Small Business, Enterprise and Employment Bill

Written evidence submitted by Enterprise Inns plc (SB 30)

INTRODUCTION AND SUMMARY

1. Enterprise Inns plc (Enterprise) is a leading operator of leased and tenanted pubs in the UK. We currently have a portfolio of over 5000 premises offered for let, or already let, on a variety of different agreements, ranging from 2-5 year tenancies to 30 year leases. Pubs available for let on such agreements may be occupied initially for a short period on a tenancy at will (TAW). Within most of the agreements there are a variety of purchasing obligations requiring the commercial tenant to source some or all of his drinks from Enterprise. We also have agreements with no purchasing obligations, also known as free of tie (FOT) agreements, and a small number of sites which we now operate on a managed house basis in order to fulfil the potential of the property asset.

2. A key feature of the tied pub model is that it offers tenants the advantages of lower costs of entry and rent and the opportunity to run their own businesses while enjoying support from Enterprise in the form of SCORFA benefits throughout the lifetime of the landlord and tenant relationship. In contrast to other types of commercial letting, it is genuinely in the interests of the property owner for its tied tenants to be successful.

3. As the OFT has repeatedly confirmed, the pubs market in the UK is characterised by a significant degree of competition and choice. Our pubs may be located on the same high street, or in the same towns or villages, next to or near tied pubs owned by other large or small pub companies, managed pubs, pubs operated under franchise agreements, wine bars, restaurants, FOT pubs, clubs or other licensed premises (including restaurants), and/or supermarkets that aggressively retail alcohol for home consumption, all competing to attract customers.

4. Enterprise operates in a heavily regulated industry which has faced challenging economic circumstances in recent years. The UK pubs market is a fast developing environment which has moved on in the 18 months since April 2013 when the Secretary of State for Business, Innovation and Skills (BIS) launched the Pub Companies and Tenants Consultation (the Consultation). The industry continues to evolve to meet the demands of consumers and Enterprise is concerned that the current uncertainty surrounding the regulation of the industry and the anticipated statutory framework should not stifle investment, innovation and evolution.

General comments on process

5. We focus here on the most important of the specific issues raised by the presentation of the Pubs Code (the Code) and the role of the Adjudicator in the Small Business, Enterprise and Employment Bill (the Bill), its Explanatory Notes, in the second reading debate of 16 July 2014 and in Jo Swinson’s open letter of 5 August 2014.

6. Enterprise continues to believe that a statutory code is not necessary, but it is reassuring that many aspects of the Bill reflect the existing voluntary provisions of the legally binding UK Pub Industry Framework Code (version 6) (IFC). We welcome the attention paid to the success of the IFC. However, the Bill does contain some errors and inconsistencies which we examine below.

7. The policy to be implemented in the Bill and Code was confirmed in BIS’ June 2014 Response to the Consultation, which rejected calls for a mandatory free of tie or an introduction of a reduction in purchasing obligations. We understand that the Committee stage is not the place for disappointed factions to attempt to reverse policy decisions. The Government now has an opportunity through the committee scrutiny process and later debates on the Bill to crystallise BIS’ policy as set out in the Response.

8. Our comments are made on the basis that the draft of the Code attached to BIS’ June 2014 Response is substantially the text that will form the basis of the consultation on the secondary legislation in due course. Should a further draft be released, Enterprise may need to make further submissions.

Contents of this submission

9. We comment below on:

A Scope of application – the 500 pub threshold

B Scope of application – definition of "tenancy"

C Scope of application – rent assessment provisions

D Parallel Rent Assessments

E Concluding remarks

A SCOPE OF APPLICATION – THE 500 PUB THRESHOLD

10. The Government’s proposal is that all tied relationships should be covered by the fair and lawful dealing principle (s.36(3)), but that only pub companies having more than 500 pubs should be covered by the Parallel Rent Assessment (PRA) methodology to test the "no worse off principle" (s.36(4)).

11. It is, however, necessary to be more specific as to the types of tenancy to which the Code should apply and the situations in which any "no worse off" PRA should be carried out. Certain refinements are also required to qualify that principle, including "no worse off" than whom and over what period and at what time.

12. The 500 pub threshold has not been justified and remains wholly arbitrary. The Consultation provided no evidence for it, and the Government’s Response still failed to address the issue of why - if a threshold is needed at all – 500 pubs is an appropriate number. Jo Swinson’s 5 August 2014 letter perpetuates a myth based on a misreading of calls to a BII helpline which BIS itself acknowledged in amendments to the Consultation website were not complaints.

Consequences for operators

13. The enhanced Code would apply to only a small number of companies. This creates the potential for the Code to influence the competitive position of pubs in the same high street, suburban or village location. For example, where in close proximity there is one FOT pub, one tenant tied to a family brewer or sub 500 pub company and one tenant tied to a large pub company, according to the current drafting:

a. for the FOT pub, as with any commercial premises, the market effectively dictates the rent;

b. for the family brewer/sub 500 tied tenancy, the parties agree the rent and other terms under a requirement that the landlord treats the tenant "fairly". The tenant can ask the Adjudicator to intervene if he can point to treatment which is not "fair" and is a specific breach of the Code. The rent assessment provisions would apply only in the defined exceptional circumstances, i.e. very rarely;

c. the tenant tied to the large pub company can demand a PRA and/or seek arbitration of his rent assessment. It has also been suggested that the Adjudicator might have extensive powers to reset the rent and potentially to interfere with other aspects of the tied bundle, essentially to replace a free market transaction with a regulated price controlled contract.

Consequences for tenants

14. The application of the Code to only a section of the industry, and the application of parts of that Code to only the tied tenants of the large pub companies, would create a two tier system within the group covered by statute. It appears that in a short while many tied tenants would have less protection than they previously enjoyed when all parties worked together to develop the IFC and to support PIRRS and PIRC.

B SCOPE OF APPLICATION – DEFINITION OF "TENANCY"

15. At s.61(2) the Bill defines a tenancy to include not only leases but also agreements excluded from the protections of the Landlord and Tenant Act 1954 (LTA 1954) and tenancies at will.

16. The principle of fair and lawful dealing should, of course, characterise all relationships between landlord and tenant. However, it seems that in an effort to demonstrate inclusivity and fairness, the Government may have misinterpreted the varied nature of different letting agreements and the respective rights and obligations of landlord and tenant that they contain.

Leased premises

17. The Code should apply to existing tenants who have a tied lease protected and assignable under the LTA 1954. Such leases represent for both parties a longer term investment and commitment to the business, to which a value is attributable. There should be no distinction between tenants of large pub companies and others for this purpose.

18. Insofar as the Government proposes the introduction of a PRA validation of a rent assessment, it is to this category of tenant that such provisions should apply.

Excluded agreements

19. An agreement excluded from the LTA 1954 (an "excluded agreement") is very different. Such agreements are usually for up to five years, have no provision for cyclical rent review (unless the purchasing obligations are released), are not assignable, have reduced tenants’ repairing obligations and end on contractual expiry of the term or sooner at the tenant’s option. Upon contractual expiry, the landlord is entitled to deal with its own property and recover possession or grant a new lease or a new tenancy of the same premises to the incumbent tenant or to another party on the same or different terms, or consider other options for the use of the premises.

Tenancies at Will

20. A TAW is a commercial agreement entered into voluntarily on both sides. It is a short term arrangement – a "gap filler" used for the tenant to enter into possession while the parties’ negotiations are ongoing.

21. A TAW benefits tenants, as it gives a new entrant an opportunity to test his aptitude for the business before entering into a formal longer term arrangement. Both parties to a TAW are aware of its terms and choose it as appropriate to specific circumstances.

22. It would be very unlikely for a TAW to continue for more than 12 months as it is an "easy in, easy out" arrangement with very short notice periods intended to enable each party to terminate at will. It has been described by the courts as the lowest estate known to law - the tenant has no certain estate as the landlord can take back possession, and the tenant can hand back possession, as each pleases.

23. However, a TAW is the least profitable, most disruptive and management intensive arrangement for a pub company, which will resort to a TAW only where the alternative is that the premises are closed and secured, putting them at risk of vandalism, susceptible to squatters, a target for anti-social behaviour and in danger of becoming unattractive, expensive to return to a usable state as a public house and eventually no longer viable. All this produces a detriment to the environment and the local community. Recent reports by PwC and the Local Data Company indicate that in the first nine months of this year alone, the UK’s town centres saw nearly a thousand more shop closures than openings. We are extremely concerned that the deterioration of the high street could be exacerbated by the inclusion of TAWs within the scope of the Code, meaning that those pubs are more likely to close.

24. It is not sufficient or appropriate for BIS to rely on a supposition that it is "unlikely" that a TAW tenant will request a Code rent assessment. Such a claim lacks the legal and commercial certainty that must characterise the Bill and the Code.

25. Rent assessment provisions are wholly inappropriate for TAWs. Given the short term, at-will nature of such contracts, no rent review could fit into TAW arrangements in practice.

26. The application of the PRA provisions to large pub company TAWs, but not to others, would mean that while the former’s pub would likely remain closed due to the onerous enhanced Code provisions, a sub-500 could freely let a pub on the same high street on a TAW for as long a term as suited the landlord and tenant.  This would create a direct benefit to the sub-500 company and distort the market.

27. BIS suggests a concern that TAWs could be used as an avoidance mechanism and/or that TAWs that extend beyond 12 months, and thus take on the characteristics of a longer term agreement could – whether by accident or design – result in a tenant not having the same protections as one who signed a longer lease. Even in those circumstances, the tenant will retain the ability to exit at will or to enter into negotiations with the landlord about a different form of tenancy to which the Code would apply.

C SCOPE OF APPLICATION – RENT ASSESSMENT PROVISIONS

28. Having identified the types of agreement to which the basic and enhanced Code should apply, we would like to address the circumstances in which it is appropriate to use the enhanced (PRA) provisions.

Existing tenant, tied lease

29. In the case of an existing tenant under a tied lease (not an excluded agreement) the enhanced provisions can workably apply in full. This includes a rent assessment at lease renewal and on request if there has been none for more than five years, as well as in the exceptional circumstances.

Existing tenant, excluded agreement

30. In the case of an existing tenant under an excluded agreement, the enhanced provisions should apply to enable him to call for a rent assessment if he has been in continuous occupation of the same premises under a tie for at least 12 months and he has a contractually enforceable agreement with his landlord to continue his business in those premises on a tied basis for at least another 6 months, but only in the exceptionally rare situation of there occurring an event outside the tenant’s control, unforeseeable at the time the agreement was entered into and which impacts significantly and permanently on that tenant’s ability to trade.

Prospective tenant, tied lease

31. It is a novel and wholly inappropriate concept that in a free market parties who have not yet concluded contractual negotiations, and have no compulsion to conclude them, might have their negotiating positions fettered by legislation.

32. The application of the PRA mechanism to any prospective arrangements is highly speculative. It would be extraordinary if in the case of a small, arbitrarily selected group of pub companies – but for no other commercial property owner in England and Wales - every new lease offered on the open market were open to a routine validation or adjudication of the rent and other terms before it was even entered into. We are concerned that the practicalities of such arrangements have not been addressed. The potential for uncertainty and disruption of the market place is huge.

33. If a prospective tenant in the final stages of negotiation for a new tied lease (not an excluded agreement or TAW) is to be able to call for a PRA, then as a matter of law the landlord is under no obligation to enter into an agreement with that tenant and is free to grant a lease to another bidder on whatever terms that other bidder may agree. The law of property allows a landlord to choose whether and with whom he concludes an agreement for the use of his property. It is not the function of the Bill, the Code, an Adjudicator or an arbitrator to interfere with those rights.

Exceptional circumstances

34. We welcome the Government’s assurance in the Response that the precise definitions of the circumstances in which the PRA provisions may have effect where an exceptional event occurs outside of the tenant’s control will be the subject of further consultation. Two refinements in particular need to be considered during the consultation on the Code.

35. The first point is to emphasise that the trigger of an upward alteration to the price of tied products ought to be only where such an alteration is permanent. This would reduce the possibility that a tenant might use a temporary change to engage the review mechanism. Guidance will need to explain that the mischief the Code seeks to address would not include, for example, the passing on of government-imposed duty increases.

36. The second point is that trigger events outside the tenant’s control should be those which were unforeseeable at the time of entry into the agreement (not simply unpredicted) and which have a significant and permanent adverse impact on the tenant’s ability to trade. This would recognise that a tenant should carry out due diligence on the premises and environment before entering into the agreement, just as he would when purchasing a house or taking any commercial premises on a lease. The Code provides that the tenant must take professional advice, and that the pub company must, where appropriate, provide information about likely material changes in commercial conditions in the pub’s catchment area and how these might influence the tenant’s trading environment.

D PARALLEL RENT ASSESSMENTS

37. The Government has taken a policy decision to enable the Adjudicator to make – or to supervise the making – of PRAs. The Bill currently suffers from some ambiguities and lacks consistency in its treatment of the PRA. Some refinements are necessary to create a system of PRAs which is more reflective of the industry and of the differences between the tied and the FOT models.

The challenge

38. There remain difficulties with the comparison of "an apple and an orange". This view is shared by many in the industry. London Economics has warned that ensuring that the PRA is carried out in the most effective way is the key risk to BIS in the delivery of its policy. RICS has recognised the difficulty of industry comparisons across different types of agreement.

39. Anyone carrying out a PRA must not only address the vexed issue of the different types of agreement, but also recognise that all agreements are individual to the specific circumstances. There is no standard tied agreement, just as there is no standard FOT agreement, nor any standard FOT drinks supply terms.

The role of the Adjudicator

40. The duty of the Adjudicator is to ensure compliance with the Code. There appears, however, to be some confusion as to the extent of the Adjudicator’s powers in relation to PRAs and the tenant’s ability to seek arbitration of a rent assessment.

41. A tenant’s request for an adjudication relating to a PRA would arise (i) where a pub company refuses a legitimate formal request for a PRA; or (ii) where the tenant believes that the pub company has not justified the rent assessment in accordance with the Code (the PRA was carried out improperly or its results not properly applied) and that he will be "worse off" if the proposed rent is imposed than if he were to run a FOT business at the same premises.

42. There would be a breach of the Code in those circumstances in the alleged failure of the pub company to prove that the tied offer met the "no worse off" test. The Adjudicator must decide whether the PRA has been carried out in accordance with the Code and relevant guidance and methodology and/or the results of the PRA had been properly taken into account by the pub company, and advise the parties accordingly. If the Adjudicator found a breach, then the Adjudicator could order the company to deliver or amend a PRA. If the rent could not then be agreed, the Adjudicator could direct that the parties engage the arbitration or expert determination provisions in the existing lease agreement between them.

43. We agree with the Government’s position in its Response that this should be the whole of the Adjudicator’s role in relation to a PRA. There is no suggestion in the Bill or the Response that the Adjudicator would have the power to set a new rent under the lease.

44. It is the Arbitration Act 1996 which must continue to apply to all rent arbitrations. Commercial leases already provide for the appointment of an arbitrator and an arbitration in accordance with the Arbitration Act, or of an independent expert and the conduct of an expert determination. It is not the purpose of the Bill indirectly to amend that Act.

45. We are therefore very concerned at the recent suggestions by some that the Adjudicator would have powers under the Code to intervene in the setting of any new rent. Jo Swinson’s 5 August 2014 letter stated "if the Adjudicator finds that there has been a breach of the Code in relation to the [PRA] then one of the remedies available to him is to set the tied rent figure so that the projected profit is equal to or greater than under the free-of-tie scenario".

46. This goes much further than the position taken by the Government in the original Consultation and the Response. We do not believe that this is necessary, desirable or realistic, or consistent with law and practice elsewhere in the commercial property market.

47. The drafting at s.38(3) could be interpreted to suggest that the Government proposes that the Adjudicator should be able to back-date the effect of his decisions. The Code needs to maintain the principle of no retroactivity and must respect the legitimate expectations of business. Decisions must be forward looking. Where a dispute concerns a lease renewal, the result of any adjudication should take effect from the date of the renewal, including where the adjudication is completed after that date. In other cases – for example where a tenant requests a rent assessment because one has not been carried out for more than five years - the new rent should take effect no earlier than the date on which, following any initial discussions with the pub company, the tenant delivered a formal, substantiated request for such assessment.

Rules and guidance

48. The Code and accompanying guidance will need to include very clear rules of the road on how a comparison is made. The PRA concept needs to be implemented in a demonstrably fair, objective, transparent and verifiable manner. Gaining acceptance of the regime through the adoption of workable PRA rules and explanatory guidance will be the key initial activity of the Adjudicator.

49. Supervision of the drafting of the rules and guidance is an activity which must be undertaken by the Adjudicator, not by BIS. That will best demonstrate the Adjudicator’s independence and objectivity.

50. The draft rules and guidance will need to be developed by a working group which represents all affected facets of the industry, with a responsible and demonstrably independent chairperson (not aligned to any specific industry interests).

51. The purpose of the rules and explanatory guidance will be to establish the criteria and methodology to be applied in carrying out a PRA. They will need to be clear, objective and rigorous, while remaining workable - flexible enough to reflect the different situations which may give rise to a PRA. In this context we note that the role of the RICS qualified assessor is to "keep the score", not to make the market.

52. Without those rules and guidance in place the Adjudicator will not be able to judge whether the Code has been followed when a PRA is provided by a landlord, or be able to demonstrate to the industry that his decision is correct.

The importance of RICS

53. The Bill inadvertently omits a specific reference to RICS. S.36(6) provides only that the Code may make provision about how rent assessments are constructed and presented and may specify that such assessments must be conducted in accordance with provisions of documents specified in the Code. This gives wide discretion and creates an uncomfortable uncertainty.

54. The June draft Code, at Part 7 para 14, states that all rent assessments for the negotiation of new tenancies, rent reviews and/or renewals must be produced, prepared and conducted in accordance with the RICS guidance prevailing at the time and be signed by a qualified RICS valuer. Jo Swinson’s 5 August 2014 letter reiterates the use of the RICS guidance and oversight.

55. This is the appropriate approach. What is needed in the Bill is an absolute commitment to the use of the RICS guidance by including explicit reference to RICS in the text.

Key issues in any PRA

56. It is common ground that one size cannot fit all assessments. The Committee must not think that "no worse off" can be demonstrated in terms of a specific number.

57. It will be the task of the working group to produce the detailed rules and guidance, following industry consultation. Nonetheless, we would like to highlight some key issues that we believe must be addressed in those rules. The following list is by no means exhaustive.

58. The rules and guidance must utilise RICS guidance.

59. The free market plays a significant role in establishing rents of all types. The assessment of the open market value of premises on any type of tenancy relies upon the market potential of each site. It is against this background that the PRA rules and guidance must corral the huge number of moving parts that affect rental values into a coherent, replicable methodology.

60. The assessment will consider the local competitive conditions, including what number, type and variety of competing establishments are in the same catchment area.

61. The assessment must be based, not on the actual accounts of an incumbent operator, but on the realistic maintainable business plan projections of a competent new operator bidding to rent the pub in the open market. This highlights two key concepts – the realistic maintainable business or fair maintainable trade (FMT), and the reasonably efficient operator (REO).

62. The realistic maintainable business plan will not be limited to the sale of beer. If demand in the market for alcoholic beverages declines, the REO will seek to exploit all available sources of income appropriate for the offering at the particular premises, which may include a range of drinks, food, amusement machines, functions, gardens, the letting of accommodation and other uses.

63. As RICS explains, the objective concept applicable to the tenant is not the individual, but an REO. Precise characteristics do not need to be set out in detail. The concept is that the same REO is tenant under the different conditions of the tied and the FOT agreements.

64. From these elements the assessor will find a fair, maintainable total gross profit.

65. At s.62(1) the FOT contract is assumed to be on the same terms as the tied contract except for the tie ("unchanged except in respect of terms relating to such ties"). This ignores and fails to quantify typical differences between these types of contract, which may include the length of the agreement, the inclusion or not of full repairing requirements, whether the contract includes upward/downward rent reviews, whether the tenant has Code protection, different market conditions for access to finance and different exit values. These are characteristics that the PRA analysis will need to accommodate.

66. The comparison has to account for SCORFA. It cannot assume that the FOT landlord provides the same benefits as in a tied contract. The assessor will need to take into account the market price to a FOT tenant of acquiring equivalent support and services. The point will also need to be recognised in the drafting at s.62(1)(b).

67. The comparison is a realistic maintainable business over the lifetime of an agreement. Over that period of years the pub will see good times and bad, when a tenant could sell more or less product, or enjoy income from other sources at his premises, depending on the conditions in his local market, the state of the economy and/ or other external factors as diverse as changes in government policy and the weather.

68. Valuation and rent assessment are not exact sciences. The many variables in producing a worked FMT P&L create a real risk of cumulative error. Case law recognises that an assessor may allow a tolerance of 10% either side of a figure which is suggested as an appropriate rent for premises. The same valuation tolerance should be recognised by the Adjudicator in deciding whether a PRA has been properly carried out and should be taken into account by an arbitrator.

Definitions/drafting points

69. The references to the "no worse off principle" and to the PRA need to be consistent.

70. We have explained above certain key elements which must drive the drafting of the Code, rules and guidance in relation to the PRA. For convenience, they may be summarised in list format to include:

· RICS and RICS guidance

· the same premises facing the same local competition

· the objectively defined tenant, i.e. the REO

· the objective standard of the realistic maintainable business (or FMT), using the full range of options to exploit the premises

· accommodation both personal and for letting

· assessment over the whole lifetime of the agreement, assuming the same period in each case

· adjustments for the different fundamental characteristics of each form of lease, including rent review provisions and repairing obligations

· SCORFA, including the availability of discretionary financial support in tied agreements

· a normal valuation tolerance, taking the assessment in the context of the local market as a whole

71. In this context we suggest that:

a. the statement of the "no worse off" principle in s.36(4) needs to encompass these points, at least including reference to a tied tenant being no worse off than a free of tie tenant on typical free of tie lease and drinks supply terms in the same premises over the lifetime of the agreement;

b. the definitions of a tenant and tenancy (s.61) must incorporate the concept of the REO trading at FMT; and

c. At s.62(1), the PRA concept is to understand the open market rent that would be payable by a tenant in those premises if the tenant were free of tie, or if he were tied. For consistency with a revised s.36(4) the reference should be to "those premises", rather than to "the tied pub".

E CONCLUDING REMARKS

72. If the proposed powers of the Adjudicator were to extend to a role as arbitrator to determine tied pub rents and to force changes in other aspects of a tied agreement, which ought to be freely negotiated between properly advised parties, those powers would deprive the affected pub companies of their rights to unfettered use of property, raising concerns about restrictions on the operation of a free commercial market, arguably incompatible with the Government’s obligations under European conventions and treaties.

73. The Government now has the opportunity to ensure, through the current process, that statutory intervention interferes as little as possible with the freedom of all companies to compete fairly in a highly competitive industry. We hope that the Bill will go no further than to implement Government policy as set out in the Response, and that the resulting Act and Code will adhere to industry standards and guidance and the Adjudicator will be enabled to develop a robust, sensible and flexible methodology for comparisons between tenancy types in those few instances where such comparisons may be really useful to both pub companies and tenants, and provide relevant protections to tenants in their ongoing relationships with their landlords.

October 2014

Prepared 15th October 2014