The Commerce Commission is recommending to businesses that are considering lodging or giving effect to a land covenant to consider the potential impact on competition, and whether the covenant is at risk of breaching the Commerce Act 1986.
What is a covenant?
The definition of ‘covenant’ is in section 2 of the Commerce Act 1986 and means ‘a covenant annexed to or running with an estate or interest in land’.
A covenant is a promise which creates a legal obligation by someone to do something (a positive covenant), or not to do something (a restrictive covenant) regarding that land.
Covenants are often registered on the Record of Title for the land. These covenants bind anyone who subsequently acquires or leases the land. Covenants can also be contained in another interest in the land such as a lease. This includes an exclusivity clause in a lease which typically prevents a landlord from leasing adjacent or proximate premises to a tenant’s competitors.
This article refers to restrictive land covenants and exclusivity clauses in leases. Both are a ‘covenant’ in terms of the Commerce Act.
Commerce Commission market studies
In October 2018, Parliament passed an amendment to the Commerce Act to empower the Commerce Commission to undertake market studies to see if a particular market is working well or not.
So far, the Commission has completed three market studies to examine:
- the retail fuel market (completed in December 2019);
- the retail grocery market (completed in March 2022); and
- the residential building supplies (completed in December 2022).
In each of the market studies, the Commission found that that restrictive land covenants and exclusivity clauses in leases potentially negatively impact on competition, by raising barriers to entry or expansion in the market and making it harder for competitors to compete and gain scale.
The Commission was also concerned by the widespread use of such practices in these markets.
Below are some examples from the studies:
In the retail fuel market:
- When some fuel companies closed retail sites, a restrictive covenant (called a Non-Petroleum Use covenant) was registered against the Record of Title for the land to prevent its future use by another fuel retailer.
In the retail grocery market:
- Restrictive land covenants were used to stop a competitor from establishing itself near a major grocery retailer’s planned or existing store.
- Major grocery retailers entered into commercial leases with landlords containing exclusivity clauses to prevent or restrict the operation of competing business in adjacent or proximate premises. This practice appeared to take place largely in shopping centres or malls.
In the residential building supplies market:
- Restrictive land covenant and exclusivity clauses in leases were used in a similar way to the retail grocery market study.
- Restrictive Covenants were registered on Records of Title in residential developments to give a merchant preferential rights to quote for supplying building materials for any new housing to be constructed on the land.
In its final report into the residential building supplies market, the Commission recommended an economy-wide review of the use of restrictive land covenants and exclusivity clauses in leases to assess whether a wider multi-sector solution is needed to address their impacts on competition more generally.
The Commission also advised that it intended to undertake a compliance programme in early 2023 to promote broader compliance with the Commerce Act in this area.
The Commerce Act
The Commerce Act prohibits the use of covenants that substantially lessen competition in a market.
Section 28 of the Commerce Act prohibits the requiring, giving, carrying out, or enforcing of a covenant that has the purpose, effect, or likely effect of substantially lessening competition in a market. These covenants are also unenforceable.
In some circumstances a covenant may also breach section 27 (which relates to anti-competitive arrangements) and section 30 (which relates to cartel conduct) of the Commerce Act.
In response to the retail grocery market study report, in June 2022 the Government passed into law the Commerce (Grocery Sector Covenants) Amendment Act 2022. This introduced new sections 28A and 28B, which deems any grocery sector covenants to breach section 27 or section 28 of the Commerce Act where:
- a ‘designated grocery retailer’ has an interest in it; and
- it is likely to impede the development or use of the land as a retail grocery store (or any other retail store that is likely to compete with a retail grocery store).
In all other sectors, whether a covenant breaches the Commerce Act requires a fact specific analysis of the effect of the covenant on competition to be undertaken by the Commission.
Commission fact sheet
In March 2023 the Commission published a fact sheet outlining its approach to assessing whether a covenant is in breach of section 28 of the Commerce Act.
The Commission advises that a covenant is more likely to have a substantial effect on competition when:
- the covenant has a broad scope and/or long duration;
- the effect of the covenant is to strengthen or reinforce barriers to entry or expansion by competitors (for example, where zoning or regulatory restrictions mean there is limited availability of suitable land);
- existing competition in the relevant market is already limited;
- the covenant restricts the use of land for specified purpose(s) (for example, to prevent a competitor of the original covenantor from operating on a site); and
- the covenant limits landowners’ freedom to choose what they buy or sell, or who they do business with.
Where there are multiple covenants that benefit the same person or associated person, the Commission advises that it will assess the combined effect of the covenants. Accordingly, while an individual covenant may not substantially lessen competition, multiple covenants may breach section 28.
There are some exceptions to section 28 of the Commerce Act, and the Commission has the power to authorise a land covenant that lessens competition where it is satisfied that the benefits to the public outweigh the harm.
Penalties for breaches of the Commerce Act
If the courts find an individual or body corporate has breached the Commerce Act, the penalties are:
- for an individual, a maximum of $500,000; and
- for a body corporate, the greater of:
- $10 million, or
- three times the commercial gain, or, if this cannot be easily established, then 10% of turnover.
Every separate breach of the Act may incur a penalty.
Given the Commission’s focus on compliance with the Commerce Act, it is strongly recommended that a business seeks legal advice if there is any concern that a proposed or existing covenant is at risk of breaching the Commerce Act.