11 Tenancy Agreements: Implications of the Basic Payment Scheme

3.83 In practice the implications of the financial support arrangements of the common agricultural policy will be of considerable importance in the drafting of the tenancy agreement, and are likely to be reflected in specialist clauses in many farm business tenancies.

3.84 The key facets of the CAP support arrangements that need to be considered when drafting the terms of a farm business tenancy agreement are the following¹⁷⁵:

•The allocation of payment entitlements to each producer (‘active farmer’) from the beginning of 2015. These are personal to the producer and not attached to the land per se. In England, allocations were ‘rolled forward’ from pre-existing single farm payment entitlements under the predecessor to the basic payment scheme. Allocations of single farm payment entitlement were, in England, originally calculated by reference to (a) the historic claims of the farmer in a reference period from 2000-2002¹⁷⁶ and (b) the average regional entitlement calculated a reference to the number of entitlements claimed by farmers in 2005. Entitlements moved in stages to a calculation based entirely on average regional entitlements by 2012. Allocations in Wales were made on a historic claims basis;

•To ‘unlock’ payment entitlements, each entitlement has to be ‘matched’ with eligible hectares of agricultural land. Entitlements will usually be registered in the tenant’s name and brought to the holding by him, whereas the landlord provides the land on which the payment can be claimed – although the tenant may ‘match’ his entitlements to land he owns or rents elsewhere to unlock the payment;

•Under the single payment scheme, there was a rule until 2008 that in order to unlock the payment, land must have been ‘at the farmers disposal’ for a continuous 10 month period beginning at any time in the period between 1 October in the calendar year preceding the application for the Single Farm Payment and ending on 30 April in the year of the application.¹⁷⁷ The so-called ‘10-month’ rule had implications for the drafting of various tenancy clauses eg break clauses and user clauses.¹⁷⁸ It was replaced from 1 April 2008 by a simpler qualifying rule that the farmer must have the eligible land at his disposal on 15th May in each year of claim.

•The claimant must be an ‘active farmer’ to qualify for the basic payment;

•Farmers entitled to a payment under the scheme must observe, on all their eligible hectares of land, the ‘greening component’ of the scheme ie ‘the agricultural practices beneficial for the climate and the environment’ laid down in the European Regulations.¹⁸⁰ These are crop diversification, maintaining existing permanent grassland, and a requirement to have ‘ecological focus areas’ on the agricultural area concerned.¹⁸¹ There is no requirement to ‘set aside’ arable land from production, but every farm with an arable area exceeding 15 hectares must maintain at least 5% of its arable area as an ‘ecological focus area’;¹⁸² and

•Payment entitlements that have not been used for a period of two consecutive years will be ‘lost’ and will revert to the national reserve, except in cases of force majeure or in exceptional circumstances¹⁸³.

(a)Payment Entitlements: Protection Clauses

3.85 Payment entitlements may be provided by the landlord, or they may be brought to the holding by the tenant. In either case, a key issue concerns the ability of the landlord to make provision in the tenancy agreement requiring the tenant to leave the entitlements at the termination of the tenancy – for the benefit, for example, of an incoming tenant. The interaction of tenancy clauses with the European regulations for successive forms of farm support is problematic. The essential difficulty for the draftsman is to be found in trying to anticipate the future form of farm support.¹⁸⁴ Many farm business tenancies granted since 1995 will, for example, contain quota protection clauses. Some will contain clauses drafted in more general terms, while others will have specific clauses dealing with Dairy Quota and/or with Livestock Premium Quotas. Livestock quotas are no longer applicable, and dairy quotas were abolished from 31 March 2015.

3.86 The following factors are relevant to an assessment of the terms to be include in a farm business tenancy:

(i)Obligation to Transfer Entitlements

3.87 The availability of the basic payment will underpin the tenant’s ability to pay rent in many cases. If the landlord has made entitlements available to the tenant this should be recorded in the tenancy agreement. As the entitlement is not attached to the land it cannot count as a landlord’s or tenant’s improvement for the purposes of either rent review or compensation on termination. If the tenancy includes a clause recording any entitlements made available by the landlord to the tenant, however, this would empower an arbitrator to consider it on rent review alongside other terms of the tenancy agreement having a bearing on the market rent for the holding.¹⁸⁵ The same would be true of a clause recording basic payment entitlements brought by the tenant and contractually committed to the support of farming operations on the holding.

3.88 The inclusion of a term obliging the tenant to transfer entitlements to the landlord on termination of the tenancy will be more problematic. The basic payment scheme is expressly characterised by the EU legislation as ‘direct income support’ for farmers.¹⁸⁶ There is no obligation on the tenant to deliver up to the landlord the land leased together with any entitlements relating thereto.¹⁸⁷ Where the tenant has brought the entitlements to the tenancy relationship, any clause requiring him to deliver them up to the landlord on later termination of the tenancy may well infringe EU law.¹⁸⁸ In this context it should be noted that in England the allocation of basic payment entitlements was ‘rolled forward’ from existing entitlements under the single farm payment scheme.

3.89 If the landlord wishes to oblige the tenant to transfer entitlements to him on conclusion of the tenancy, it will be necessary to include appropriate terms in the tenancy agreement defining the basis on which the entitlements transferred are to be calculated, and specifying a contractual basis for calculating the compensation to be paid by the landlord. It must also be remembered that the entitlements can only be held by an ‘active farmer’,¹⁸⁹ and that they will be lost to the national reserve if they remain unused for 2 years. The entitlements, being personal to the producer and unattached to land, are not ‘improvements’ for which compensation is available under the statutory compensation provisions of the 1995 Act. The tenancy agreement can be tailored to meet the particular requirements of the parties in this respect – by (for example) requiring a fixed number of entitlements to be transferred, or by requiring entitlements to a certain value to be transferred. In each case the basis for compensation must also be agreed. The entitlements cannot be split so as to allow the tenant to retain the historic claim element, and the landlord the regional average element, of the claim to which they give rise. The market value of the entitlements will be one possible basis, or an agreed proportion of the market value on termination of the tenancy.

(ii)User Clauses: Protecting Entitlements

3.90 The general considerations affecting the choice of user covenant to be incorporated in most farm business tenancies have already been discussed.¹⁹⁰ The decoupling of farm support from production by the basic payment scheme has further implications for the choice of user covenant where farm diversification is in prospect, or where it is proposed to take land out of production (for example as an ecological focus area) for any length of time. The framework regulation governing the introduction of the basic payment scheme¹⁹¹ requires member states to ensure that ‘all agricultural land, especially that which is no longer used for production, is maintained in good agricultural and environmental condition’ (‘GAEC’, emphasis added). The statutory management requirements and standards of GAEC that must be met by farmers in receipt of the single farm payment are set out in separate regulations for England¹⁹² and Wales.¹⁹³ The detailed rules implementing this requirement are discussed in Chapter 15 below.¹⁹⁴

3.91 It follows that, in cases where substantial diversification is in prospect, care will be required to protect basic scheme payment entitlements. The tenancy should include clauses providing that any land taken out of production be maintained in good agricultural and environmental condition. It will also be necessary to ensure that enough land is maintained in good agricultural and environmental condition to support (or ‘match’) the basic scheme payment entitlements which the tenant holds, and which are essential to the profitability of the farm enterprise. Clearly, where the tenancy envisages diversification into non agricultural business activities, the land so used will be unavailable for this purpose and cannot support basic scheme payment entitlements. A key question in the treatment of basic scheme payment entitlements, therefore, will be whether the tenant is to be obliged to put the land to full agricultural use (and if so whether the type of farming envisaged is to be specified) or whether he will be permitted to simply maintain the land in good agricultural and environmental condition.

3.92 Moreover, it must be remembered that any basic scheme payment entitlement which is not used for a 2 year period will be confiscated without compensation to the National Reserve.¹⁹⁵ The tenancy should include terms obliging the tenant to exercise his right to claim the basic scheme payment in respect of any entitlements contributed by the landlord, and to pay compensation if any entitlements so provided are forfeited through non-use. Whether he should be required to use the land within the tenancy to ‘unlock’ the basic scheme payments, or additional land (either taken on by the tenant for this purpose or owned or rented by the tenant elsewhere) will be a matter for the individual judgement of the landlord and tenant when negotiating the tenancy agreement. Where the landlord chooses to avoid potential problems by requiring the continuation of full agricultural production on all or part of the land to be let, the necessary result will be that, although the payment of subsidy through the basic scheme payment is in theory decoupled from production, it will be explicitly ‘recoupled’ by the terms of the tenancy agreement.

(iii)Quota Protection Clauses

3.93 Many farm business tenancies entered into before 2015 will contain express clauses to protect dairy quota for the benefit of the holding. Prior to its abolition in March 2015, the presence or absence of dairy quota registered for a holding would have substantially influenced the value of the landlord’s reversion. An agreement entered into before the Mid Term Review of the CAP in 2003 will not contain clauses dealing with the decoupled single farm payment (which bears some similarities with the basic payment scheme); and one entered into before 2015 will not contain clauses dealing with the specific requirements of the basic payment scheme as outlined above. One question that arises, therefore, is the extent to which the quota protection clauses often found in older forms of farm business tenancy will address some of the problems discussed above in relation to protecting entitlements under the CAP basic payment scheme.

3.94 Quota was registered in the name of the registered producer (often the tenant), and it could give rise to problems where the lease contained no provision specifically dealing with it. Unlike basic scheme entitlements, however, dairy quota attached to the land – specifically to ‘areas of land used for dairy production’ within a holding, a phrase which was given a wide interpretation by the English courts.¹⁹⁶ Its transfer was governed by the Dairy Produce Quotas Regulations 2005,¹⁹⁷ which provided for the transfer and re-registration of quota where there was a change of occupation of a holding (or part), other than one pursuant to a variety of short term arrangements.¹⁹⁸ Any transfer by way of a short term farm business tenancy, sub tenancy, grazing let for 10 months or more, or assignment, could carry with it quota if the land concerned had been used for dairy production in the recent past.

3.95 If the lease contained a covenant against assignment or underletting, a transfer of quota by means of any of the methods recognised by the 2005 Regulations would potentially constitute an irremediable breach of tenancy.¹⁹⁹ This would have entitled the landlord to invoke forfeiture proceedings. A subtler problem arose, however, where the ‘holding’ (defined for these purposes in the European law sense) contained both leasehold and freehold land. The tenant could, over a period of years, switch dairy production to freehold land within his agricultural unit, the effect of which would be to ‘massage’ registered quota onto freehold land over which the landlord had no control. Its subsequent disposition by the tenant would not then be restrained. To prevent this, and to ensure the tenant retained registered quota on leased land to which it was originally allocated, many farm business tenancies contain suitably drafted clauses restraining the tenant from selling, leasing, or otherwise dealing in quota without the landlord’s consent. And to prevent the confiscation of unused quota to the National Reserve, clauses were often included in the tenancy agreement obliging the tenant to retain dairy production at a specific (agreed) level.²⁰⁰ For the same reasons, the tenancy may also have identified the areas used for dairy production, and prohibited the tenant from either ceasing dairy production on the land in question or moving production to other land. Clauses of this kind will still be relevant to govern the use of the land within the tenancy, but will no longer have any relevance to their primary original objective – the protection of quota (the latter having been abolished).

3.96 Whether a quota clause of this type would be interpreted so as to protect basic payment entitlements must be open to doubt. Quota clauses have been strictly construed by the courts, and their impact and scope limited to the specific objectives and the factual matrix surrounding their agreement by landlord and tenant. So, for example, more general quota protection clauses, drafted with previous marketing schemes in mind, were held to be ineffective to restrict the tenant’s ability to disposal of dairy quota. In Lee v Heaton²⁰¹ it was held that a covenant ‘not to dispose of the whole or any part of any basic quota under a marketing scheme’ did not apply to prevent a disposition of milk quota: the Dairy Produce Quota Regulations did not establish a scheme for regulating the marketing of milk, but rather imposed a levy on disposals of milk products in order to curb overproduction within the European Community.²⁰² An express clause, of the kind outlined above, would have been required if dealings in dairy quota were to be restricted.²⁰³ Similarly, in National Trust v Birden²⁰⁴ a share farming contract included a quota protection clause that provided that ‘any production grants or subsidies paid to either party in respect of livestock or other agricultural production or cessation of production on all or part of the land or otherwise’ was to be shared between the landlord and the farmer in fixed proportions. The landlords failed to establish their claim that the clause applied to require a sharing of payments unlocked by single payment entitlements subsequently awarded to the tenant. The court stressed that the single payment scheme was wholly different from earlier subsidy schemes, and construed the clause strictly in favour of the tenant. The single farm payment was a form of income support and not caught by the terms of the quota clause.

3.97 Following the introduction of the basic payment scheme, the key question will be whether quota protection clauses in existing tenancies are sufficiently wide to be applicable to basic payment entitlements. This will, in each case, be a question of the interpretation of the clause in question. Unlike dairy quota, payment entitlements under the Basic Payment Scheme do not attach to the land or to the holding. Key questions will therefore be whether the clause defines the payment rights it seeks to protect by reference to allocations attached to land, or allocated by reference to the land, and whether it refers in general terms to financial support/subsidy or payments for marketing produce. If the latter is the case, the decision in Lee v Heaton²⁰⁵ would indicate that the courts may be reluctant to interpret the clause as applying to payment entitlements – which are personal to the producer and not linked to either production or marketing. Indeed, the essence of the Basic Payment Scheme is the decoupling of production from support payments, a factor that makes any linking of protection clauses in the tenancy with obligations to continue agricultural production problematic in terms of protecting payment entitlements.

3.98 Although basic payment scheme entitlements are fundamentally different from dairy quotas, they bear some resemblance with the former regime for livestock premium quotas. Livestock quotas are no longer applicable, and payments previously received under schemes covered by livestock premium quotas²⁰⁶ will have been incorporated into the historic claims on which the original Single Farm Payment entitlement for livestock producers was calculated in 2005. It has therefore no longer been necessary to incorporate this type of clause in new farm business tenancies for livestock enterprises since 2005. Many older farm business tenancies may contain such clauses, however, and the question in these cases is whether the clause can now cover the basic payment scheme so as to protect payment entitlements. This will be a question of interpretation in each case, but the issues will be different to those applicable in the case of dairy quota clauses, owing to the fundamental difference between the two quota regimes.

3.99 Livestock quotas were producer-linked, unlike dairy quota (which is land-linked), and therefore gave rise to problems of a quite different nature when land was being let under a farm business tenancy. The livestock quota regime also created wider conceptual problems concerning the relationship of the quota with property rights in the producer’s holding. As has been explained, because dairy quota was tied to the land dealings in it could be restrained by property based means eg by including a covenant against assignment or subletting in the farm tenancy agreement. The potential problems with livestock quota were quite different. Because it was not tied to the land, a farm tenant could in principle transfer quota without reference to his landlord. Moreover, if a departing tenant sold the whole of the quota allocated for the holding, the landowner could be left with a farm that not only had no quota, but which was also unsuitable for any other type of farming.²⁰⁷ This would have prejudiced the landowner’s interest and depressed the rental value of the holding, as an incoming tenant would either have to bring quota, or the landlord would have to acquire fresh quota before reletting. A covenant against alienation would not prevent dealings in livestock quota, and the landowner was therefore potentially exposed.

3.100 The European provisions for both suckler cow premiums and sheep annual premium quotas implicitly recognised that member states may encounter problems where producers are not the property owners of the holding for which quota is allocated, in that they permitted member states to introduce transitional measures to achieve ‘fair solutions’ between landowner and tenant.²⁰⁸ In the UK landowners from whose property quota had been transferred were a priority group for allocations from the national reserve, a concession that was intended to be a remedial measure alleviating some of the problems outlined above, by permitting the allocation of fresh quota for an incoming tenant. Because of the potential problems, however, landowners letting land after 1992 commonly made specific provision for livestock quota in the tenancy agreement. This was often achieved by the use of special quota clauses obliging the tenant to maintain sheep and/or suckler cow production at a given level, or at the level obtaining at the start of the tenancy, and giving the landlord a pre-emption on the sale by the tenant of any quota. An indemnity was also sometimes taken against the cost of replacing any quota removed from the holding by the tenant. Where encountered today, this type of clause is unlikely to be interpreted so as to protect basic payment scheme entitlements, unless drafted in very general terms referring to CAP support schemes. As indicated above, moreover, the insertion of clauses requiring production to be maintained at a certain level (a common feature of livestock quota protection clauses) is contradictory to the nature of the basic payment scheme, which provides income support decoupled from production.

(b)Terms as to Land Use and the ‘Greening’ Conditions

3.101 The landlord will not wish to be involved in routine matters connected with subsidy applications, and the basic payment scheme does not require the landlord’s consent before a claim is made by a tenant/producer. Under the decoupled basic payment scheme the tenant is entitled to cease production without prejudicing his ability to claim payment of subsidy, provided he maintains the land taken out of production in good agricultural and environmental condition (GAEC).²⁰⁹ The tenant will also be required to meet the ‘greening component’ for the payment. This includes observing the rules on crop diversification in the case of arable producers, and maintaining the necessary ‘ecological focus area’ (‘EFA’) required by the European regulations. A farmer with more than 15 hectares of arable land must maintain Ecological Focus Areas on their land, and these must total at least 5% of the arable land of the holding (whether or not they are claiming the basic payment on that land).²¹⁰ The payment is decoupled, however, and the maintenance of agricultural production is not a prerequisite for payment. The landlord may need to be aware of the long term implications for the character of the holding of a change of production – or of a decision to cease production altogether on the whole or part of the holding and simply maintain the land in good agricultural and environmental condition.

3.102 Most tenancies entered into after the McSharry reform of the CAP in 1992 will contain user clauses dealing with land use issues relating to set aside and subsidy claims. These will commonly (for example) include covenants obliging the tenant to notify the landlord of applications made to participate in support schemes such as the beef special premium scheme, arable area payments scheme, suckler cow premium scheme or sheep annual premium scheme (all now closed and superseded first by the single farm payment, and now by the basic payment scheme). Most such clauses will include a reference incorporating within their scope and application any successor or continuation scheme to that relevant when the tenancy was granted. Such clauses would appear unproblematic in their application to the basic payment scheme, which rolled over claims under the single farm payment, and therefore for these purposes incorporates (via the historic claim element of the SFP entitlement) any claims to the relevant subsidies mentioned, and is arguably their ‘successor’ for these purposes. The application of the basic payment scheme is more straightforward than its predecessors, but being ‘decoupled’ from production it does not require the tenant to maintain agricultural production in order to clam payment. Additionally, adherence by the tenant to some of its land use prescriptions have the potential to cause prejudice to the landlord’s interest if not addressed in suitably drafted covenants in the tenancy agreement.

3.103 The set aside of arable land was a feature of the SFP, but this no longer applies under the basic payment scheme. Nevertheless, the new requirement to maintain ecological focus areas would appear to carry with it an inherent obligation to put at least 5% of the arable land on a holding to non-agricultural uses that are environmentally beneficial. On closer inspection, however, the actual land management requirements that have been laid down in England for EFAs require practises that are largely part of the normal agricultural management of many holdings. Thus, all of the following can be EFAs and used towards calculation of the 5% requirement²¹¹: land lying fallow; buffer strips; areas with catch crops or green cover; areas with nitrogen-fixing crops; and, additionally, landscape features are in most circumstances also considered to be ecological focus areas. Detailed guidance is given by the Rural Payments Agency on each of the EFA components.²¹² A farmer putting land aside as an EFA will not, therefore, normally be contravening a tenancy term to maintain the land let solely for agricultural use – unless a discrete area of the holding is set aside as an EFA and taken out of production eg by establishing a nature reserve or wildlife sanctuary. Where the tenancy includes a user covenant restricting the tenants land use exclusively to agriculture, then permission will be needed before this could be done.

3.104 Nevertheless, in most cases it will still be essential for the landlord to have detailed information as to the management plan for the holding, and of the areas designated as EFAs in each year of the tenancy, as this could have an impact on the holding’s management in future years. Similarly, a producer taking on additional land on a farm business tenancy would need to know which areas have been allocated as EFAs in previous years – as this would have implications for the crop rotation on the reminder of his holding. As a consequence, it would be prudent for a farm business tenancy to include covenants by the tenant requiring him to consult with the landlord as to the choice of EFA options for managing the land let, and requiring him to keep and make available to the landlord detailed records of the land set aside as EFAs in each year of the tenancy, and also records of cropping and of land maintained as permanent grassland.

3.105 As noted above, a key characteristic of the basic payment scheme is the fact that payment entitlements are held by, and are personal to, the producer. They are not attached to the land let by a farm business tenancy. This fundamental feature of the scheme has implications for the drafting of tenancy agreements were land is to be let to a producer as part of a composite holding – and farmed with land either owned or rented elsewhere by the tenant. In order to claim payment the producer must declare ‘eligible hectares’ (parcels of land) in the member state where the payment entitlements have been allocated.²¹³ ‘Eligible hectares’ are defined to mean²¹⁴ ‘any agricultural area of the holding … that is used for an agricultural activity or, where the area is also used for non-agricultural activities, is predominantly used for agricultural activities’. The ‘holding’, for these purposes, means ‘all the units used for agricultural activities and managed by a farmer situated within the territory of the member state’.²¹⁵ This will include all the land owned, rented or otherwise under the control of the claimant – and not just the land that is subject to the farm business tenancy in question. For the purposes of EU law the ‘holding’ may be considerably larger than the ‘holding’ as understood in English law under the AHA 1986 or Agricultural Tenancies Act 1995.

3.106 A producer farming a composite holding could therefore put aside large areas of land as EFA on the tenanted portion of his holding in order to unlock his basic scheme entitlements – while maintaining full productive capacity on land owned or rented elsewhere. This may prejudice the landlord if the land let is returned at the end of the tenancy in a condition requiring considerable expenditure to return it to profitability. It may also expose the tenant to a claim for dilapidations. It may therefore be appropriate to include a covenant preventing the use of land as EFA without the written consent of the landlord. In particular, if land is let on a short term basis, and the tenant farms extensively elsewhere, the landlord may wish to restrict the area that can be used as EFA – or to prevent its use as EFA by the tenant at all. Conversely, in a longer fixed term tenancy the landlord may wish to consider whether the tenancy should specify the nature and value of the basic payment scheme entitlements held by the tenant, and the proportion of them to be maintained and ‘matched’ to the land let by the farm business tenancy in order to secure payment. This may protect the landlords position on rent review, where it is now clear that entitlements under the basic payment scheme are accountable as a relevant factor in establishing the open market rent for a holding.²¹⁶