Friday, 20 November 2009

Restrictive supermarket leases: going, going...gone?


Introduction
In September 2009, Mr Graeme Samuel, the Chairman of the Australian Competition and Consumer Commission (ACCC), announced a “major breakthrough for grocery competition in Australia”.[1] The “breakthrough” referred to a deal brokered by the ACCC which saw Coles Myer and Woolworths agreeing not to enforce restrictive provisions in over 700 of their leases with supermarket landlords around Australia (Settlement). Dr Craig Emerson, the relevant Minister also described the Settlement as “pro-competitive”.[2]

The Settlement has many pro-competitive benefits. It also raises a number of questions, including:

  • Why were some existing restrictive provisions preserved for up to five years under the Settlement? 
  • Why were Coles and Woolworths not prosecuted by the ACCC for what appears to be quite blatant anticompetitive conduct? 
  • Why didn’t the ACCC seek pecuniary penalties against Coles and Woolworths for these restrictive lease provisions, particularly in the light of the ACCC’s earlier case against Coles and Woolworths for broadly similar conduct in relation to restrictive liquor agreements? 
The Settlement
The Settlement is contained in two separate section 87B undertakings (Undertakings) from Coles and Woolworths.[3]  These Undertakings are identical in their content. [4]

The Undertakings begin by setting out the relevant background. Reference is made to the ACCC inquiry into the competitiveness of the grocery market conducted in 2008. The Undertakings state that in the course of its inquiry, the ACCC identified the existence of a wide range of restrictive provisions in lease agreements which could prevent the entry of supermarket operators into shopping centres.

The Undertakings also refer to an ACCC’s industry-wide investigation into whether the restrictive provisions uncovered by the ACCC could have the purpose and/or effect of substantially lessening competition in a market. It appears that the ACCC’s investigation is continuing.

Clause 7 of the Undertakings describes a number of the restrictive provisions which the ACCC identified in Coles and Woolworths leases with shopping centre owners. For example, the ACCC identified provisions which:

  • prohibit the lessor from granting a lease agreement to, or allow the entry of, another supermarket operator in the shopping centre in which the relevant (Coles or Woolworths) supermarket is located; 
  • impose a penalty upon the lessor if the lessor grants a lease agreement to, or allows the entry of, another supermarket operator in the shopping centre in which the relevant (Coles or Woolworths) supermarket is located; 
  • prohibit the lessor from granting a lease agreement to another supermarket operator, or to another supermarket operator over a certain floor size, in which the relevant (Coles or Woolworths) supermarket is located. 
The Undertakings then describe the ACCC’s concerns about the restrictive provisions. The Undertakings state that the ACCC had concerns that the making or giving effect to the lease agreements containing such restrictive provisions may have had the purpose, effect or likely effect of lessening competition in various retail grocery markets. In addition, the ACCC was concerned that the restrictive provisions may have had the effect of preventing and/or hindering other supermarket operators from entering and competing in various retail grocery markets.

Finally, the Undertakings set out what Woolworths and Coles have agreed not to do – namely not to:

a) give effect to, or threaten to give effect to, a restrictive provision contained in a lease agreement that is in operation as at the commencement of this Undertaking, after a period of five years from the date at which the relevant (Woolworths or Coles) supermarket commenced trading; or

b) enter into a lease agreement that includes one or more restrictive provisions.

The number of leases with restrictive provisions is not stated in the Undertakings. However, an insight into the extent of Coles and Woolworths’ conduct can be gleaned from the Media Release issued about the Settlement by Minister Emerson on 18 September 2009. In his media release, he stated that:

This pro-competitive agreement means that out of 750 active restrictive leases involving Coles and Woolworths, 602 will cease immediately…the remaining 20 per cent will be gone within five years and no restrictive provisions will be allowed in new stores.[5]
Pro-competitive aspects of settlement
There are clearly a number of pro-competitive benefits arising from the Settlement.

First, Coles and Woolworths have agreed not to give effect or threaten to give effect to any of the existing restrictive provisions in the future (subject to one significant exception discussed below). This is a very important pro-competitive benefit of the Settlement, as it may facilitate the entry of other supermarket operators, such as Aldi, Foodworks and IGA, into shopping centres which were previously monopolised or dominated by Coles or Woolworths. Whether these companies actually end up opening supermarkets in shopping centres will depend on a range of factors, particularly whether there is available space within the existing shopping centre to set up a new supermarket. However, there is now at least a theoretical possibility that such companies will be able to set up competing supermarkets in shopping centres around Australia.


Second, Coles and Woolworths have undertaken not to enter into lease agreements that include “one or more restrictive provisions” in the future. There is no time frame on this future undertaking, which means that Coles and Woolworths will be prevented from entering into such restrictive provisions forever. This is also a very important pro-competitive aspect of the settlement as it provides shopping centre owners with certainty that Coles and Woolworths can no longer insist on the inclusion of restrictive provisions in their leases. However, it appears that the scope of this undertaking is limited to the types of restrictive provisions which are defined in clause 7 of the Undertakings. This means that while Coles and Woolworths are prevented from insisting on the inclusion of the restrictive provisions which are defined in clause 7, they are not prevented from insisting on different types of restrictive provisions.

Third, the Settlement will have the effect of opening shopping centres up to greater competition much more quickly than would have been the case if the ACCC had been forced to litigate the matter. Even if the ACCC litigated this matter successfully, it would have taken a long time, perhaps years, for the ACCC to obtain orders declaring the restrictive provisions to be illegal and void.

Negative aspects of the Settlement

Despite the pro-competitive benefits of the Settlement discussed above, the Settlement also has a significant number of negative aspects.

Preservation of restrictive provisions
The most obvious concern about the Settlement is the fact that it does not apply to restrictive provisions in leases which have been in operation for less than 5 years from the date that the relevant Coles or Woolworths supermarket commenced trading. In other words, the ACCC has effectively permitted Coles and Woolworths to enjoy the benefits of a large number of restrictive provisions for a period of up to five years. As stated in Dr Emerson’s media release, this “carve out” applies to 148 separate leases throughout Australia.

It is not clear why the ACCC acquiesced to this exception. Either the restrictive provisions in the lease agreements are illegal and should be prohibited or they are not – there is no middle ground. The Undertakings contain no justification for this "carve out” and the ACCC, Coles or Woolworths have been quite silent on the reasons for this significant exclusion. It would be helpful if the ACCC were to provide some public explanation of why it agreed to this particular condition.

This condition to exempt some restrictive provisions for up to five years is even more puzzling when one considers the clear statement made by the ACCC in the Undertakings about the potentially anticompetitive effects of the restrictive provisions. In the Undertakings, the ACCC stated that it was concerned that the restrictive provisions:
  • may have substantially lessened competition in retail grocery markets; and 
  • may have prevented and hindered other supermarkets from entering retail grocery markets. 
An effect of the conduct described in the Undertakings is that it was likely to lead to higher prices for consumers. It is basic economic theory that companies seek to exclude competitors from markets so that they can enjoy greater pricing power in those markets.

Accordingly, given the ACCC’s serious concerns about the restrictive provisions, it is difficult to understand why it agreed to allow Coles and Woolworths to continue conduct for a period of up to five years in 148 different locations throughout Australia which may have the effect of (1) substantially lessening competition, (2) excluding competitors from markets and (3) leading to higher grocery prices for consumers.

De-facto authorisation?

A related concern is whether the Undertakings constitute a de-facto authorisation by the ACCC of the restrictive provisions in the 148 leases. By carving out these 148 lease agreements, the ACCC has effectively indicated that Coles and Woolworths’ conduct can continue without any fear of legal action from the ACCC.

This raises the question of whether it is appropriate for the competition regulator to effectively authorise conduct (about which it has serious concerns) without following the established legislative process for authorisation set out in the TPA.[6]

There are three significant differences between the approach which the ACCC took to negotiating the Settlement and the way it would have had to approach the matter had Coles and Woolworths lodged an authorisation application.

First, under the Settlement the ACCC was able to negotiate the terms of the Undertaking with each of Coles and Woolworths behind closed doors, with no public scrutiny. The proposed Undertakings were not issued for public comment prior to them being executed by the parties. However, in an authorisation the entire process is conducted in public with interested parties being given ample time to comment on both the proposed conduct as well as any proposed undertakings.

Second, in the Settlement there is no reference to the net public benefit arising from permitting 148 lease agreements to continue for up to five years. However, in an authorisation, Coles and Woolworths would have had to demonstrate that preservation of these 148 leases was likely to result in a public benefit which outweighed the likely public detriment constituted by any lessening of competition. There is a very strong argument that Coles and Woolworths would not have been able to satisfy this onus in relation to the 148 leases. In fact, there dos not appear to be any public benefit arising from the preservation of these restrictive provisions.

Finally, under the Settlement there does not appear to be any right for potentially disaffected parties such as Aldi, Foodworks or IGA Supermarkets to challenge the ACCC’s decision. However, disaffected parties are able to appeal an authorisation decision to the Australian Competition Tribunal.

Accountability
A further concern with the Settlement is that the ACCC does not appear to have made any attempt to hold either Coles or Woolworths accountable for the anti-competitive harm which their conduct may have caused. It is logical to assume that by excluding competitors from up to 750 markets around Australia, Coles and Woolworths have reaped significant commercial benefits from this absence of competition. It also makes sense that by not having to compete with a variety of competitors in particular markets, Coles or Woolworths have been able to maintain higher prices to consumers than would otherwise have been the case.

Despite the obvious potential for competitive harm to both competitors and consumers, the ACCC has apparently not taken any steps to hold Coles and Woolworths accountable for this potential harm. It appears that Coles and Woolworths are simply being permitted to retain the financial benefits they may have obtained from their anticompetitive conduct.

Antecedents – the Liquor case
Coles and Woolworths have sought to impose restrictive provisions on competitors and potential competitors in the past in not dissimilar circumstances.

In 2005, Liquorland (Australia) Pty Ltd, a fully owned subsidiary of the Coles Myer Group paid a penalty of $4.75 million after it admitted entering into illegal agreements with applicants for liquor licences in NSW.[7] In this case, Liquorland objected to liquor licence applications which had been lodged by new entrants and then proposed a series of restrictive provisions in return for Liquorland’s agreement to withdraw its objection. The purpose of these restrictive provisions was to ensure that the new entrant could not operate, or could not operate effectively, as a competitor in the relevant retail liquor market.
In 2006, the Federal Court found that Woolworths had also have entered into similarly anticompetitive agreements in various NSW retail liquor markets.[8] The court found that the Woolworths’ agreements contained restrictive provisions which had the purpose of substantially lessening competition in various retail liquor markets in NSW. The Federal Court ordered Woolworths to pay a pecuniary penalty of $7 million for entering into these illegal agreements.

Therefore, Coles and Woolworths have engaged in very similar conduct to that described in the Settlement in the past. Liquorland has admitted entering into illegal restrictive agreements which were aimed at excluding competitors from markets, while Woolworths has been found by the Federal Court to have entered into illegal restrictive agreements for the purpose of substantially lessening competition and excluding competitors from markets. Both companies were ordered to pay significant pecuniary penalties for their illegal conduct.

Despite this background, the ACCC has not sought to take legal proceedings against Coles and Woolworths for their conduct in imposing restrictive provisions to prevent competition in retail grocery markets.

It is very difficult to understand why the ACCC took such a different approach in these two matters.

Conclusion
The grocery settlement sets a poor precedent in terms of how the ACCC may choose to settle what appear to be very serious anticompetitive contraventions of the TPA in the future.

The Settlement is alarming if it points the way to how the ACCC will deal with serious contraventions of the TPA in the future. Will the ACCC continue to negotiate settlements in relation to potentially anticompetitive conduct rather than taking legal proceedings and seeking pecuniary penalties? Will the ACCC not pursue litigation and pecuniary penalties against major corporations which have been found by a court to have breached the same provisions of the TPA in the past?

However, of most concern is the fact that in the future companies may be able to obtain de-facto authorisation from the ACCC for some of their potentially illegal conduct without being required to apply formally for authorisation or indeed without having to provide any public interest justification for being granted such a generous dispensation by the ACCC.

[1] Supermarket agreement opens way for more competition, ACCC News Release, dated 18 September 2009 - http://www.accc.gov.au/content/index.phtml/itemId/893478
[2] Competition barriers to major supermarkets being torn down, Media Release by The Hon Dr Craig Emerson, Minister for Innovation, Industry, Science and Research, dated 18 September 2009 - http://minister.innovation.gov.au/Emerson/Pages/COMPETITIONBARRIERSTOMAJORSUPERMARKETSBEINGTORNDOWN.aspx
[3] Section 87B is an administrative tool which permits the ACCC to accept undertakings from businesses to settle investigations, including consumer protection, restrictive trade practices and merger investigations. Though s87B undertakings are not approved or otherwise brought to the attention of the Federal Court when they are executed, they can be enforced in the Federal Court in the event that its terms are breached.
[4] Undertaking to the ACCC given for the purposes of section 87B by Coles Group Limited, dated 17 September 2009 - http://www.accc.gov.au/content/item.phtml?itemId=893471&nodeId=a2da716b9168b7809f0d8eb136328eb9&fn=Undertaking.PDF and Undertaking to the ACCC given for the purposes of section 87B by Woolworths Limited, dated 17 September 2009 - http://www.accc.gov.au/content/item.phtml?itemId=893470&nodeId=09c305f68e7f97f331d7f32a15c7a31e&fn=Undertaking.PDF.
[5] See footnote 2 above.
[6] The Trade Practices Act 1974 provides a process whereby business can apply to the ACCC to have potentially illegal conduct authorised. This regime only applies to the restrictive trade practices provisions of the TPA, including mergers, but excluding misuse of market power. The ACCC can only authorise conduct if it is satisfied, after a period of public consultation that the conduct delivers a net public benefit. The relevant test for agreements which may breach section 45 of the TPA is that the conduct is likely to result in a public benefit which outweighs the likely public detriment constituted by any lessening of competition. See Authorisations and Notifications: A Summary, ACCC, January 2007 - http://www.accc.gov.au/content/item.phtml?itemId=776052&nodeId=6a570b34b0d37c0545766f52476ca354&fn=Authorisations%20and%20notifications:%20A%20summary.pdf
[7] See Federal Court penalised Liquorland $4.75 million for anticompetitive liquor deals, ACCC News Release dated 31 May 2005 - http://www.accc.gov.au/content/index.phtml/itemId/687035/fromItemId/2332. See also ACCC v Liquorland (Australia) Pty Ltd [2005] FCA 683 - http://www.austlii.edu.au/cgi-bin/sinodisp/au/cases/cth/FCA/2005/683.html?query=^liquorland%20%20%20competition.
The author was responsible for running this particular investigation and litigation while employed as a Director at the ACCC.
[8] See Woolworths penalised $7 million for anticompetitive liquor deals, ACCC News Release, dated 22 December 2007 - http://www.accc.gov.au/content/index.phtml/itemId/773813/fromItemId/622289. See ACCC v Liquorland and Anor [2006] FCA 826 - http://www.austlii.edu.au/cgi-bin/sinodisp/au/cases/cth/FCA/2006/826.html?query=^liquorland%20%20%20competition.
The author was responsible for running this particular investigation and litigation while employed as a Director at the
ACCC.