This article was originally published in Lawyer Monthly and can be accessed here. 

The law as a weathercock? – The Supreme Court examines restraint of trade clauses in leases

Peninsula Securities Limited  v Dunnes Stores (Bangor) Limited  [2020] UKSC 36

Recently, the Supreme Court took the relatively rare step of overturning a decision of its predecessor, the House of Lords Appellate Committee. In doing so, also upholding the validity of restrictive covenants prevalent in commercial leases of a particular type and vintage.

The decision has some relevance for property investors in assessing how they might extract value from property portfolios in the increasingly challenging environment of the retail property market.

The Facts

The case concerned a covenant in a lease of a substantial retail unit on a retail park in Derry granted in 1981 between by Mr Shortall to Peninsula. The covenant was in terms that

“… any development on the lessor’s lands comprised in the Lessor’s folio and on his other lands shall not contain a unit is size measuring three thousand feet or more for the purpose of … trading in textiles, provisions or groceries in one or more units”

The site of the retail park on which the store was located was in what the developer described as an “economic and political wasteland” in Northern Ireland. Dunnes Stores was, and remains, a retailer of high repute and attracting that retailer as an “anchor tenant” was of great benefit to Mr Shortall in getting other, smaller, retailers to take leases on the site.

Recently, the success of the shopping centre had declined. In the opinion of Peninsula, this was a direct result of the existence of the restrictive covenant. To arrest this decline, Peninsula sought a declaration from the Northern Ireland equivalent of the Upper Tribunal that the covenant represented an impediment to the enjoyment of its land, and was unenforceable and should be modified to substitute a substantially greater area which Peninsula could let for a use otherwise prohibited by the covenant than would be allowed by the covenant.

Peninsula also requested a declaration that the covenant engaged the doctrine against restraint of trade and, as such, was unenforceable unless the terms of the covenant were reasonable. The latter issue was remitted first to the High Court in Northern Ireland, where it was decided that the doctrine was not engaged and then appealed to the Court of Appeal, where that decision was reversed on the basis that the doctrine remained engaged on Peninsula acquiring title from Mr Shortall. Dunne’s Stores thus appealed to the Supreme Court on the point.

Esso Petroleum Limited v Harper’s Garage (Stourport) Ltd [1968] A.C. 269 (“Esso”)

The law rested on the House of Lords decision in Esso that a covenant restrictive of the use of land engaged the doctrine only if the covenantor had, by entry into it, surrendered  a pre-existing freedom to use the land as he wished. It was agreed that whilst Mr Shortall had held the title to the land subject to the covenant, that covenant had engaged the doctrine. The key question was, therefore, whether or not Peninsula’s ownership continued to engage the doctrine.

The Pre-Existing Freedom test

The pre-existing freedom test was introduced by Lord Reid in Esso as being the criterion in distinguishing between a covenant which restricted trading from a property and which engaged the doctrine and a covenant in such terms which did not.

As Lord Reid put it,

“a person buying or leasing land had no previous right to be there at all … and when he takes possession of that land subject to a negative restrictive covenant he gives up no right or freedom which he previously had.”

The problem with the decision in Esso was that the majority of the House of Lords did not explain why a covenant restrictive of the use of land was more likely to offend public policy, when the covenantor enjoyed a pre-existing freedom in relation to its use than when he enjoyed no such freedom.

The potential absurdity of this distinction was framed perfectly by an example given by J.Heydon in an article entitled “The Frontiers of the restraint of trade doctrine [i] ”:

“If all the landowners in Yorkshire agree not to trade on their Yorkshire land, the restraint of trade doctrine would apply because all of the landowners are surrendering a pre-existing freedom and the agreements would be unenforceable. But if X buys all of the land in Yorkshire, covenanting not to trade on the land, the Esso test prevents the doctrine from applying, so the covenants are all enforceable. In each case the public and parties restricted are equally damaged. Why should the common law be prevented from controlling the second case…”

In terms of public policy, there was no explanation why a restraint should engage the doctrine if the covenantor enjoyed a pre-existing freedom; but why an identical restraint should not engage the doctrine if he did not do so. The conclusion of the Supreme Court was, therefore, that the pre-existing freedom test, as a test for whether the doctrine was engaged, should be overruled.

The Trading Society Test

The nuance in the decision in Peninsula was that it did not overrule Esso entirely, only that part of it which imposed the pre-existing freedom test. In Esso Lord Wilberforce, as an alternative to the existing freedom test, proposed a “trading society test” as deciding whether or not the doctrine was engaged by the covenant concerned. That being that:

“…one can only explain [restrictive covenants imposed in the sale or lease of land] by saying that they have become part of the accepted machinery of a type of transaction which is generally found acceptable and necessary, so that instead of being regarded as restrictive they are  accepted as part of the structure of a trading society”.

Lord Wilson conceded that the trading society test did not appear any more defensible. It seemed to concede that the law follows where many might expect it to lead. However, it deserved to be retained as the test. In phrasing resonant of a judgement of the late Lord Denning, Lord Wilson put the question as:

“is the law to be determined as if by a weathercock which answers only to the direction of the wind”

Such criticism failed to recognise the nature of the Common Law as:

“a law built by the judges on the part of the people over seven centuries. Generated from below not imposed from above.”

Lord Wilberforce’s pragmatic test recognised that the Common Law is inevitably a patchwork. It reflected the importance attached on the one hand to freedom to trade and on the other to the enforceability of contracts in the interests of trade. The former generates the doctrine and the latter that helps it keep within bounds.

Lord Wilberforce’s test also recognised that a change in society’s circumstances might precipitate a change in public policy which would require re-examination of whether a type of covenant should continue not to engage the doctrine or continue to engage it.

The Decision

This conclusion led the Supreme Court to consider whether it should depart from one of its previous decisions, which it was permitted to do so, [ii] where:

“too rigid an adherence to precedent may lead to injustice in a particular case and unduly restrict the proper development of the law”

With what Lord Wilson described as “appropriate hesitation”, the Supreme Court decided that it should depart from the existing freedom test. The objections to it being that it had been consistently criticised for over 50 years, its reasoning had “scarcely been defended” and, as a consequence the common law, had “been limping between the continuing authority of the test in our jurisdiction and its rejection in Australia and parts of Canada”.

It had long been accepted across the common law world that a shopping centre lease may include restrictive covenants on the part of the lessor in relation to the use of other parts of the centre. There were no grounds considering that social changes required re-examination of the conclusion that by reference to the trading society test whether the covenant had at no time engaged the doctrine. Consequently, Dunne Stores’ appeal would be allowed and Peninsula’s common law claim dismissed.

Commentary

The 1966 Practice Statement also said of the circumstances in which it should be invoked that:

“[the court] will bear in mind the danger of disturbing retrospectively the basis on which contracts, settlements of property and fiscal arrangements have been entered into…”

The Supreme Court, therefore, treads a fine line between upholding precedent and changing it where, on reconsideration of a decision, it appears now to be incorrect. The awkwardness of the distinction in the pre-existing freedom test seems to justify the Supreme Court overruling it in this case.

Covenants similar to those in the Dunnes Stores lease will be found in many leases granted to anchor tenants of 1970’s and 1980’s town centre and retail park developments. Often these leases were granted on long terms of 50 years and over, and which will still be in existence. Had Peninsula’s appeal upheld, landlords might have been able to free themselves from the potentially restrictive and harmful effect of these covenants. To many in the present climate, this may have assisted in efforts to revive failing retail portfolios. Until it is decided that prevailing circumstances require reconsideration under the trading society test, so as to engage the doctrine in relation to such covenants, that will not be the case.

[i] (1969) 85 L.Q.R. 229

[ii] ( Practice Statement (Judicial Precedent) [1966] 1 W.L.R. 1234)