Restrictive covenants in leases and restraint of trade – The Supreme Court’s change of mind

September 3, 2020

A version of this article appeared in the October 2020 issue of PLC Magazine. You can view this version on their website here.

By Andrew Vinson

It is not uncommon for lawyers to be asked to advise on restrictive covenants affecting land in the context of the use to which that land can be put. In the context of leases this often takes the form of a covenant which might be argued to restrain trade, often in the context of the management of retail developments.

In the recent case of Peninsula Securities Ltd v Dunnes Stores (Bangor) Ltd [2020] UKSC 36 (“Peninsula”), the Supreme Court has revisited this issue and departed from the previous approach the House of Lords set down in Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd [1968] AC 269 (“Esso”). This is a significant change which is of importance to practitioner’s in this area who will be familiar with the Esso test and the vagaries that it threw up, particularly in relation to leases which had been assigned.

The majority decision in Esso had been the subject of much criticism since shortly after it was decided. Put simply, the House of Lords stated that the question of whether a restrictive covenant is a restraint of trade or not was to be approached by applying what has come to be known as the “pre-existing freedom test”. That meant that the question to be asked in considering whether the doctrine of restraint of trade was engaged was whether the covenantor was surrendering a right or freedom he or she previously had. If there was such a pre-existing freedom then the doctrine was engaged. If there was not such a freedom, it was not.

In Peninsula, the Supreme Court had the opportunity to reconsider Esso and the public policy that was engaged. It has determined that the pre-existing freedom test no longer has application as public policy cannot justify a distinction based upon those with pre-existing freedoms and those without. It has favoured the minority view of Lord Wilberforce in Esso, to the effect that the test now to be applied in such circumstances is one of a “trading society”. Such covenants restricting the use of the demised property in leases are to be viewed in the context of practice and needs of a trading society. The balance has to be struck between the freedom to trade and the enforceability of contracts in the interests of trade. The Supreme Court has noted that this is intended to be a broad and flexible doctrine with the aim of allowing the common law to be applied concomitantly flexibly in such situations.

In Peninsula, the issue was whether a covenant which prevented the construction of a substantial shop within a development in competition with an existing retailer offended the doctrine of restraint of trade. The Supreme Court had no difficulty determining that it did not in applying the trading society test. Such covenants were well established within trading society in relation to shopping centres.

This change in approach is substantial and, although it may allow for greater variation in decisions and increased ambiguity for lawyers in providing advice to clients it will, at least, provide for greater flexibility in decision making to reflect particular circumstances rather than the application of a previous policy which was increasingly hard to justify.