Tied pubs - pubs code consultation: workshops with tenants

5. Research findings: Market Rent Only (MRO) leases

This chapter addresses pub tenants' views on the requirement to offer MRO leases and how this should be governed in the Code.

5.1 Overall views, concerns, benefits and drawbacks

The smaller operators who participated in the research were very enthusiastic about MRO leases and viewed it as a potentially transformational development, providing greater leverage in relations with the pub-owning companies and the subsequent freedom to invest and run their businesses as they saw fit. It should be noted however that these operators were on FRI (Full Repairing and Insuring) leases, meaning they had a large degree of responsibility already, with the main link to the pub-owning company being the keg beer tie. Small tied operators with leases whereby the pub-owning company assumed responsibility for insurance and repairs may have a different perspective.

The larger operators were more cautious about MRO leases. Whilst potentially a good thing for many, they worried that the benefits of MRO leases may not materialise for some small operators particularly when it comes to repairs and maintenance, and they may miss the financial backing of a pub-owning company. Some worried that the MRO lease option would be little different from FRI, leaving the small inexperienced operator with potentially large liabilities and relatively little influence.

"One little pub, something happens to your roof, where's the money coming from? Hard for the guy in the small pub. The problem is that if something material breaks, they won't be able to borrow 10 or 20 thousand pounds."– Pub tenant

One operator of multiple premises also made the point that sourcing your own beer and getting good deals is difficult for a small independent pub.

"I've had vans on the road trying to get beer [due to current beer shortages], the deals aren't that good. We don't have the buying power, not like the breweries. Even as a multiple. So people with one pub don't have a chance." – Pub tenant

While not completely hostile to the idea of MRO leases, then, larger operators were concerned that they would be seen as a panacea for some would-be publicans and tenants looking for a change. Above all, however, they wanted the MRO lease provisions in the Scottish Pubs Code to be finalised as soon as possible to end what they viewed as a damaging period of uncertainty.

The smaller operators on FRI leases, both experienced publicans, were personally enthusiastic about MRO leases and would consider them for their own businesses. Unlike some of the larger operators they saw MRO leases as significantly different from the FRI lease.

"We'd definitely consider an MRO lease. We buy barrels from [large brewer] and they make £82,000 'wet rent' from us without factoring in the £60K rent we pay. With an MRO I could get a much better deal saving as much as £75 a keg which nets back a huge amount to me that I can invest. We have a repair and insure lease, all these costs fall to us, so there's no benefit to us to be tied to someone." – Pub tenant

A key concern was around triggers for MRO lease requests. Smaller operators felt strongly that these should not be tied to the five-year rent review and should be available more frequently than once every five years. In particular, returning to the concerns around automatic rollover of leases, they felt that a MRO lease request should always be an option at the end of a lease period, providing the tenant has been compliant. The MRO lease itself should also automatically roll over, again providing the tenant has been compliant.

"You wouldn't want the 5-year rent review to be the only trigger for an MRO request – we've just had a rent review, it's 5 years until another one, [we] wouldn't want to be forced to wait that long to request an MRO... It needs to be within x months of the start of a lease, or twice yearly etc. Not 5 years. It should be automatic at any point during and especially at the end of the lease – because people often just don't get their leases renewed." – Pub tenant

It was also viewed as important that the process of applying for a MRO lease and receiving a decision be strictly time-limited. As noted, operators were well aware that lengthy wrangling can seriously harm a business.

"It should just be a process where the MRO can be requested and it goes through within a set timeframe – not getting tied up for months. It's important the process is set in terms of weeks or months, time limits." – Pub tenant

5.2 Exceptions to the obligation to offer a MRO lease: Substantial investment by the pub-owning company

All the tenants we spoke to believed the main, and often only, reason for an exception to the obligation to offer a MRO lease was if a substantial investment had been made by the pub-owning company. Many mentioned this spontaneously. Unpacking this, tenants explored how they would define 'substantial', and viewed it in terms of the amount of money spent but also the nature of the work and the impact on the business. In short, routine maintenance could be very expensive but might not count as 'substantial'.

"We call it a 'tickle'… painting and decorating, changing things like the fixtures and fittings can make a pub look different but it's not substantial."– Pub tenant

"Contractors are extortionate, what we call a 'sparkle', a lick of paint and some signage, recovering of seating… Also a 'ready to let' investment just to make sure everything is compliant – they can throw £100,000 or £150,000 at that alone." – Pub tenant

Looking at the types of work, 'substantial' tended to be viewed as something that changed the nature of the business in some way, bringing in new or increased revenue.

"It has to be defined as a transformational investment, a partnership investment… stuff that requires planning consent and licensing consent tells you it's substantial alternations to the property, that's good indicators it's decent money." – Pub tenant

"As soon as contractors come in and you're having to close, that's substantial, so new floors, new walls, changing the layout, an outside area. Things the business can realise extra revenue from e.g. a new seating area, a new food area – the pubco invests in it and everybody gets a bit extra." – Pub tenant

Routine or essential maintenance – e.g. a roof repair, repainting the premises, re‑upholstering or replacing tables and chairs – would not count as substantial because it does not change the business in any way.

"Things like replacing beer pythons and remote coolers – that's just wear and tear, you expect it when you're putting 300 barrels through lines, after a while that system's going to give up." – Pub tenant

Tenants appreciated that pub-owning companies required a certain amount of time to realise a return on investment. This was generally seen to govern the length of time an exception to the MRO lease obligation should last. Around three to five years was broadly accepted as a reasonable time for pub-owning companies to see a return on investment.

"There's no other reason other than investment from the landlord or pubco why people shouldn't be able to get a MRO. Most businesses look for ROI in 3-5 years. After that there should be an option fairly quickly and without debate to go for a MRO or request another investment if the tenant is happy with it." – Pub tenant

However, some believed that this should not be rigid. The performance of the investment could be monitored and the investment treated as a kind of loan, so if the investment outperformed in terms of generating returns during the three to five year period that could bring forward the end of the exemption period for requesting a MRO lease – an early waiver, in other words.

"In terms of MRO exemption, the investment should be seen like a loan – so if the investment overperforms you'd be able to pay back that 'loan' quicker and thus go for a MRO sooner." – Pub tenant

"The waiver needs to reflect the amount of money that is going to be spent. [It] needs to be calculated on return on investment." – Pub tenant

5.3 Other potential exceptions

Participants were also asked about the following potential exemptions to the requirement to grant a MRO lease on request:

• uninvested sites at the start of tenancies;
• very short tenancies; and
• for a period of time after making a MRO lease request

Regarding uninvested sites, tenants were generally against exempting these for experienced operators, although they could see why an exemption would make sense for less experienced businesspeople. An uninvested site could be especially appealing to an experienced businessperson if they have the freedom of a MRO lease to realise the site's potential in the way they see fit.

"Fewer experienced people are coming into business due to restrictions and lack of autonomy, so uninvested sites would be appealing to prospective experienced businesspeople on a MRO basis if they can see the potential of the site." – Pub tenant

Offering MRO leases for uninvested sites, at least to experienced businesspeople with a track record, could also benefit the pub-owning company by removing expense and freeing them up to focus on their strengths, in the view of one pub tenant.

"It would be a good deal for the pubco as we would pay them rent and double the barrelage. It takes expense away from pubco and they can focus on what they do best – sell beer and help promote the business. Let us come in and make it viable, make it profitable. And when I retire they have a viable business to lease out again." – Pub tenant

Views were mixed regarding exemptions for very short tenancies. Some thought it was reasonable as a year-long tenancy would give both sides, tenant and company, the opportunity get to know the suitability of the tenant and the nature and viability of the business. Then a more informed decision could be made by the tenant on whether or not to apply for a MRO lease.

"A year is perfectly acceptable, so everybody knows the deal." – Pub tenant

However, many were concerned that such an exemption would accelerate the unwelcome trend amongst pub-owning companies noted earlier towards offering only short tenancies. In order to avoid the obligation to offer a MRO lease, pub-owning companies may be tempted to offer only very short tenancies if they were exempted.

"It's open to manipulation by pubco – if there is an exemption, they will only provide short leases with no MRO option. There's no obligation to offer a long tenancy. That would be a MRO killer essentially." – Pub tenant

For less experienced operators on a very short tenancy, an exemption would make sense. As one tenant pointed out, under a MRO lease there is no access to a BDM, who many felt was most useful for people new to the business. However, again, the freedom of a MRO lease for a very short tenancy could be attractive to experienced operators.

"Short tenancies are usually offered because the previous tenant hasn't worked out. So a MRO on a short lease is a great opportunity to test the water and for guys like us – experienced operators." – Pub tenant

Tenants were asked for their views on an exemption for a period after making a request for a MRO lease. Some felt that some kind of restriction was needed to avoid numerous repeated requests 'chewing up resources' as one tenant put it.

"I think there should be a minimum period, at least once every three years. Annually would be problematic. It will chew up resources." – Pub tenant

However, many felt there would need to be flexibility and exceptions reflecting the fact that material circumstances can change at any time. The approach should allow for negotiation and mutual consent rather than be strictly rule-bound.

"Things can affect your business, then you'll want to be in a MRO, it needs to be a mutual agreement. Things change and you can be eligible later. You would still need that clause in it – you can only apply once in a five-year period, unless there's a material change." – Pub tenant

Some also stressed that from the tenant side, requesting a MRO lease implied a serious, long-term commitment. It was something that for most would not have been considered lightly.

"Requesting a MRO implies a serious long-term commitment – it's saying 'we ain't going away any time soon'." – Pub tenant

5.4 Information required prior to requesting a MRO lease

Tenants listed a number of things they would need to know in advance relating to the nature of the lease and the previous performance and viability of the business. Two essential pieces of information were an assurance that you would be completely free of a beer tie, and an understanding of what the market rent should be, preferably based on a source of information other than the pub-owning company.

"You need to know if you're free of beer tie in that you can go to anyone e.g. your local brewers and mainstream brewers. As long as we know we can go to the open market for our beer." – Pub tenant

"We need to know what the market rent is. [We] would rather not get that information from the pubco – we'd pull in an estate agent or solicitor. If there's no agreement on market rent it needs to go to somewhere independent to decide – not the pubco, not attached to our business either. An independent body that assesses the fair market rent transparently." – Pub tenant

One tenant said that it would be key to ensure it was not a 'put and keep' lease whereby you are required to put the property in a reasonable condition and keep it there.

Looking at the business side, a transparent history of maintenance costs was important for prospective MRO leaseholders to know as they considered likely costs in the future.

"Transparency and cost for maintenance… what the costs have been for the landlord for compliance and maintenance… that gives you a clear indication of what you're gambling with." – Pub tenant

Previous performance in terms of sales was also important to factor in to considerations.

"If I'm taking on a new business I'd need to know how many barrels has it done previously."– Pub tenant

Other information mentioned as important included:

• Assurance that the building and contents meet all codes and legislation (including gas and electricity certificates)
• Previous copy of the dilapidations report (one tenant was concerned that pub-owning companies are "notorious at charging people for dilapidations but not actually doing them" so proof that the work had actually been caried out was important)
• Schedule of condition of the property prior to moving in
• Any impact on the amount of insurance to be paid

Regarding unreasonable terms for a MRO lease, some mentioned liability for building issues. If there was a fault that was present but not apparent when the MRO lease was signed, it should not automatically be the responsibility of the tenant. In their view, the onus needs to be on the pub-owning company to ensure the premises are safe for trading.

5.5 Timescale for negotiating a MRO lease

All tenants were clear that timescales and milestones for the process were crucial to prevent negotiations dragging on and ultimately damaging businesses. Three to six months was generally seen as a reasonable timeframe from the application to signing the lease. Despite some debate, overall, six months would be acceptable to most as an absolute maximum timescale.

"I think six months is reasonable otherwise they will string it out. It ties in with the notice period too."– Pub tenant

There was some debate over whether three months was too short a time or not. Some were concerned about whether there would be the resources available in terms of adjudication and oversight to deal with this shorter timeframe.

"Three months is too short a time, [there] would have to be a whole stream of adjudicators. Are there enough surveyors to cope? With the six months, you have to set out a time frame for each part of the process, you need to allow that sometimes tenants will push it back and it will go to the adjudicator."– Pub tenant

The smaller, experienced operators erred towards a shorter timescale of three months. One tenant broke down the potential timetable as follows:

"The timescale needs to be on how long it takes to get an offer back from the pubco – a month seems reasonable to me. Once you apply they need to come back with an offer within the month. The whole thing needs to be concluded in three months as there will be to-ing and fro-ing. Also you need to allow time to get an independent person in as well." – Pub tenant

Smaller operators were especially concerned about pub-owning companies 'dragging out' negotiations and claimed that this is what had happened in England. Interestingly, at least one tenant blamed this on pub-owning companies in England insisting on negotiating a completely new lease rather than simply altering the existing lease.

"There has to be a timescale. In England, negotiations have been dragged out by pubcos insisting on a complete new lease for a MRO whereas it could easily be done by a deed of variation on the existing lease."– Pub tenant

Consequently, the preference for smaller operators especially as far as the Scottish Pubs Code was concerned was for deeds of variation to create a MRO lease (i.e. altering the existing lease) rather than negotiating a new lease.

"You can do literally anything with a deed of variation. All you're taking out is two things – the tie and the deposit amount because a deposit applies to a commercial agreement and is usually three months in advance." – Pub tenant