The Supreme Court Examines Restraint of Trade Clauses in Leases

Peter Robinson, partner at Hunters Law, analyses what this case could portend for property holders.

The Supreme Court rarely overturns decisions made by itself and its predecessor. But in Peninsula Securities Limited v Dunnes Stores (Bangor) Limited [2020] UKSC 36, it did just that, upholding the validity of restrictive covenants in longstanding commercial leases. For property investors in a difficult market, this may have an impact.

The case concerned a covenant in the lease of a substantial unit on a Derry retail park, granted in 1981 by Mr Shortall to Peninsula. The covenant stated: “… 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.”

Described by the developer as an “economic and political wasteland”, the retail park had Dunnes Stores as an “anchor tenant” which helped attract smaller retailers to take leases there. Peninsula believed that the restrictive covenant had caused decline. To remedy this, it sought a declaration from the Northern Ireland equivalent of the Upper Tribunal that the covenant:

• represented an impediment to the enjoyment of its land;
• was unenforceable;
• 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 it;
• engaged the doctrine against restraint of trade and was unenforceable unless the terms of the covenant were reasonable.

The High Court in Northern Ireland decided that the doctrine was not engaged. The Court of Appeal then reversed the decision because the doctrine remained engaged on Peninsula acquiring title from Mr Shortall. Dunnes appealed to the Supreme Court.

The law rested on the House of Lords decision in Esso Petroleum Limited v Harper’s Garage (Stourport) Ltd [1968] – 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. Although Mr Shortall had held the title to the land subject to the covenant, it was agreed that the covenant had engaged the doctrine. The key question was whether or not Peninsula’s ownership still engaged it.

The pre-existing freedom test was introduced by Lord Reid in Esso to distinguish between a covenant which restricted trading from a property, and engaged the doctrine, and one which did not. As he 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.”

Although Mr Shortall had held the title to the land subject to the covenant, it was agreed that the covenant had engaged the doctrine.

However, the House of Lords in Esso 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. In public policy terms, 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. The Supreme Court therefore concluded that the pre-existing freedom – as a test for whether the doctrine was engaged – should be overruled.

The Peninsula decision overruled only that part of Esso which imposed the test. In Esso, Lord Wilberforce proposed an alternative “trading society test” in deciding whether the doctrine was engaged: “…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 appeared no more defensible: it seemed to concede that the law follows where many might expect it to lead. Nevertheless, it deserved to be retained. With Denning-like phrasing, he posed the question: “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 the patchwork nature of the Common Law, reflecting the importance attached to freedom to trade and, conversely, to the enforceability of contracts in the interests of trade. The former generates the doctrine and the latter helps keep it within bounds. The Wilberforce test further recognised that societal changes might precipitate changes in public policy which would require re-examination of whether a type of covenant should continue to engage the doctrine.

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

With what Lord Wilson described as “appropriate hesitation”, the Supreme Court departed from the existing freedom test, and from a previous decision, where “too rigid an adherence to precedent may lead to injustice in a particular case and unduly restrict the proper development of the law.”

The objections were: 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”.

Across the common law world, it had long been accepted that a shopping centre lease may include restrictive covenants on the lessor in relation to the use of other parts of the centre. There were no grounds considering that societal 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, Dunnes’ appeal was allowed and Peninsula’s claim dismissed.

The 1966 Practice Statement (which permitted the House of Lords to depart from one if its previous decisions that it would have otherwise been bound to follow) also said of when it should be invoked: “[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 pursuant to the Practice Statement. The awkward distinction in the pre-existing freedom test seems to justify overruling it in this case.

Covenants similar to those in the Dunnes’ lease commonly occur in leases granted to anchor tenants of 1970’s/80s town centre and retail park developments, typically granted on 50 year+ terms. Had Peninsula’s appeal been upheld, landlords might have been able to free themselves from these covenants’ potentially harmful effects. This might have helped to revive retail portfolios, but until it is decided that current circumstances require reconsideration under the trading society test, by engaging the doctrine, that will not happen.