binding contract such as the lease.

  30.  This "option" kills two birds with one stone. Just as with the enforcement of the codes of practice, by offering tenants a free of tie option where the pubcos/brewers have a genuine incentive to ensure that the benefits they offer outweigh the burden of their ties, the existence of a free of tie option would encourage continued efforts by pubcos to ensure they are offering a fair and reasonable tied rent to their tenants otherwise they risk losing their tie agreements in exchange for free of tie agreements in which they are unable to benefit in any way from the product ties.

  Naturally, should you require copies of full transcripts of Brooker and the RICS report I have them readily available and can email them as attachments upon request.

31 December 2009

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