Statutory guidance

Guidance on clarity in the MRO procedure

Published 17 March 2023

Applies to England and Wales

Guidance on clarity in the MRO procedure

Introduction

Parliament intended that the Pubs Code etc. Regulations 2016 (as amended by the Small Business, Enterprise and Employment Act and Pubs Code etc. (Amendment) Regulations 2021) (the “Code”) should deliver on two core principles:

• Fair and lawful dealing by pub-owning businesses (“POBs”) in relation to their tied pub tenants (“tied tenants”);

• That tied tenants should not be worse off than they would be if they were not subject to any product or service tie.

These principles underpin the whole of the Pubs Code and are intended to address the issues that led to its introduction. The Market Rent Only (“MRO”) process is, in particular, the critical route by which the second of these, the “no worse off” principle, can be delivered.

The regulated tied tenant can serve a MRO notice each time they have the right to renegotiate their tied rent under the Code. Parliament’s intention is to provide the tied tenant with the opportunity for effective negotiations in respect of their tied deal, with the right to choose to go free of tie if they feel that is the better option for their business. Where the tied tenant can judge whether they would be worse off than if they were free of tie, and choose between the two options, commercial pressure is exerted on the POB to offer a competitive tied offer, and the tied tenant’s negotiation strength is improved. It is important to remember that tied tenants can use the MRO process whether or not they have any wish or intention to take on a free of tie tenancy and can, if they choose, use it purely as a negotiating tool at their tied rent review.

The fact that the tied tenant has the legal right, at certain gateways, to walk away from the tied arrangement provides an important incentive to the POB to deliver on its duty to treat them in a fair and lawful manner throughout the tied tenancy.

For the tied tenant to be fully empowered by the MRO process as Parliament intended, that process has to work smoothly, and not involve barriers or unnecessary disincentives which can supress tenant appetite for using it. If the tied tenant is frustrated in accessing their statutory right to MRO, or there are obstacles which make it an unrealistic option, the commercial pressure exerted on the POB, including in the negotiations over the tied deal, is reduced. The ability of the tied tenant to effectively access a compliant MRO offer is therefore central to the success of the Code in fulfilling the core principles. This statutory guidance addresses issues that have come to the attention of the Pubs Code Adjudicator (“PCA”) as areas which represent possible barriers to tied tenants exercising their rights.

The PCA seeks to reduce the potential areas for disputes over the compliance of a MRO option, and thus the need for arbitration referrals, which can be a cumbersome and costly mechanism for resolving a dispute and a disincentive to tied tenants pursuing the MRO option. Where there is a financial benefit to the POB in the tenant remaining tied, this can disincentivise it from seeking a swift resolution to the proceedings. In arbitration there is the potential for inequality of arms with a tied tenant facing a well-resourced and professionally represented POB. The costs and formality of an appeal to the High Court against an arbitration award may deter tied tenants from challenging an award even if they may have grounds to do so.

Reliance on arbitration to resolve disputes has reduced and, additionally, amendments to the Code effective from 1 April 2022 introduced a 3-month resolution period to provide a greater opportunity for the parties to negotiate before having to decide whether to refer a dispute to arbitration. Nevertheless, in addition to seeking to further reduce the reliance on arbitration, there are good reasons for ensuring improved clarity, consistency and fair dealing for tied tenants in the MRO process to ensure a level playing field for tenants in negotiations.

It is not sufficient for concessions which remove barriers to the MRO for a tenant to simply be in negotiations by a POB on a case-by-case basis. This can affect the tied tenant’s negotiating strength and delay the MRO process and does not provide consistency and clarity to all tenants considering using the MRO process.

The PCA seeks to promote this greater clarity and consistency in the dealings of POBs with their tied tenants under the Code via this statutory guidance. The PCA believes this should assist tenants in being clear and confident about the use of the MRO process. It will be to the advantage of all – both tied tenants and POBs, to have greater clarity on the parameters of what can be expected from the MRO process and consistency of approach from all POBs.

This guidance is published under s.61 of the Small Business, Enterprise and Employment Act 2015. The PCA must take account of it when carrying out its functions. This guidance is to come into effect from 1 May 2023, including in relation to cases where a MRO notice is served on or after that date.

Transparency around proposals of rent in the MRO procedure

1) This guidance seeks to ensure that POBs take a consistent approach and deal fairly with the offer and negotiation of rent in the MRO process.

2) When proposing and negotiating a MRO rent, the POB should act consistently with the principle of fair and lawful dealing in relation to their tied tenants, and in a way which will facilitate the tenant being able to meaningfully compare a tied and MRO operation for their business. This ability to make a comparison facilitates the principle that tied tenants should be no worse off than they would be if not subject to a tie. An offer being made on a clear basis, and the tied tenant being fully informed of the basis on which a POB has calculated their MRO rent offer, will assist in facilitating effective negotiations and avoid unnecessary delay.

3) The process for determination by an Independent Assessor of a market rent for the pub, where agreement cannot be reached as to the rent, adds time and cost to the MRO procedure. It is preferable for the parties to be able to reach agreement wherever possible. This supports the statutory aims and objectives of the Code.

4) Amendments to the Code in force since 1 April 2022 require the POB when making a MRO proposal to include alongside the proposed terms of a MRO tenancy, a statement of the proposed rent that would be payable under the MRO tenancy. They also create a single longer period of three months during which the parties can simultaneously negotiate the terms and the rent. The requirement to specify the rent has been introduced to encourage and enable the parties to negotiate the proposed rent alongside the terms. These changes therefore focus on improving the process before a formal dispute can be referred to the PCA on terms or the Independent Assessor as to the rent.

5) A duty is imposed on the tied tenant and POB to seek to agree the rent payable under the MRO tenancy. Consistent with the core principles of the Code, this duty requires the parties during the MRO procedure to conduct those negotiations in good faith.

Provision of information to support the rental offer:

6) The provision of clear and logical information to support the rent offer facilitates and supports the discharge of that duty by both parties. Demonstrating clearly how the rent offer has been calculated should ensure that the POB can show a logical rationale for its approach. The need to provide evidence of this at the start of the MRO process can support the POBs’ internal processes to ensure that its valuation staff provide a proposed rent which is commercially justifiable. As a consequence, the tied tenant is able to engage in negotiations early and effectively with an analysed rent offer and make a judgement on whether to accept the MRO offer or tied offer, to negotiate further, or to refer the rent to the Independent Assessor. In order to support this, the PCA expects that POBs should carefully consider whether to comply with Royal Institution of Chartered Surveyors guidance when preparing and presenting the MRO rent offer. Compliance with such guidance is, more often than not, likely to ensure good practice and failing to comply would require justification.

7) The provision of this information is likely to mean that the tied tenant will be better able to assess an analysed offer against its own trading and properly consider the MRO proposal and its own negotiating position. The informed tenant can have confidence in considering their right to the MRO option and make an effective choice about the tied or free of tie model for which the Code provides.

8) The PCA considers it desirable that there be consistent minimum standards of information provided by all POBs to all tied tenants. It is recognised that some POBs do provide a significant amount of information to their tied tenants, however it is important in the interests of those tenants that there be consistency and clarity across the industry to ensure that tenants know what they can expect and are able to access information regardless of their POB. Variations in practice, including provision of less than the minimum described in this guidance, would require justification by a POB taking that course.

Provision of comparables:

9) One element of the provision of such information would be for POBs to provide the tied tenant with details of any comparable evidence it has had specific regard to in calculating the MRO rent proposal and, where available, this should include any “profits based analysis” for those comparables, which it has used to support or inform the rent proposal. Such information would be a useful starting point for tied tenants to consider the offer and assist in their approach to any negotiations. POBs would not be required to disclose confidential information, such as any comparable tenant’s actual trading accounts. In compliance with the duty in regulation 32(A)(1) of the Code that the POB and tied tenant must seek to agree a MRO-compliant tenancy and rent payable for that tenancy, the POB should act reasonably when responding to any requests made by the tied tenant for further information about a MRO rent proposal. That duty would usually require the POB to give careful consideration to the provision of the information mentioned in this paragraph. An unjustified decision not to provide such information may amount to a breach of that duty.

Tenant’s improvements:

10) The key mechanism by which a tied tenant is able to judge whether they are no worse off is by comparing their existing tied deal with a free of tie arrangement (obtained through the MRO process) so as to decide which is best for their business. There is no express inclusion of any assumption in s.43(10) of the 2015 Act that improvements carried out by the tied tenant are to be disregarded when establishing the “Market Rent”. A tied rent arrived at on the basis of different assumptions and disregards, including the value of tenants’ improvements, considered alongside a MRO rent which does not include such assumptions, may risk not being a direct or useful comparison. In order to ensure that a tied tenant understands how a proposed MRO rent has been calculated and to enable them to understand or negotiate the proposed MRO rent, the PCA considers that the POB should be clear as to whether the MRO rent offer disregards the rental value relating to any tenant’s improvements and, if so, it should specify what those improvements are.

11) When making the MRO rent offer, normal commercial considerations apply, and the tied tenant and POB both have a duty to seek to agree the rent. When negotiating with an existing tenant there is no prohibition under the Code preventing the MRO rent offered from including a disregard for tenants’ improvements if this follows the POB’s normal commercial practice, nor preventing the parties from agreeing that such a disregard be incorporated into the MRO rent figure as part of negotiations.

12) As part of the information provided by a POB to an Independent Assessor under regulation 37 of the Code, the PCA expects that in most cases it will be likely that information about the approach to tenant’s improvements, including whether or not the POB considers that the Independent Assessor should disregard value attributable to any tenant’s improvements, will be information relevant to the Independent Assessor’s rent determination. As such, the PCA considers that this should be included when a POB is providing information to the Independent Assessor.

Minimum levels of information:

13) Based on the information provided by a POB, the tied tenant should be able to understand how the proposed MRO rental figure has been calculated, including the reason for any assumptions and disregards involved in the calculation. Where the information is reasonably available, the following reflects appropriate minimum levels of information to be provided by a POB when they make an offer of proposed rent to be paid on a MRO tenancy:

a) Any information or documents listed in Schedule 3 of the Code that the POB would be required to provide to an Independent Assessor as part of the Independent Assessor determination process;

b) A detailed profits valuation showing relevant heads of income (with associated gross profit ratios), staffing and other costs, allowance for tenant’s capital and tenant’s bid;

c) Barrelage assumptions in relation to wet turnover with an explanation where these materially differ from the actual barrelage figures;

d) An elemental breakdown of, and justification for, levels of any additional turnover such as food, rooms, gaming machines etc;

e) Details of the POB’s comparable evidence in accordance with the section in this guidance entitled “Provision of comparables” above.

f) Confirmation as to whether, in preparing the MRO rent proposal, the POB has valued the property in its existing state or whether it has disregarded the value of any tenant’s improvements and what those improvements are.

14) It would not be usual that the POB seeks information from the tied tenant at this stage. The POB is not required to obtain information from the tied tenant which the tenant may hold in order to provide information with the MRO rent proposal. The information provided by the POB should properly evidence and support the MRO rental calculation it has made in that case. It is not intended that there be a burden or requirement on the tied tenant to provide information to the POB beyond that which would be otherwise available to it. Any attempt to require burdensome information from a tenant would require compelling justification.

Removing uncertainty of potential financial barriers in the MRO procedure

15) Financial considerations are known to have the potential to hinder tenant access to the MRO option. Affordability of the cost of accessing MRO may be a key consideration for tenants. Costs often include the size of any rental deposits and when they are to be paid, the number of months’ rental payments that may be required in advance and the cost of any terminal dilapidations at the pub when the MRO proposal is offered by way of new tenancy.

16) Though flexibility is seen by some tied tenants with regard to such upfront costs, including within negotiations, the PCA considers that some consistency of approach between the POBs would be in the interests of simplicity and clarity for all tied tenants as to the accessibility of the MRO option.

17) When a tied tenant takes the MRO option they are entering into a commercial free of tie tenancy with the POB. That relationship is different to the one under the tie and different lease terms may be reasonable and appropriate. However, the MRO is a unique arrangement, whereby an existing tenant converts as of right to a free of tie agreement. This guidance aims to strike a balance between the desirability of removing actual or perceived barriers to MRO for tied tenants and the commercial considerations applying at the start of an arms-length negotiated free of tie tenancy.

18) One of the requirements for a tenancy to be MRO-compliant is that it does not contain any unreasonable terms or conditions. Where the issue arises the PCA (or arbitrator so appointed) is empowered to determine (and may be required to determine) when a MRO proposal is non-compliant because a tenant asserts that its terms or conditions are unreasonable. Reasonableness is to be considered in all the circumstances of the case both individually and in combination. In arbitration, it may well be that the person asserting a term or condition is unreasonable needs to show that it is. It is to be recalled that it is not just for tenants to raise these issues in arbitrations as the PCA has a duty to investigate and, where necessary, impose sanctions, in respect of breach of the Code, which includes the provision of unreasonable terms.

19) Each case referred to the PCA for arbitration will be considered on its own facts, however it is appropriate that the PCA sets out guidance on certain issues that may be taken into account when determining unreasonableness and which can result in a finding that a MRO proposal is non-compliant. The PCA may consider the same or similar issues as part of the exercise of her statutory regulatory powers to enforce the Code.

Incremental build up:

20) The High Court has made it clear that the starting point for a MRO lease is not necessarily the tied agreement ^{[footnote 1]}. However, the fact of the existing relationship between the parties may be of relevance when looking at the reasonableness of a MRO proposal. MRO is not the same as a negotiation on the open market and the PCA will take this into account where appropriate when exercising statutory functions such as determining an arbitration referral based on whether an offer is MRO-compliant.

21) Where the issue of whether a term or condition is unreasonable is raised in an arbitration, or where the issue arises for consideration during statutory enforcement of Pubs Code duties, this will be determined by the PCA or by the appointed arbitrator. When determining whether any term which proposes an increased deposit or a move to less frequent rental payments than under the tied tenancy is or is not unreasonable one circumstance which may well be taken into account is the extent to which the MRO lease provides for a transitional period during which such a requirement is “built up” from the existing position under the tied lease.

22) In this way, the PCA considers that whether a POB has given proper consideration to offering such a period of transition in respect of an increased deposit or less frequent rental payments will be a relevant factor in assessing the reasonableness of the MRO offer. This consideration should take into account the existing landlord and tenant relationship between the POB and tied tenant and the amount of the additional sums involved. The PCA expects that in most cases POBs should offer some period of build-up. A decision to offer no transitional period at all may lead to a finding that a term or condition is unreasonable, and any decision to offer no transitional period would need to be properly justified by the POB to explain how Code compliance has been achieved in the absence of this.

23) The PCA considers it likely that it will be not unreasonable for any transitional period offered to be personal to the individual tied tenant in each case, for example, by way of a “side letter”.

24) The PCA expects that a transitional period offered should be meaningful in the context of the amounts involved. As an example of a minimum period, a year would be considered normal and sufficient in most cases. However, a shorter or no transitional period may be appropriate where the amount of deposit or rent in advance to be built up is reasonably considered small or negligible, and longer may occasionally be appropriate.

25) The PCA expects that a POB will keep records of its reasoning for offering a certain transitional period in any case. This will form part of the record (the Compliance Checklist) which must be completed by the Code Compliance Officer when they are preparing a MRO proposal, and will be available to the tied tenant, and/or the PCA, on request. If a POB considers that in all the circumstances and in accordance with any policy it is not appropriate to offer or agree a transitional period with an individual tied tenant, the reasons for this should be clearly recorded.

26) The POB should make it clear early in the MRO procedure, and where possible no later than at the point of making the initial MRO rent offer, what transitional period in respect of an increased deposit or less frequent rental payments it will offer to the tied tenant. The POB should be open to negotiation with the tied tenant about this offer as part of overall negotiations, consistent with its duty to seek to agree a tenancy or licence that is MRO-compliant and the rent payable for that occupation.

Obligations in respect of pub condition:

27) The costs of terminal dilapidations, where the MRO is offered by way of new tenancy, have the potential to hinder a tenant’s access to MRO. The PCA considers it is beneficial for there to be a level of consistency across the tied industry in the approach to dilapidations where they interact with the MRO process. If what tied tenants can expect in the MRO process is simple, clear and consistent, they are more likely to understand it to be fair, and it is more likely to give tied tenants confidence in using the process.

28) The Code supports the expectation that as a matter of good estate management the condition of the premises will be managed effectively throughout the tied tenancy and makes provision for a schedule of condition to be updated and reviewed at appropriate points in the tenancy. The existing tied tenancy will contain rights for a landlord to deal with issues relating to the condition of the premises, and the landlord will also have rights under any MRO tenancy that may be entered into. Where the tied tenant is to remain in continuing occupation of the previously tied premises under a MRO compliant tenancy following the MRO procedure there should therefore be contractual rights for the landlord to enforce dilapidations, compliance and repairs issues. If a POB requires the completion of terminal dilapidations or completion of compliance issues as a condition of a MRO tenancy, the PCA considers this may result in a finding of an unreasonable term or condition. Such an approach will require specific justification as to why it has been taken in an individual case and how Code-compliance has been considered and implemented by the POB. Such a justification might, for example, include, a situation where the POB is forced to require dilapidations to be addressed as otherwise a real risk of the POB becoming in breach of any covenant, duty under contract, breach of the criminal law or liability for any statutory penalty might arise.

29) Given the above, the preparation of schedules of dilapidations will usually be avoided, along with the delay which this might cause. Where, however, a schedule of dilapidations is served, the POB should ensure it does not cause charges to be imposed on the tenant, merely because they have sought a compliant MRO proposal (such as a charge for an inspection of condition on receipt of a MRO notice) which will be payable even if they decide to remain tied. This does not affect the right to serve a terminal schedule of dilapidations where it would otherwise be usual practice at the end of the term or otherwise is facilitated under the terms of the lease.

30) The PCA expects that POBs will adopt a consistent and predictable approach to dilapidations following the request for a MRO option, so that tied tenants know what they can expect. Details of the POB’s approach should be available to all tied tenants.

Regulation 50 and decisions at renewal in respect of the Landlord and Tenant Act 1954

31) Regulation 50 of the Code requires that the POB must not subject a tied tenant to any detriment on the ground that the tenant exercises, or attempts to exercise, any right under the Code. This duty would likely be breached if, as a result of the tied tenant attempting to exercise a right under the Code (such as serving a MRO notice), or discussions between the tenant and Business Development Manager (“BDM”) preparatory to exercising any Code right, the POB made a decision to oppose a lease renewal which it would not otherwise have made had the tied tenant not exercised (or proposed to exercise) its Code right. Regulation 41(1)(c) of the Code requires a POB to ensure that its BDM deals with tied tenants in a manner that is consistent with the principle of fair and lawful dealing.

32) In any investigation or arbitration which involves allegations of a POB subjecting a tied tenant to detriment on the ground that they exercised or attempted to exercise a Code right, the PCA expects the POB to be able to evidence its position and the reasons for decisions having been made which are compliant with the Code. Where a POB does not have appropriate, contemporaneous records of a decision to take back premises into management or otherwise oppose lease renewal, the PCA is likely to take that into account in the exercise of regulatory functions, including when determining why such a decision was made when considering whether it was connected to a tied tenant’s attempts to exercise a right under the Code. Discussions between a BDM and tied tenant should be consistent with these recorded decisions. Where they are not, or where decisions or discussions (consistent with regulation 41(4)(a)) are not recorded, the PCA may be more likely to draw an adverse inference in respect of compliance with the duty under regulation 41(1)(c).

1. Ei Group PLC v (1) John Clarke & (2) Lesley Minnett [2020] EWHC 1858 (Ch) ↩