Scottish Pubs Code and related regulations: business and regulatory impact assessment

4. Options

Sectors and groups affected by the Scottish Pubs Code and related regulations

4.1. In this BRIA, the impact(s) of various requirements of the Scottish Pubs Code and related regulations are considered for two main groups in detail: pub-owning businesses (landlords) and pub tenants that are in a tied pub contract. Further impacts are also considered on other groups such as consumers, beer producers, surveyors and public sector actors such as the Scottish Courts and Tribunals Service (SCTS). There is no anticipated impact on local authorities or organisations in the third sector. The impacts of each option are set out in the costs and benefits paragraphs 4.22 to 4.86.

4.2. Under the Act, the Scottish Pubs Code must include certain requirements. The two requirements with the largest impact(s), as assessed in this BRIA, are:

• MRO leases – the landlord must, in certain circumstances, offer a tenant a lease, which does not include any product or service ties.
• Guest beer agreements – the landlord must, in certain circumstances, offer a guest beer agreement (allowing the tenant to buy and sell a beer outside of the tie).

4.3. In the BRIA we have also assessed the proposals on rent reviews/assessments, for although these are not required by the Act, they could have a significant impact on the sector, depending on the option selected:

• Rent reviews – rent reviews typically occur as per the terms of existing contracts between tenants and pub-owning businesses. Under the code, the landlord must allow for a rent review if there is more than 12 months left on a lease and a rent review has not been requested or a rent assessment has not been carried out in the past 5 years.

4.4. The code, if passed, will also clarify certain technical functions of the Scottish Pubs Code Adjudicator, including specifying the level of potential financial penalties for breaches to the code, the level of fees for bringing cases to the Adjudicator, and rules around arbitration, including Adjudicator expenses. This BRIA considers options to deliver these aspects of the code and the functions of the Adjudicator and identifies impacts to different groups.

4.5. This BRIA primarily considers first round effects of the regulations on different sectors and groups; however, it is recognised that there may be indirect second round effects arising from the implementation of certain elements of the code. This BRIA considers potential second round effects to the various options set out.

Options

4.6. The options set out in this BRIA are grouped into two parts. The first part relates to three specific features of the code as set out in the regulations - MRO leases (A), guest beer agreements (B) and rent reviews/rent assessments (C) - with three or four options considered under each of the three features which may have substantial impacts on groups such as pub-owning businesses and tenants.

4.7. The second part considers a more technical set of options with respect to financial penalties (D), fees (E) and expenses (F), and arbitration rules (G). A summary of the options in these two parts is provided in Table 1 and Table 2. The options preferred by the Scottish Government are highlighted in blue. The various impacts of these options are considered in the costs and benefits paragraphs 4.87 to 4.97.

4.8. It is standard practice that costs and benefits of policy options in a BRIA are compared to a ‘do nothing’ or status quo baseline. However, it is also the case that all options examined must be genuine policy options. As it is already a requirement under the Act, as agreed by the Parliament, for the code to require pub-owning businesses to offer MRO leases and to offer to enter into a guest beer agreement in certain circumstances, a do-nothing option for these aspects of the code would not be genuine policy options. To avoid any confusion arising from this point, a do-nothing option is not considered in this case.

4.9. It should be noted that currently a voluntary code of practice exists in the pub sector for pub-owning businesses and tenants. However, this voluntary code has been found to be ineffective in delivering the objectives as set out in this BRIA. The voluntary code has not been signed by all pub-owning businesses and the Scottish Parliament’s Economy, Jobs and Fair Work Committee found that awareness of the voluntary code was low amongst tenants^[18]. Doing nothing would not satisfy the requirements of the Act and would also prevent the Scottish Government from achieving its aims through the Scottish Pubs Code, to improve the position of tied pub tenants through creating a statutory framework to govern the relationship between pub-owning businesses and their tied pub tenants. Tied pub tenants in Scotland would also have fewer opportunities than tenants in England and Wales as they could not require their pub-owning business to offer an MRO lease which is currently available to tenants in England and Wales under their statutory Pubs Code.

4.10. Pub-owning businesses will be required to operate in a regulated environment under a statutory code, which will benefit all parties through providing consistency across the sector as a whole and reducing ambiguity about what is expected from pub-owning businesses that operate under the tied pub model. We recognise that intervention in tied lease agreements should only be carried out where necessary to bolster a sector for the benefit of the wider community, and the selection of the preferred options has been focused on finding a fair balance between the rights of the different parties.

Scottish Pubs Code

4.11. MRO Leases (A): the code will require pub-owning businesses to offer MRO leases in certain circumstances when requested by tenants. An MRO lease is a lease which is free of ties and does not contain any unreasonable terms. MRO leases support the sector as a whole by providing a clear route for tied pub tenants to become free of tie and clarity for both parties about when that can occur. The MRO lease requirement is one of the main ways that a tenant can establish that they are not worse off than they would be if they did not have any ties and ensure a fair share of risk and reward, particularly for experienced tenants. The options considered in the BRIA for MRO leases are set out in Table 1. It is already a requirement under the Act, as agreed by the Parliament, for the code to require pub-owning businesses to offer MRO leases and therefore there is no ‘do nothing option’ considered. The Scottish Government’s preferred approach is Option 3 (see Table 1).

4.12. Guest beer agreements (B): the code will require businesses to offer a guest beer agreement in certain circumstances when requested by tenants. A guest beer agreement allows a tenant to sell to their customers at least one beer that the tenant has chosen, at a price of the tenant's choice. The beer can be changed as often as the tenant wishes as long as it meets the requirements set out in the code. The options considered in this BRIA for guest beer agreements are set out in Table 1. It is already a requirement under the Act to require pub-owning businesses to offer to enter into a guest beer agreement in certain circumstances therefore there is no ‘do nothing option’. The Scottish Government’s preferred approach is Option 2.

4.13. Through guest beer agreements and being able to sell at least one guest beer, tenants may have more autonomy to shape their business in response to customer demands locally, which may deliver better customer choice and increased profits for the tenant. Indirectly, it may potentially support brewers, which would in turn support the wider community of tied pubs and brewers. It was recognised in the consultation that some pub-owning businesses already permit tenants to stock some non-tied beers, in which case a guest beer agreement provision in the code could have limited impact on current business practice.

4.14. Rent reviews/rent assessments (C): a rent review is a mechanism by which the ‘dry’ rent paid by the tied pub tenant to the pub-owning business is re-evaluated and potentially adjusted. The purpose of the process is to ensure that the rent paid by the tied pub is fair and reflects market conditions. The rent review can be influenced by various factors such as changes in market conditions, the pub’s performance, and any investment made by either party.

4.15. Rent reviews typically occur as per the terms of existing contracts between tenants and pub-owning businesses. Rent assessments are normally initiated only by pub-owning businesses. As part of the code, a pub-owning business may be required to give the tenant a rent assessment statement as part of a rent review process either within their contract or when appropriate within the code. The code sets out what information must be provided and what must be included in a rent assessment statement. Most of this is similar to the voluntary code and the English and Welsh Pubs Code. It includes additional requirements, such as basing profit and loss estimates on actual costs relevant to the pub or if not available, to a comparable pub in the vicinity. Option 1 would not place requirements or restrictions on pub-owning businesses in relation to rent reviews and assessment and is an available option under the Act. The Scottish Government’s preferred approach is Option 3.

4.16. Insights from stakeholder engagements show that there is a level of information asymmetry in the industry, with tenants calling for increased transparency around the process of determining rent. Obligating the pub-owning businesses to provide the tenant with a rent assessment statement is expected to close some of the gaps in information disclosure and support greater transparency around the process, as the statement discloses all the matters that have been relied upon to determine the rent. This increased level of information is expected to increase a tenant’s bargaining power and codify best practice. It will help pub-owning businesses by having more informed tenants and manage their expectations. By enabling tenants to be more informed about the costs of running tied pubs and current market conditions this could improve tenant’s management of their pub and thereby potentially deliver benefits to consumers, local community and the wider supply chain.

Table 1: Overview of Scottish Pubs Code Options considered in the BRIA

MRO (MRO) leases (A)

Option 1: Do Nothing: Not applicable*

Option 2: Minimal Code: MRO leases are only to be offered as part of new leases and no unreasonable terms are specified.

Option 3: Limited Code: An MRO lease must be offered to tenants if requested, except where investment by pub-owning businesses meets or exceeds an exemption threshold, or where an exemption applies Unreasonable terms would be specified.

Option 4: Maximum Code: MRO leases must be offered to tenants if requested, regardless of circumstance. Unreasonable terms would be specified. No exemptions apply.

Guest beer agreements (B)

Option 1: Do Nothing: Not applicable*

Option 2: Minimal Code: A guest beer agreement must be offered but only in relation to beer with a production level under 5,000 hectolitres.

Option 3: Limited Code: A guest beer agreement must be offered but only in relation to beer with a production level up to 100,000 hectolitres^[19].

Option 4: Maximum Code: A guest beer agreement must be offered on any types of beer, regardless of production level or other circumstances.

Rent reviews or rent assessments (C)

Option 1: Do Nothing: Rent reviews occur as per the terms of an existing contract and are normally initiated only by pub-owning businesses.

Option 2: Minimal Code: Reviews only occur when the landlord is proposing a rent change (excluding indexation).

Option 3: Limited Code: Reviews only occur when the lease does not include a rent review mechanism. The rent review could only be requested in certain circumstances e.g., lease is longer than 1 year and only if a rent review has not been requested within the past 5 years. No rent review for material circumstance change.

Option 4: Maximum Code: Reviews occur every 5 years or when material circumstances change, regardless of whether they have a contractual rent review clause or not.

*A do-nothing option is not possible under the Act for the MRO lease and Guest Beer Arrangement, hence these are not considered. Options highlighted in blue are Scottish Government preferred options.

Financial Penalties, Fees, Expenses and Arbitration Rules

4.17. Financial penalties (D): the Act already provides for the Adjudicator to take action, including by imposing a financial penalty, if a pub-owning business fails to comply with the Scottish Pubs code. The Act also requires Scottish Ministers to define the permitted maximum penalty either by specifying it as an amount or by setting out a methodology by which it is to be determined. A do-nothing option is therefore not a genuine policy option. The Scottish Government’s preferred approach is Option 3 (see Table 2). The rationale for this is set out under Costs and Benefits.

4.18. Fees (E): the Act requires Scottish Ministers to set out arrangements for a fee to be made by tenants to the arbitrator when submitting a dispute for arbitration under the code. A do-nothing option is not a genuine option as the legislation requires a fee.

4.19. Expenses (F): the Act requires that the Scottish Ministers must make regulations to require tied pub tenants to pay a fee to the Adjudicator in situations where the Adjudicator, or a person appointed by the Adjudicator, is the arbitrator because of a referral or request made by the tenant. Option 1 is the preferred Scottish Government option and would not require tenants to be liable in some cases, under the terms of section 17(4) to (6) of the Act, for reasonable fees and expenses in relation to an arbitration. Instead, under this option, the matter of expenses will rely on the discretion already provided to the Adjudicator.

4.20. Arbitration (G): the Act requires the Adjudicator to act as arbitrator, or appoint another person to do so, if there is a dispute between a tied pub tenant and a pub-owning business about whether the business has complied with the code. Option 1 would mean it would be up to the Adjudicator to conduct arbitration either in line with rules issued by the Chartered Institute of Arbitrators (CIARb) or the rules of another dispute resolution body. The Scottish Government’s preferred option is to enable the Scottish Arbitration Rules and processes set out in the Arbitration (Scotland) Act 2010 to allow the Adjudicator to determine whether to apply these, the CIARb rules or those of another dispute resolution body to cases brought to the Adjudicator.

Table 2: Overview of Financial Penalties, Fees, Expenses and Arbitration Rules options considered in the BRIA

Financial penalties (D)

Option 1: Do Nothing: Not applicable*

Option 2: The permitted maximum would be defined as a specific figure.

Option 3: The permitted maximum would be defined as a percentage of annual turnover, intended to be 1%.

Fees (E)

Option 1: Do Nothing: Not applicable*

Option 2: A nominal fee of £10, fulfilling the requirement for Scottish Ministers to provide for a fee to be paid.

Option 3: A set fee of £250 would be payable by a tenant when submitting a dispute for arbitration under the code.

Expenses (F)

Option 1: Do Nothing: Do not require tenants to be liable in some cases for reasonable fees and expenses in relation to an arbitration. Rely on discretionary rules.

Option 2: Specify circumstances when a tenant is required to make a payment to the Adjudicator in respect of the expenses of an arbitration.

Option 3: Not applicable

Arbitration Rules (G)

Option 1: Do Nothing: The Adjudicator can use the CIARb arbitration rules or those of another dispute resolution body to arbitrations.

Option 2: The Arbitration (Scotland) Act 2010 would be treated as if it were commenced for the purposes of statutory arbitrations under the Tied Pubs (Scotland) Act 2021, allowing the Adjudicator to apply these, or the CIARb or rules of another dispute resolution body to arbitrations.

Option 3: Not applicable

*Options highlighted in grey are not genuine options under the Act. Options highlighted in blue are Scottish Government preferred options.

Costs and Benefits of Market Only Leases (A)

Costs and Benefits to Tenants

4.22. Option 2 – Minimal Code would allow for tenants of new leases (after the code comes into effect) to request, and subsequently shift onto, an MRO lease. The expected impact upon tenants of making this transition would be for them to benefit from the ability to source formerly tied products independently and do so at a lower cost, relative to when ‘tied’. In realising these benefits, it is also expected that in moving onto an MRO lease, benefits would be offset (to some degree) by the tenant incurring additional costs as they forego discounted property rent, and goods and services offered as a part of the ‘tie’ by the pub-owning business (sometimes referred to as SCORFA^[20]). Whilst the tenant will have the opportunity to retain more profit out with a tie, the tenant will also take on more risk under an MRO lease.

4.23. In the analysis of costs and benefits it is supposed that risk-averse tenants, who may view the tied contract as preferable to an MRO lease under conditions of uncertainty with respect to future sales of beer, will not choose an MRO lease and will continue in a tied contract. It would of course be possible that some tenants could be worse off after moving to an MRO lease, if the change in the lease was combined with lower-than-expected future beer sales. For the purpose of this BRIA, it is assumed that there is similar future demand for beer under all options considered, as market fluctuations in beer demand would not be a direct result of a chosen policy option in the context.

4.24. In engaging with industry and stakeholders, the scale of these costs and benefits (as well as the net position) are highly varied, situation-specific and their value can be highly subjective. As such, it is estimated that the illustrative net annual benefit for an individual tenant would range from £0 to £23,800 per year. Taking these figures and multiplying by the estimated 700 (assuming, in the upper bound, that all tied pubs move over to an MRO lease) tied pub tenants within Scotland (assuming no change in the number of tied pubs), gives an estimated transfer of profits of between £0 and £16.7 million per year (the upper bound reflecting a situation where all tied pubs move over to an MRO lease), with the true figure likely falling in this range. This estimate presumes market conditions remain broadly similar. Further details on the costs and benefit estimates and relevant sources, assumptions and dependencies are included in Annex A.

4.25. The impact for tenants overall and the estimated transfer of profits will be dependent upon how many tenants would wish to request and, subsequently, move on to an MRO lease. With reference to Option 2, some of these factors will be outside the control of the tenant, as the option states that MRO leases would only be offered as a part of new leases and no unreasonable terms will be prohibited by the code^[21]. Despite engagement with stakeholders, given the commercially sensitive nature of the information and non-uniformity of tied pub agreements, it has not been possible to suitably estimate how many tenants would be eligible per annum. However, it is highly likely that this would be realised over a much longer period of time compared to options where tenants could request an MRO lease option at any time as fewer numbers of tenants will be able to request MRO leases initially. Therefore, the transfer of any profits from pub-owning businesses to tenants will likely be at a slower rate under Option 2 compared to Options 3 and 4.

4.26. Under Option 2 it is also conceivable that pub-owning businesses may use strategies to make MROs unattractive to tenants or to thwart them completely as no unreasonable terms would be specified under this option. For example, it was found in England and Wales that following the introduction of the Code, pub-owning businesses sought brand new tenancy agreements for MROs^[22]. These new tenancies reportedly included new, unfavourable terms, such as requiring rent in advance, the requirement for large deposits and dilapidation requirements^[23]. This would potentially reduce the number of MRO leases that are pursued by tenants and therefore ultimately reduce the benefits to tenants in the form of profit transfers when compared to options 3 and 4.

4.27. Option 3 – Limited Code and Option 4 – Maximum Code offer increasingly greater flexibility and eligibility for tenants relative to Option 2, with Option 3 requiring MRO leases to be offered except following specific levels of investment being made to the pub by the pub-owning business and except when there are other exemptions. It is perceived that the benefits for an individual tenant here would be similar to or the same as those set out in Option 2, but they may be realised earlier under Option 3 and 4.

4.28. Determining the eligibility of tenants to a right to request an MRO lease under Option 3 depends on the specific criteria added to the level of investment exemption. Option 3 provides that in circumstances in which the pub-owning business has invested significantly in the tenant’s pub, there is a level of reassurance and guarantee that the pub-owning business can realise sufficient returns on this investment through ‘wet rent’ and other terms of the tie. Due to the investment, it is supposed that under this option the tenant is sufficiently compensated to forgo their right to request an MRO lease option for a period of time following the investment. Further analysis of the potential impact of different investment thresholds on tenants and pub-owning businesses is set out in Annex A.

4.29. Option 4 would offer the greatest degree of flexibility and eligibility to tenants in being able to request an MRO lease option and the greatest opportunity for a transfer of profits from pub-owning businesses to tenants.

4.30. It is expected that the number of requests for MRO leases will increase, progressing from Option 2 through to Option 4. This is because the restrictions on a tenant’s ability to request an MRO lease option will become less limited. However, with an MRO lease under Options 2-4, tenants would be exposed to more risk, including from market fluctuations, due to losing the risk-sharing mechanism of the tie. As such, it should not be assumed that, even if eligible to request an MRO, a tenant would seek to switch to an MRO lease under Options 2, 3 or 4. Given the varying nature of tenant’s circumstances, as described above, any benefits might be considered insufficient against the associated costs and additional responsibilities and risks for tenants. Equally, upon requesting an MRO lease offer, tenants might choose not to move forward with such an option – either because they feel better informed about the benefits which a tied lease brings or that they are able to negotiate a ‘better’ tied lease with the pub-owing business (which may in itself lead to a transfer of profits).

4.31. The evidence that not all tenants will choose to pursue an MRO is borne out in figures on the adoption of MRO options in England and Wales, reported by the British Beer and Pub Association (BBPA)^[24]. Of the 1,381 MRO notices which have been received and where an outcome has been reached between 2016 and 2023, 26% resulted in a free-of-the agreement, whilst 58% resulted in a new tied arrangement being agreed.

4.32. It should however be noted that take-up of MRO leases in Scotland is expected to be higher than it has been in England and Wales^[25], as there is more flexibility in the code on when tenants can request MRO leases.

4.33. Where the tenant and pub-owning business are unable to agree on the terms of an MRO lease, tenants may face some additional costs with respect to appointing an independent rent assessor. This is covered in more detail in paragraphs 4.44 to 4.46. Briefly, the cost of appointing an assessor is likely to be between £3,000 and £6,000 per case, with costs split equally between the tenant and pub-owing business. Costs to tenants may be between £1,500 and £3,000 per MRO lease that is disputed. Based on an analysis of the number of MRO cases that may go to independent arbitration, this could cost tenants collectively around £12,000 to £24,000 per year.

4.34. Under these options – and in particular under Option 4 – pub-owning businesses may over time react by looking to move existing tenants from tied pub contracts to other styles of management agreements when leases expire in order to protect against any risks arising from MRO requests to their profits. This would have the effect of reducing the choice of business models available to future prospective tenants of tied pubs. There is some evidence underpinning this. The survey of SBPA pub-owning businesses in summer 2022, when asked as a result of the code as proposed in the written consultations, what pub owning businesses would do with their pubs– amongst 3 responding pub-owning businesses, 30% of their total pubs would be turned into other pub models, 8% of pubs would be sold and 1 % would be closed, would turn these into other pub models. However, if there were no MRO exemptions, amongst responding pub-owning businesses all said they would look to turn tied pub businesses into other pub models, all also said they would look to sell tied pubs as an ongoing business and 43% said they would close tied pubs (this does not necessarily mean changing, selling or closing their entire estate but rather changing, selling or closing part of their tied pub estate).

4.35. In England and Wales, where a code has been in existence since 2016, the number of non-managed pubs (which includes tied pubs) has decreased over time ^[26], but in the Second Statutory Review of the Code and the Pubs Code Adjudicator the UK Government state this cannot be attributed to the code, given a similar decrease has been experienced in Scotland. What is evident is the proportion of pubs which are managed, such as franchises, have increased in England and Wales. However, having a wider range of business models may support the pubs sector as a whole by providing different opportunities for people to enter the sector and run their own pub and by providing different options for pub-owning businesses to tailor their estate.

Costs and Benefits to Pub-owning Businesses

4.36. Option 2 – Minimal code, would introduce the requirement for pub-owning businesses to offer MROs but only in restricted circumstances, i.e., at the time at which a new lease is being prepared. We have not formally consulted on this option, but we believe this is likely to be the preferred option of most pub-owning businesses, given they have expressed concerns through our consultation exercises about all tenants being able to request MRO leases from day one of the code and how this could be managed. As outlined under the costs and benefits to tenants, as the option to start an MRO lease is likely to transfer profits from a pub-owning businesses to tenants, pub-owning businesses will incur costs under Option 2 of between £0 and £23,800 per tied pub per year. It is also the case that under Option 2 there is scope for pub-owning businesses to adopt strategies to make MRO leases less attractive to tenants through introducing unreasonable terms into new leases.

4.37. Pub-owning businesses would be increasingly impacted by Options 2-4 as the terms of eligibility of tenants to request an MRO lease option would lead to less control by pub-owning businesses over a tenant’s management of the pub. This could lead to the pub-owning business having a lower share of any profits generated from tenant business, but this would be potentially offset by a reduction in risks from market fluctuations due to higher dry rent under an MRO lease and savings made on SCORFA benefits that were provided under a tied lease.

4.38. Specification of unreasonable terms under Option 3 and Option 4 would lead to less control over the content of leases and potentially less favourable terms for the pub-owning business. Under these options – and in particular Option 4 - pub-owning businesses may over time react by looking to move existing tenants from tied pub contracts to other styles of management agreements when leases expire in order to protect against any risks arising from MRO requests to their profits.

4.39. As part of the consultation on the Scottish Pubs Code, proposals were included to specify circumstances when an MRO lease option need not be offered by pub-owning businesses. These circumstances included when the pub-owning business had invested significantly in the tenant’s pub. In doing so, the aims were to provide businesses with a level of reassurance and guarantee that they can realise sufficient returns on their investment and the tenant is sufficiently compensated to forgo their right to request an MRO lease option. This would ensure a fair share of risk and reward under regulatory principle 3.

4.40. The proposed investment exemption under Option 3 is for 5 years from the date an investment agreement was agreed, where the pub-owning business is investing in capital improvement works to the pub to the sum of £35,000 or more or 1.5 times the annual rent of the pub or more, whichever is the greater.

4.41. The existence of an investment threshold under Option 3 may have a number of different impacts on the level of investment into tied pubs. In some circumstances, pub-owning businesses may be disincentivised from making investments which, combined, amounted to less than the set threshold. In other circumstances, pub-owning businesses may be incentivised to make additional investments (above those planned) to meet or exceed the threshold in order to guarantee the tied lease against an MRO lease request. It might also be possible that some tenants choose to invest in pubs themselves under an MRO lease – offsetting any reductions in investment by pub-owning businesses – however such investments would be subject to greater credit-constraints and higher borrowing costs faced by tenants relative to pub-owning businesses. Further analysis of the potential impact of different investment thresholds on tenants and pub-owning businesses is set out in Annex A.

4.42. Under Option 4, an MRO lease available to all tied pubs at any time has scope to disincentivise and reduce investment made by pub-owning businesses into tied pubs. This has been highlighted by stakeholders during the consultation process. However, should investment from pub-owning businesses decrease, impacts could be partly mitigated through more investment into pubs managed under an MRO lease via tenant self-funding through loans or other means. Responses to the consultation showed that some tenants would welcome the freedom to invest and run their businesses as they saw fit under an MRO lease.

4.43. Under Options 2-4, in instances where the tenant and pub-owning business are unable to agree on the terms of an MRO lease, it is possible that it will be referred to an independent assessor for market rent assessment and possibly arbitration. In these instances, there will be an associated administrative cost, composed of the anticipated cost of an independent assessor being appointed and the frequency at which one will be needed.

4.44. As an indication, guidance shared by the Pubs Code Adjudicator in England and Wales suggest that the fees of an appointed independent assessor will range between £3,000 to £6,000^[27] - subject to an agreed structure, which is banded - based on the annual rental value of the pub.

4.45. As part of the Tied Pubs (Scotland) Bill Financial Memorandum and based on the Pubs Code Adjudicator Arbitration data in England and Wales^[28], it was estimated that there could be an average of 23 MRO requests made in Scotland each year. A proportion of these MRO requests may require independent assessment. As set out in Annex A, we estimate that around a third of such cases may require an independent assessment.

4.46. The independent assessor’s fees are to be split equally between the pub-owning business and the tenant in such cases. This means total costs based on the Financial Memorandum analysis for pub-owning businesses would be between £12,000 and £24,000 per year.

Costs and Benefits to Other Groups

4.47. Under Options 2, 3 and 4, there potentially could be an impact on consumers who might see changes to the running of some pubs and more choice in the drinks and food available. The number of pubs where this might happen would be likely to increase from Option 2 through to Option 4, as the number of MROs might be expected to increase in line with the opportunity.

4.48. Although difficult to quantify, it is possible that some consumers could face increased prices if the adoption of a MRO lease and the, subsequently, greater responsibility for their businesses resulted in low profit margins for some tenants.

4.49. Conversely, some consumers could face lower prices (or greater choice) due to tenants having greater flexibility and choice in the drinks and services that they provide.

4.50. With Options 2-4, there could be some impact on groups such as surveyors who contribute to the MRO development process, and those working on arbitration, such as the Adjudicator, and in the SCTS who would be involved in any appeals taken under the Scottish Arbitration Rules. The greatest impact is likely to be under Option 4, where more tenants could be expected to request MRO leases because they would be available regardless of circumstances. The number of arbitration decisions appeals occurring under the equivalent provisions in England and Wales have given rise to only 4 appeals since provisions came into force and no appeals have been made since 2021^[29]. On this basis, the SCTS considers that any additional costs will be subsumed within existing SCTS budgets. The SCTS also highlighted that an applicant in an appeal before either the Outer or Inner House may incur additional court fees and separate costs incurred should they instruct/ obtain legal representation.

Second Round Effects

4.51. As with any intervention, there is a high degree of uncertainty around the eventual outcomes, owing to the dynamic and unpredictable nature of markets. Tenants and pub-owning businesses could respond in several ways to the provision of tenants being able, dependent upon eligibility, to request an MRO lease option from their landlord – with the responses likely to vary between individuals and businesses. Tenants and/or pub-owning businesses may feel that the strength of their tied-lease offer is such that there is little response required. Pub-owning businesses may also seek to better communicate the benefits of the tie to their tenant(s) or, indeed, look to improve what they offer as part of the tie.

4.52. It is also likely that, in response to tenants seeking and taking up an MRO lease, pub-owning businesses may decide to manage more pubs directly, in order to guarantee ongoing sales to those pubs, or may choose to abandon the tie altogether. So, whilst the provision would initially expand the number of options available to both current and prospective tenants, it may well result in fewer tenancies being offered in future, although other entry routes to the pubs sector may become more available. It may also mean a change in the nature of pub-owning businesses, with fewer requirements for staff in SCORFA related roles such as business development and branding roles.

Costs and Benefits of Guest Beer Agreements (B)

Costs and Benefits to Tenants

4.53. Option 2 – Minimal Code would require pub-owning businesses to offer a guest beer agreement if requested by their tenant except where the tenant already has an agreement in place which matches the criteria of a guest beer agreement set out in the Act and code^[30]. The guest beer agreement will allow tenants to sell a beer of their choosing in addition to the tied beers required by their lease, provided that the annual production level of the chosen beer brand does not exceed 5,000hL. According to analysis of beer brand sales data from market research company, CGA by Nielsen, this would include the vast majority (96%) of beer brands in the UK, but only a small proportion (4%) of total annual UK sales of beer (see table 1B in Annex B).

4.54. The expected impact on tenants of having a guest beer agreement would be for them to benefit from greater autonomy and flexibility, enabling them to buy a guest beer directly from the supplier at market prices and potentially increase their income and their customer base. However, whilst the tenant will have the opportunity to make more income from the guest beer line, the tenant will also take on more risk by choosing to sell a free-of-tie beer line, in accordance with the regulatory principle of a fair share of risk and reward. As set out in Annex B, a key uncertainty in assessing the benefits and costs associated with a guest beer agreement is the extent to which consumers will choose to substitute tied beer purchases with a guest beer. We have limited evidence on which to base appropriate assumptions, with stakeholders claiming the impact could range from 2% of tied beer sales being substituted (in the case of a small production beer) to 40% being substituted (in the case of the guest beer being a popular brand). The net benefits calculated here should therefore be treated as illustrative.

4.55. It is estimated that the illustrative net annual benefit per individual tenant could range from £800 to £5,900 per year. All tied pub tenants are not expected to take up a guest beer agreement under the code. A survey of 31 tenants, conducted by SLTA, suggests that 20 tenants (65% of those responding) would choose to take up a guest beer agreement under the code^[31]. It is expected that under Option 2, there will be less take-up, owing to the relatively higher restrictions than in other options. As a result, it is assumed that 25% of the 700 tied pubs would request for a guest beer agreement under the code. This gives an overall estimated benefit to tenants ranging from £0.1 million to £1.0 million per year. Further details on costs and benefit estimates and relevant sources, assumptions and dependencies are included in Annex B. This option supports the third regulatory principle that a pub-owning business and tenant should fairly share the risks and rewards amongst parties. Tenants have greater access to the rewards of a tied pub tenancy, alongside a greater share of the risk as the guest beer brand they select may not sell well in their pub. Pub-owning businesses are also likely to have reduced reward – ensuring this is fair informs the selection of option 2, with the smallest impact on the pub-owning business. Lastly, this is a practical option, as it should be easier for both tied pub tenants and pub-owning businesses to identify whether a beer brand qualifies as a guest beer.

4.56. Option 3 – Limited Code offers tenants access to more beer brands relative to Option 2, with the maximum threshold for annual production of a qualifying beer brand being set higher at 100,000 hL. This would include 99% of all beer brands in the UK, adding an additional roughly 240 beer brands to that offered in Option 2. Similar to Option 2, under this option a guest beer agreement need not be offered by the pub-owning business if one is already in place, and it meets the criteria of a guest beer agreement set out in the Act and the code.

4.57. The illustrative net benefit per individual tenant would range from £5,900 to £11,800 per year under Option 3. The benefit is expected to be relatively higher than in Option 2 as tenants would have access to more popular beer brands which may mean more consumers will switch from a tied beer. As a result, it is expected that take-up of guest beer agreements would be higher under this option, with approximately 50% of tied pub tenants assumed to take up a guest beer agreement. Therefore, the total benefits seen by tenants as a whole is expected to range from £2.1 million to £4.1 million. Further details on these illustrative estimates are included in Annex B.

4.58. Option 4 – Maximum Code offers tenants greater eligibility and no restrictions in selecting a beer brand as a guest beer. Under this option, it is expected that tenants would choose the highest selling and most popular beer brands to offer under their guest beer agreements. As a result, the illustrative estimated net benefit to an individual tenant is expected to range from £11,800 and £15,700 per year. The expected higher sales and lower risk from choosing to sell a more popular beer brand is anticipated to result in greater take-up of the guest beer agreements provision, with an assumed 75% of tied pub tenants taking up a guest beer agreement. The total benefit by tenants as a whole is therefore expected to range from £6.2 million to £8.2 million per year. Further details on these illustrative estimates are included in Annex B.

4.59. Under Option 4, tenants are expected to see a loss in investment from the pub-owning business, with pub-owning businesses stating that they would be looking to reduce investment by 75-100% if guest beer agreements were unrestricted. The impact of this reduced investment has not been quantified as there is a lack of data available to help us understand the current level of investments made by pub-owning businesses, the drivers of such investments and the speed/ability for pub-owning businesses (and tenants) to realise their returns. This is partly to be expected, given the varying nature and scale of any such investments within business.

4.60. The Scottish Pubs Code Regulations 2024 state that a guest beer agreement must not vary the existing lease except to the extent necessary to include the guest beer agreement and to provide for a service equipment charge, if such a charge has been agreed between parties. It is therefore not possible for pub-owning businesses to mitigate against any losses through increasing ‘dry rent’ in the short-run. In the long-run, however, under Options 2-4, it is possible that a pub-owning business may, when a lease is renewed, seek to recover lost revenue arising from any displacement of sales of tied-beer due to a guest beer agreement, through increasing dry-rent. Even if a tied pub has not chosen to introduce a guest beer agreement, the pub-owning business may reasonably expect that the tenant will introduce one under a renewed lease and therefore seek to increase dry rent higher than it otherwise would be in a new lease. Therefore, it is important to note that the profit transfer benefits of a guest beer agreement under each option may be partially or fully offset in the long run for tenants. The tenant will also bear higher risks and be more exposed to market fluctuations in demand if dry rent is set higher than in Options 2 or 3.

4.61. The degree to which pub-owning businesses seek to increase dry-rent is expected to be less likely under Option 2. As discussed in Annex B, the net benefits calculated in this BRIA are on the assumption that total sales of beer before and after the introduction of a guest beer agreement are unchanged for a given pub. Therefore, it is a ‘zero-sum game’: each pint of guest beer sold will mean one less tied beer sold. This simplifying assumption may be less likely to hold in the case of Option 2, as smaller, less popular, niche or local guest beers could attract new consumers^[32] and increase overall beer sales - limiting any impact on wet sales for pub-owning companies. This is less likely under Options 3-4 if the beer chosen is likely to be popular with existing consumers. Some pub-owning businesses already permit tenants to sell some non-tied products which demonstrates that the sale of a small production guest beer is unlikely to have a significant impact on tied beer sales in practice.

4.62. Under Options 3-4, it should be noted that the incentive for pub-owning businesses to increase dry rent at the point of the renewal of a lease to mitigate against any possible reductions in wet-rent caused by the introduction of a guest beer agreement would have to be weighed against the risk that the tenant would have more of an incentive to request an MRO lease or a rent review in circumstances of rising dry rent.

Costs and Benefits to the Pub-owning Businesses

4.63. Option 2 – Minimal code would require pub-owning businesses, if requested, to offer guest beer agreements to tenants, allowing tenants to sell a guest beer brand with an annual production of up to 5,000hL. Pub-owning businesses need not offer a guest beer where they already offer one that meets the criteria set out in the code. Sales of guest beer are expected to substitute some of the sales of tied beer, resulting in a negative impact on the pub-owning business’ profits or wet-rent (at least in the short-run). As set out above, the degree to which tied beer is substituted for guest beer under each option is a key uncertainty. The estimates below should therefore be treated as illustrative.

4.64. Under Option 2, the illustrative expected impact on the pub-owning business’ wet-rent will range from a loss of £800 to a loss £5,900 per tied pub tenant requesting a guest beer agreement per year^[33]. With an estimated 25% of tied pub tenants expected to request and be eligible for a guest beer agreement, the total cost to pub-owning businesses as a whole will range from £0.1 million to £1.0 million per year. These estimates relate solely to possible changes in wet rent. Annex B shows that revenue for a tied-beer brewer will also decline. Further details on these estimates and relevant sources, assumptions and dependencies are included in Annex B. Option 2 does have the benefit to both pub-owning businesses and tenants in the sense that it should be easier for them to identify whether a beer brand qualifies as a guest beer brand.

4.65. Option 3 – Limited code would similarly require pub-owning businesses, if requested, to offer guest beer agreements to tenants. However, tenants can choose a guest beer brand with an annual production level of up to 100,000hL. Similar to Option 2, pub-owning businesses need not offer a guest beer where they already offer one that meets the criteria set out in the code. Tenants are expected to choose the highest-selling and more popular brands, therefore resulting in greater substitution from the tied beer, relative to Option 2. As a result, the illustrative impact on pub-owner turnover will range from a loss of £5,900 to a loss of £11,800 per tied pub tenant per year. With an estimated 50% of tied pubs requesting a guest beer agreement under this code, the total cost to pub-owning businesses will range from £2.1 million to £4.1 million per year. Further details on these estimates and relevant sources, assumptions and dependencies are included in Annex B.

4.66. Option 4 – Maximum code would require pub-owning businesses to offer guest beer agreements to tenants, if requested, regardless of circumstances, and with no restrictions to the production level of beer chosen by tenants. Tenants are expected to choose the highest-selling and most popular brands to maximise profits. As a result, substitution from tied beer is expected to be high, resulting in greater negative impacts on pub-owning business’ profits, relative to Option 2 and Option 3. The estimated illustrative losses to pub-owner turnover are expected to range from £11,800 and £15,700 per year. With an estimated 75% of tied pub tenants seeking to take-up a guest beer agreement, the total cost to pub-owning businesses as a whole is expected to range from £6.2 million to £8.2 million per year. Further details on these estimates and relevant sources, assumptions and dependencies are included in Annex B.

4.67. As mentioned earlier, the Scottish Pubs Code Regulations 2024 state that a guest beer agreement must not vary the existing lease except to the extent necessary to include the guest beer agreement and to provide for a service equipment charge, where such a charge has been agreed between parties. It is therefore not possible for pub-owning businesses to mitigate against any losses through increasing ‘dry rent’ in the short-run. It is important to note however that this situation is likely to change when a lease is renegotiated, and as such, some of the annual losses calculated may overstate the impact on pub-owning businesses in the long-run.

Cost and Benefits to Other Groups

4.68. Options 2, 3 and 4 are expected to benefit consumers through increased consumer choice. The impact is expected to be great under Option 2 and only marginally increase from that with Option 3. Although Option 4 provides the most choice for the tenant, it is expected that gains to consumers in terms of improving choice will be marginal as tenants are predicted to choose one of the few top selling brands to sell as guest beer.

4.69. Option 2, Option 3, and Option 4 may also benefit consumers through potentially cheaper priced beer, depending on the cost achieved by the tenant in negotiation with the supplier and the type of beer selected.

4.70. Options 2, 3 and 4 would benefit beer producers through the potential for increased market access. Option 2 would only benefit producers of brands with smaller production levels, which covers the majority of beer brands. Option 3 would benefit producers of larger brands. Option 4 would potentially impact all beer producers, particularly larger producers as their brands of beer will potentially be competing with other rival bestselling brands of beer.

4.71. Under Options 2, 3 and 4, a tied pub tenant with a guest beer agreement would be free to choose how and from where to source the guest beer, subject to any criteria. Under Option 2, suppliers/brewers of guest beer, as a whole, would benefit from increased annual turnover ranging from £0.3m to £2.4m. Guest beer suppliers/brewers, as a whole, will benefit from increased annual turnover ranging from £4.9m to £9.7m under Option 3, and turnover ranging from £14.6m to £19.4m under Option 4. It should be noted that increases in turnover for guest beer brewers will be offset by equal declines in revenues of brewers of tied beer products. This is set out in Annex B.

Costs and Benefits of Rent Reviews/Rent Assessments (C)

Costs and Benefits to Tenants

4.72. Option 1 – Do Nothing, would have no impact on tenants. They would have no less or greater protection than is afforded at present with respect to the frequency of rent reviews. This is a viable option as the Scottish Government is not required to include rent reviews or rent assessments within the Scottish Pubs Code by the Act.

4.73. Option 2 would provide greater protection for tenants but only in limited circumstances, when the landlord is proposing a rent change not linked to indexation. Option 3 would provide greater protection for tenants than Options 1 and 2 but only for tenants whose existing lease does not include a rent review.

4.74. Option 4 would provide the greatest protection, applying as it does to all tenants. Under all of the options, the ability to request a rent review could result in increased opportunities for tenants to negotiate rent and therefore potentially more favourable rent arrangements. There would also be greater transparency for the tenant with regard to the rent review process.

4.75. There would be time and resource costs for tenants of understanding the rent assessment statement and negotiating rent, or through seeking legal or other independent advice. The cost of each rent review will depend on the amount of work involved and who is employed to complete the review. Our understanding is that most rent reviews are conducted by the pub-owning business’ own staff. While tenants may face some time-related costs in preparing for a rent review, these are expected to be fairly nominal and with the pub-owning business bearing most of the associated costs.

Costs and Benefits to Pub-owning Businesses

4.76. The status quo of Option 1 – Do Nothing would have no impact on pub-owning businesses.

4.77. Option 2 would place new requirements and restrictions on pub-owning businesses, in limited circumstances, and would place some additional costs on them e.g., legal costs, costs in relation to the provision of information or ensuring staff were in place to meet the statutory deadlines. The new requirements could prevent pub-owning businesses from setting rents without mutual agreement, thereby increasing uncertainty about rent levels and future revenues for the business.

4.78. Option 3 would have a greater impact than Option 2 because it would apply to a greater number of leases, although we have been unable to quantify how many leases it would impact. We understand that the market is moving to shorter leases (i.e., less than 5 years) and many existing leases do already have rent review arrangements within them. The impact is therefore expected to be small for the sector as a whole. Option 4 would have the greatest impact and at the greatest cost, since it would allow rent reviews every 5 years or when material circumstances change, regardless of the terms of an existing contract.

4.79. We have estimated the likely cost of a rent review to pub-owning businesses. The detail on the methodology and assumptions are set out in Annex C. Based on insights shared by the SBPA, the average cost of rent reviews carried out by responding pub-owning businesses in 2022 was £1,750 – within a range of £1,500 to £2,500.

4.80. Most of the estimated total 700 tied pubs in Scotland will not be directly affected by the rent review requirement under Option 3, as most pub-owning businesses will already have frequent rent reviews (less than every 5 years) as part of existing lease agreements. Based on intelligence from the sector, it is estimated that between 105 to 175 tied pubs will be eligible to seek a rent review in total.

4.81. There exists uncertainty on the number of tied pub tenants who would ultimately request a rent review under the code. To reflect this uncertainty, upper and lower bound estimates have been calculated for 21 to 35 pubs seeking a rent review per year (upper bound) to one to two pubs per year (lower bound). The total monetised costs to pub-owning businesses are expected to range from £1,750 to £61,250 per year. More details on the methodology behind these estimates is provided in Annex C, including the basis for the range of pubs expected to request a rent review.

Cost and Benefits to Other Groups

4.82. Option 1 would have no impact on consumers or beer producers. Options 2-4 may have a small but increasingly significant (from Option 2 through to Option 4) impact on consumers, if more favourable rent assessments and reviews led to more profitable business for the tenant and consequently, potentially cheaper prices and better conditions in the pub. Similarly, beer producers may benefit from greater annual beer volumes under Options 2-4.

Second Order Effects

4.83. There is also the possibility that Options 2-4 could lead to shorter tenancies or a movement away from tied pub arrangements to management agreements. This could lead to uncertainty for tenants and, in time, fewer opportunities for prospective tenants to benefit from tied pub leases. Additionally, pub-owning businesses may increase the dry-rent in new leases to account for the risk related to rent reviews.

4.84. This poses a problem to any future tenants who may choose to start a business by running a tied pub as a tied pub lease may no longer be as accessible compared to Option 1.

4.85. An increased dry rent could be passed on to consumers in potentially increased beer prices. This may arise from the second order effect of increased dry-rent which pub-owning businesses may start charging as a result of an increased risk from Options 2-4, thus inclining tenants to increase the price at which they sell the beer in order to offset the costs.

4.86. Ultimately, while the provision of rent reviews is expected to act as an incentive for future tenants to pursue a tied lease, it is also anticipated to act as a disincentive for pub-owning businesses to offer tied leases. One pub-owning business in the consultation^[34] “voiced concern that the new rent review arrangements could lead to continued uncertainty in the sector, impacting on ability to invest and possibly moving more pubs on to management agreements rather than tied leases.”. There is a risk that this could create an imbalance in the market for tied pubs as it is expected to create more demand but less supply of tied leases. An option with restrictions to this right, such as option 2 or 3 could partly mitigate this risk and effect.

Costs and Benefits of Arrangements for Financial Penalties, Fees, Adjudicator Expenses and Arbitration.

Financial Penalties

4.87. Option 2 would define the maximum penalty as a specific figure. It would support the Adjudicator in enforcing the code and fulfil the legal requirement to define a maximum penalty by specifying the penalty as an amount. Under the Act, appeals could be brought by a pub-owning business to the Court about the imposition and amount of the penalty. Pub-owning businesses that do not comply sufficiently with the code would incur increased costs, whereas tenants would benefit from effective enforcement of the provisions of the code.

4.88. Defining the maximum penalty as a specific figure could allow the maximum penalty to be applied regardless of the size of the business. The Adjudicator could impose the penalty on any pub-owning business which fails to comply with the code and could impose any figure up to the maximum regardless of the size of the business. However, this could disproportionally impact on smaller pub-owning businesses.

4.89. Option 3 would define the maximum penalty as a proposed 1% of annual turnover. Where the business is part of a wider pub-owning group, the percentage would apply to the annual turnover of the group.

4.90. The benefit of setting the maximum penalty with reference to the turnover of a pub-owning business is that it ensures that any costs to pub-owning businesses are proportionate to the size of the business, ensuring that penalties are non-trivial for large businesses on the one hand, and are not overly burdensome to smaller businesses on the other hand.

4.91. A maximum penalty of 1% of turnover allows for a significant penalty, if required, but the Adjudicator is able to impose a smaller penalty where they consider this appropriate under Option 3. We anticipate that the maximum penalty may only be used in cases of persistent non-compliance. This is on the basis that the only financial penalty in England and Wales that has been applied is to Star Pubs & Bars; this was set at over £2 million and was subsequently reduced to £1.25 million by the Adjudicator. The maximum 1% fine would have been £12,325,770.38^[35].

Fees

4.92. Option 2 would ensure that tenants pay a nominal fee when submitting cases for arbitration and is similar to the fee charged in low value consumer arbitration cases. Option 3 represents a more substantial but still modest fee, similar to the fee charged for tied pub tenants under the Pubs Code in England and Wales (and for the Pubs Independent Conciliation and Arbitration Service, which is £200) and uprated to take into account the inflation pressures. There was general support (although not unanimous) in the consultation across both tenants and pub-owning businesses for a fee to be set at £250. Option 3 in particular would be a fee level sufficiently high that is intending to discourage tenants from submitting minor and vexatious cases. We cannot know for certain how many additional minor and vexatious cases would come forward if a small fee was required for arbitration under Option 2, but we would assume that more cases would come forward which would create additional costs for both tenants and pub-owning businesses and the Adjudicator too.

Expenses

4.93. Both Option 1 and Option 2 would benefit pub-owning businesses. Under either option, where the arbitration has resulted in an award in favour of the pub-owning business, they would be able to request that the Adjudicator relieve the business of liability for the Adjudicator’s fees and expenses and make the tenant liable for reasonable fees and expenses.

4.94. Option 1 provides the Adjudicator with discretion to determine whether or not to make the tenant liable for reasonable fees and expenses, given there were mixed views on Option 2 in the consultation.

4.95. The extent of any fees and expenses potentially due to the Adjudicator from the tenant would depend on the individual case. In England and Wales, in their most recent review report^[36], 65 cost awards resulted in eight tied pub tenants paying towards the pub-owning businesses expenses. Six tenants paid the maximum £2,000 and two tenants paid £500 (however our legislation only allows a cap to be set for the Adjudicator’s expenses, not for the pub-owning business).

Arbitration Rules

4.96. Option 1 would mean no change to existing arrangements since the Act already provides for Chartered Institute of Arbitration rules (CIArb), or the rules of another dispute resolution body nominated by the arbitrator. It would be for the Adjudicator to decide whether the CIArb rules or another set of rules would apply in arbitration. This would ensure that arbitrations were conducted in line with recognised sectoral rules and guidelines, for the benefit of all parties involved in the dispute.

4.97. Option 2 would enable the arbitrator to choose the Scottish Arbitration Rules, in addition to the choice of the CIArb rules or rules from another nominated body. It would be for the Adjudicator to decide what set of rules would apply in arbitration. However, the additional option of the SARs would allow the Adjudicator to use modern Scotland-specific arbitration provisions if the Adjudicator wished, which would benefit all parties involved in the dispute. It is not expected that this would lead to additional costs for any of the parties involved in the dispute.