Does ‘radius clause’ in shopping centre leases breach Hong Kong’s Competition Ordinance?

Travel 50km in most European countries and there is a good chance you will encounter no more than one major city. Apply that same radius to Tsim ShaTsui and you would cover all of Hong Kong’s major islands, the entire New Territories and a good corner of mainland China.

The radius clause, a non-compete provision where the landlord restricts a tenant from opening another similar business within a prescribed radius, is a common feature in shopping centre leases in Hong Kong, as it is elsewhere.

But whilst a 50km exclusion zone may be commonplace for shopping mall tenants in other parts of the world, Hong Kong’s cramped geography and high population density means a standard radius clause could fall foul of the city’s new anti-trust regime.

In Hong Kong, as in other common law jurisdictions, landlords often insist on a radius clause before granting retailers a space in their shopping centre. By ensuring there will be no other competing locations offering the same merchandise, the landlord aims to protect its income from the widely used turnover rent arrangement, under which it earns a share of the tenant’s gross sales.

Radius restrictions typically cover one or more of Hong Kong’s four regions or 18 administrative districts, and can – in some cases – cover the entire territory. In the crowded, landlord-friendly Hong Kong market, tenants are generally powerless to resist. The city’s new anti-trust regime, however, may boost retailers’ bargaining power.

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The Competition Ordinance (Cap 619) came into full effect on December 14, 2015, setting out a cross-sector anti-trust regime. Drawn heavily from the European model, the ordinance prohibits restrictions on competition in Hong Kong through three competition rules.

The First Conduct Rule, which originates from and is similar to Article 101 of the Treaty on the Functioning of the European Union, is the rule that limits trade-restriction clauses and prohibits anti-competitive agreements, providing that:

“ An undertaking must not (a) make or give effect to an agreement; (b) engage in a concerted practice; or (c) as a member of an association of undertakings, make or give effect to a decision of the association, if the object or effect of the agreement, concerted practice or decision is to prevent, restrict or distort competition in Hong Kong.”

A landlord, by requiring its tenant to agree to a radius clause, falls under the purview of the First Conduct Rule and therefore the question of whether a radius clause is anti-competitive arises. Neither the Competition Commission nor the courts in Hong Kong have handed down a decision on such restrictive clauses regarding shopping malls. Given that the legislation is modelled on the EU, however, decisions in Europe may be indicative.

The radius clause has been challenged in Germany, when the operator of an outlet mall tried to restrict its tenants from opening up shops in other outlets within a radius of 150km for a period of 10 years. The German Federal Cartel Office found such a clause to be anti-competitive and ruled the maximum acceptable range of a radius clause to be a 50km radius for a period of five years.

In its March 2015 decision, the German competition authority cited many factors, but the key consideration was “reasonableness”. If a radius clause has features that are so unreasonable that it is obvious that the landlord’s purpose is to restrain trade, as opposed to protecting its rental income, the clause is likely to be held as anti-competitive by object under the First Conduct Rule.

The line drawn in the above German case would not be appropriate in a Hong Kong context, especially with the substantial differences between the two legal jurisdictions and the ways that shopping centres operate in the two markets. However, with no applicable local precedent, it can be expected that the commission and the Hong Kong courts will take similar factors into account.

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Another relevant precedent is the ruling by the European Court of Justice (ECJ) in December 2015 that a clause giving a supermarket anchor tenant the right to approve leases to competing stores in the same shopping centre was not anti-competitive by object – i.e. it is not automatically illegal. Similar factors to those in the German case were cited in the ECJ’s ruling, including the market strength of the companies and duration of the agreements.

While the ECJ case dealt with restrictions imposed on shopping centre operators rather than tenants, the same reasoning may be applicable if the radius clause is to be challenged in Hong Kong.

Whilst a radius clause, with the aim of protecting legitimate business interests, is widely recognised to be enforceable under common law if drafted well, Hong Kong’s new anti-trust regime raises questions for both landlords and tenants looking to protect their own interests. Germany’s 50km limit is unlikely to cut it with the Competition Commission.

Janice Yau Garton is senior associate at DLA Piper