Limiting competition can be advantageous for businesses. Competitors are prevented from entering the same geographical area and offering identical products and services. This assurance encourages businesses to invest confidently in their retail spaces, benefitting not only themselves but also surrounding businesses and landlords.
Exclusive use covenants, or competitor property controls, are tools for limiting competition. While sometimes beneficial and warranted, overbroad exclusives, especially in the grocery retail industry, can stifle innovation and lead to higher prices and limited convenience. These concerns prompted amendments to the Competition Act (“Act”), which all commercial lease parties, not just grocery stores, should endeavour to understand and appreciate.
The recent amendments, effective December 15, 2024, target Section 90.1 of the Act, including the repeal of the efficiency justification and expanding the Competition Tribunal’s (the “Tribunal”) powers to deem agreements anti-competitive if they aim to limit competition significantly. Ahead of these changes, the Competition Bureau (the “Bureau”) solicited public comments on its enforcement approach for two (2) months with a particular focus on addressing broad competitor property controls. Note that while the amendments to the Act are established as law, the enforcement framework itself is not. The Bureau is not obligated to adhere to the approach outlined in the framework for future enforcement proceedings.
Competitor Property Controls
Competitor property controls restrict commercial real estate use now and in the future. The Bureau’s enforcement framework addresses two (2) forms of control – exclusive use covenants and restrictive covenants.
1. Exclusive Use Covenants
Exclusive use covenants limit how land may be used by competitors of an existing tenant. They can take various forms, such as prohibiting a landlord from leasing a property to a prospective competitive tenant or preventing that prospective tenant from selling certain products. The primary benefit of providing exclusive covenants to tenants is to foster a stable business environment where key tenants feel secure enough to invest significantly in their premises.
2. Restrictive Covenants
Restrictive covenants are restrictions on land that apply to future purchasers, owners, and tenants, ensuring previous tenants’ businesses do not face new competition on the same property. Restrictive covenants are particularly beneficial for businesses with long-standing presence in an area. For example, a grocery retailer might include a restrictive covenant in their lease to prevent future grocery retailers from occupying the same property. This ensures that no new competitors can capitalize on the reputation and customer base that the original retailer has amassed over time.
Justifying Competitor Property Controls
The Bureau seeks to prevent broad competitor property controls, favouring justifications that enhance competition.
Exclusive use covenants can be justified if they encourage significant business investments or entry into new markets. For example, the owners of a small family Italian restaurant may hesitate to invest heavily in their space absent being granted an exclusive covenant regarding serving Italian food as their primary use, potentially leaving their retail space underutilized.
Restrictive covenants, on the other hand, being long-term in nature, restrict future property uses, which can have lasting impacts on market dynamics. The Bureau has said that restrictive covenants are justifiable only in exceptional circumstances. The Bureau has yet to clarify what constitutes an exceptional circumstance, so it remains to be seen how strictly these covenants will be scrutinized.
The Bureau provides four (4) guiding questions for evaluating property controls:
- Is the control necessary to enable market entry or new investments?
- Can the control be shorter in duration?
- Can it cover fewer products or services?
- Can it cover a smaller geographic area?
Above all, as part of the enforcement framework, the Bureau emphasizes that the duration and scope of the covenant are critical factors in assessing their justification. Even narrowly tailored controls must be carefully evaluated to ensure they are justified. A business using broad language to describe covered products might face issues. For example, an exclusive use covenant barring other tenants from selling “coffee and related products” could be deemed too broad, as it might inadvertently affect restaurants, bars, and convenience stores.
Enforcement Provisions for Offending Controls
Abuse of Dominance: The Bureau can address offending covenants by relying on two (2) sets of enforcement provisions: Sections 78 and 79 of the Act, which impact anti-competitive behaviours by dominant market players. Anti-competitive conduct must be intentionally exclusionary, predatory, or disciplinary, creating or increasing market power for the benefiting tenant. Factors such as the ability to restrict competitors, barriers to market entry, bargaining leverage, and the scope of the covenant are considered to determine dominance. The Tribunal can order remedies including ending the conduct and imposing monetary penalties to restore competition.
Anti-Competitive Business Practices: The Bureau may also rely on the anti-competitive business practices provision under Section 90.1 of the Act. This provision empowers the Tribunal to address competitor property controls and impose penalties for violations. When determining whether a practice is anti-competitive, the Tribunal considers the intent, foreseeable consequences, and the duration and scope of the covenant. The Tribunal can also consider agreements between non-competitors if they significantly aim to limit competition. The Bureau expects that with these amendments, Section 90.1 will expand the Tribunal’s authority to address competitor property controls. This will apply to agreements made within the past three (3) years and will impose substantial penalties.
Challenges and Considerations with the Amendments
While competitor property controls like exclusive use covenants and restrictive covenants are important tools, the Bureau’s framework omits discussion of exclusives related to the character of an area. Character exclusives, which limit businesses based on their impact on the area’s character, are also crucial. For instance, maintaining an upscale environment might preclude businesses like bars and arcades, which could alter the area’s character. This oversight suggests a need for more comprehensive guidelines.
Radius clauses are another notable exclusion. These clauses prohibit a tenant from operating another business within a certain geographic range, preventing competition that could cannibalize sales from the same operator’s other locations. However, this clause is primarily designed to benefit the landlord. For example, if a coffee shop tenant opens a second location in close proximity to the original location, the original location may lose customers to the new one for a variety of reasons. Consequently, landlords, particularly those who receive a percentage of sales in addition to rent, will incur losses due to the competition between the two locations. Like exclusive use covenants, radius clauses play a significant role in maintaining a stable business environment but are not addressed in the current amendments.
News and Takeaways
In response to the Bureau’s proposed enforcement framework, Loblaws has publicly committed to eliminating exclusives from their lease agreements, contingent on its competitors doing the same. While this commitment might not result in significant change due to the unlikely agreement among competitors, it highlights the shifting landscape of commercial leasing. Even still, if all grocery retailers agreed to remove exclusives from their leases, we could actually see a decrease in competition. It’s possible that larger grocery stores may seize such an opportunity to enter spaces and draw customers away from smaller grocery retailers who previously had the benefit of exclusive covenants.
Currently, the Bureau’s enforcement approach remains uncertain and there’s no definitive answer as to what covenants will be held to be enforceable and whether businesses can enter spaces where these covenants may not be upheld. Landlords may be hesitant in allowing new tenants entry into properties in potential breach of existing covenants in order to preserve their existing business relationships and reputation. Conversely, tenants may be hesitant to enter such properties as well with fear of potential litigation looming. While there is still some uncertainty, the Competition Commissioner Matthew Boswell recently commented on the Bureau’s enforcement approach in light of the new amendments.
The Commissioner noted that the amendments would contribute to the Bureau becoming a more “aggressive and active enforcer” and outlined the key aspects of the Bureau’s new enforcement approach. The Commissioner noted that there will be greater enforcement action, allowing both private parties and public-interest groups to bring actions and that there will be wider application to prevent anti-competitive conduct from “slipping through the cracks.” The Commissioner anticipates that investigations will be conducted faster, with a focus on common sense determinations, and that these investigations will be accompanied by more significant penalties. While there is no reference to competitor property controls or exclusives, the Commissioner’s comments will apply.
So should exclusive and restrictive covenants be included in new lease agreements? While generally enforceable, it is crucial to draft them carefully in line with the Bureau’s recommendations to avoid potential unenforceability. Below are some suggestions for crafting these covenants to mitigate risk and liability given the current uncertainties:
Suggestions
- Incorporate temporal and geographic restrictions. For instance, a business may restrict the covenant to prohibit the sale of a certain product within a five (5) kilometre radius for the next five (5) years. The specific time frame and geographic area should be tailored to the business and surrounding environment, with a preference for narrower constraints.
- Clearly specify the covenant’s subject matter. For example, prohibiting other tenants from selling coffee and related products in shopping centers may be found to be unreasonable. In contrast, restricting the sale of a particular item, such as an almond croissant, maybe more justifiable.
- Focus on direct competitors. A coffee shop preventing restaurants and convenience stores from selling coffee may be found to be overly broad since these establishments may sell coffee as a secondary product. Instead, it may be more effective to focus on competitors directly aligned with the tenant’s business, such as other coffee shops.
- Landlords only – Indemnity. In conjunction with any covenants, landlords should incorporate provisions that indemnify them against potential liabilities arising from the enforcement of an offending covenant or the failure to enforce a justified one. An indemnity clause safeguards the landlord should they enforce a covenant deemed an offence under the Act. This provision should explicitly state that the landlord is not required to enforce any covenant if it constitutes a legal breach or an offence under the Act, and the tenant will indemnify the landlord for any liabilities resulting from such enforcement. Sample clause below:
“It is further understood that the Landlord is not obligated to enforce the aforementioned covenant against any person if by so doing it shall be in breach of any laws, rules or regulations from time to time in force, and no provision of this Lease is intended to apply or to be enforceable to the extent that it would give rise to any offence under the Competition Act (Canada), or any statute that may be substituted therefor, as from time to time amended. Provided that the Tenant requested the aforementioned covenant, the Tenant shall indemnify and hold the Landlord harmless from any loss, injury or damage suffered by the Landlord as a result of breaching any such legislation as aforesaid, including all expenses incurred in connection with any claims, actions or proceedings brought with respect thereto, whether of a criminal or civil nature, and will reimburse the Landlord for any and all costs or expenses incurred in connection with any enforcement of this covenant by the Landlord, including legal fees on a full indemnity basis.”
- Landlords only – Defence. If the landlord chooses not to enforce a covenant believing it to be unjustifiable, and it is later determined to be justified, then the landlord may be liable for breach of contract due to failure to fulfill its obligations. Consequently, we recommend including language in the lease regarding the landlord’s belief that enforcing such a covenant would have led to a breach of the law. Sample clause below:
“The Landlord will not be liable for loss, injury, or damage suffered by the Tenant where the Landlord has not enforced the covenant as set out in Section [*] on the basis of their bona fide belief that doing so would be in breach of any laws, rules or regulations from time to time in force or would give rise to any offence under the Competition Act (Canada), or any statute that may be substituted therefor, as from time to time amended where the aforementioned covenant does not constitute a breach of any laws, rules, regulations, and does not give rise to an offence under the Competition Act (Canada) or any other statute.”
- Tenants only – Rent Abatement/Termination. A tenant should try to include language in their lease providing for rent abatements (or event termination rights) in situations where the landlord fails to uphold or enforce a covenant. The amount and duration of an abatement may vary in accordance with the importance of the covenant breached, and the tenant, property, and amount of rent in question.
If you have any questions on the above, please contact Alex C. Kolandjian and Aida Nabavi for assistance.
This publication is intended for general information purposes only and should not be relied upon as legal advice.
