Exclusivity Clauses in Lease Agreements

One of the keys for a successful commercial building, a shopping centre or an office tower, is to “lock” contractually its publicly known anchor tenants whose prestige and trade name recognition will attract other tenants and customers. Both the landlords and the anchor tenants are aware of the importance of such “locking”. Therefore, very often the anchor tenants (supermarkets and electronics stores, in most cases) will insist on having an exclusivity clause in their lease agreements. Generally, such a clause restricts the right of the landlord to lease to anchor tenant’ competitors other sites, owned by the lessor, if they are in the same building and/or within certain distance outside the building. The anchor tenant usually claims that such clause allows it to provide a wide selection of quality products at reasonable prices which, in turn, draws more tenants and consumers. Hence, exclusivity seems to favor everyone.

However, an exclusivity clause may have potential to distort or prevent competition on the relevant markets. Therefore, the general prohibition to agreements which may prevent, restrict or distort competition under article 101 of the Treaty on the Functioning of the European Union (“TFEU“) and article 15 of the Bulgarian Competition Protection Act (“CPA“) apply to them. Further, the exemption from the general prohibition of vertical agreements under the Commission Block Exemption Regulation (EU) No. 330/2010 does not apply to lease agreements and, respectively, to the exclusivity clause/s which they may include[1].

Possible approaches

Until now the Bulgarian Competition for Protection of Commission has not examined this issue. However, on an EU level the following two approaches for assessment of the exclusivity clauses in lease agreements exist:

• Formal approach

According to the formal approach every exclusivity clause might be considered as distortive for competition without analysis of the market structure, position of the market participants, its potential to distort competition and its negative effects. This, in general, is the approach of the Latvian Competition Council expressed in the case of Maxima Latvija Ltd. which operates one of the leading retail chains in Latvia.

• Efficiency approach

This is the approach followed by the UK Competition and Markets Authority. According to the efficiency approach not all restrictions in the lease agreements may violate Competition law but only those which might serve as a barrier for entry or for expansion.[2] The exclusivity clause/s might have such an effect. However, this might be established with analyses of the impact of the clauses on the relevant markets.

Two relevant markets should be considered for the purposes of the competition analyses:

• The downstream (related) market – the market of the business activity for which the site is leased.
• The upstream market – the lease market on which sites are leased for the purposes of the business activity which form the related market.

The general principles to define the product and geographic scope of the markets should apply.

Further, certain market factors should be considered in the competition analysis of the exclusivity clauses in lease agreements. Among the main factors are:

• market power on the related market

Here, it should be considered how strong is the position of the tenant on the related market on which it conducts its business activity. It is important to assess whether the tenant already faces effective competition from its competitors – i.e. number of competitors; market shares; and potential for growth and expansion are considered. The potential competition from new entrants should also be analysed.

An exclusivity clause has higher risk to foreclose the access to the related market when the tenant has stronger market position.

• existing barriers to entry or expansion on the related and upstream market

Further, the market share of the landlord on the entire market available for lease for the same purposes as those of the particular lease agreement is of higher importance than the market share of the tenant. If the landlord does not have a significant market position, competitors of the tenant will be able to lease real estate, to conduct their business and to compete with the tenant.

On the other hand, if the landlord has a strong position on the upstream lease market, this does not make the exclusivity clause anticompetitive per se. The exclusivity clause/s might have insignificant effects on the competition if their scope is limited to the same building or to a limited area within the relevant geographic related market.

If the market position of the tenant and the landlord on their relevant markets triggers is weaker, the exclusivity clause in the lease agreement may have less negative impact.

• term of the exclusivity clause

The term of the exclusivity clause/s is also important in their assessment. A longer term might be an indication of a more significant impact on the competition on the related market.[3]

• series of agreements

The effect of foreclosure of the exclusivity clause/s in a lease agreement may arise if this clause is included in several agreements. The cumulative effect of several exclusivity clauses may create a barrier for entry into the related market. Thus, the single clause may have restrictive effect on competition.

Bulgaria

As mentioned above, the Bulgarian Competition Protection Commission (“CPC”) has not examined this issue so far. Hence, we may not exclude that CPC will apply the formal approach within an assessment of exclusivity clause/s incorporated in lease agreement/s. CPC may qualify the exclusivity clause/s as a violation of article 15 of the CPA without conducting detailed economic analyses of the relevant markets and the effect of the exclusivity clauses.

In that case, the risk will be imposition of a sanction on the parties to the agreement in the amount of up to 10% of their aggregate turnover for the last financial year. In addition, the exclusivity clause/s will be null and void.

Even if CPC does not accept the above arguments for lack of anti-competitive effect and thus for lack of violation, these could be used as arguments for imposition of a sanction in the low range of up to 5% of the parties’ aggregate turnover for the last preceding year.

In this respect, arguments for application of exemption under article 17 of the CPA (101 (3) of the TFEU) from the general prohibition for anticompetitive agreements might be considered and proved: efficiency gains (e.g., more efficient distribution of products); indispensability of the exclusivity clauses (e.g., guarantee for a large investment); fair share of consumers (e.g., economies of scale passed to the consumers); and no elimination of competition (e.g., no reduction of competition so far), on order sanction to be avoid.

Expected developments

In connection with the Maxima case which was mentioned above, Latvian Supreme Court approached the European Court of Justice for guidance as to how a competition authority should assess exclusivity clause/s in lease agreements. The main point which was addressed was whether the authority should consider the market structure and the relevant market factors or whether such exclusivity clause/s should be considered as anticompetitive per se.

[1]     Para 26 of the Commission Guidelines on Vertical Restraints.

[2]     Land Agreements – The application of competition law following the revocation of the Land Agreements Exclusion Order, March 2011 (OFT1280a), Office of Fair Trading.

[3]     Para 4.26 of the Land Agreements – The application of competition law following the revocation of the Land Agreements Exclusion Order, March 2011 (OFT1280a), Office of Fair Trading.