Exclusive Franchise Territories – Do They Exist?
By Raynia Theodore Principal, MST Lawyers
It is quite common to see franchise agreements where the franchisor agrees not to establish a competing business or allow another franchisee to operate a competing business within a defined territory.
Providing an exclusive territory is often a good selling point for a franchisor and having the franchise brand to themselves will likely be attractive to a prospective franchisee.
It is important to note that this does not necessarily mean that the franchisee will have no competition! I do not know of any franchise network that has no competitors and, while a franchisor may promise not to compete with a franchisee within its territory or allow another franchisee to do so, the franchisor cannot prevent a competitive brand opening business nearby, even next door! This is a normal risk that every business owner must assume.
National franchisors with some clout with shopping centre landlords may be able to negotiate a restraint that prevents a landlord from granting leases of nearby premises to competitive brands, but this is rare.
While it is common to see franchise agreements containing exclusive territories, it is equally common to see these boundaries narrowly defined. For example, in a retailing context, the territory might be limited to a strip retail shopping precinct or a particular section or level of a shopping centre. Some franchise agreements limit the territory to the site at which the franchised business is located.
Generally, a franchisor will not want to reduce its opportunity to sell franchises by making regions too large, but at the same time to sell franchises, especially mobile service franchises, a franchisor may need to offer the comfort of exclusive territories. Despite this, some franchisors are happy to grant larger territories, however, protect themselves with provisions allowing them to split or reduce the territory if the franchisee is not meeting pre-determined performance criteria.
Exclusive area provisions also often restrict the ability of a franchisee to market outside these boundaries. This sometimes causes problems where a franchisee might want to place an advertisement in a publication that circulates in many franchised territories. Usually, in these cases, the franchisor will not permit such advertising unless the other franchisees within the territory agree to be part of the campaign.
Marketing restrictions usually also prohibit franchisees from maintaining their own website and social media sites.
A non-exclusive territory is one where other franchisees or the franchisor may conduct business within the franchised region.
Some service-based franchise systems assign an area to a franchisee and when allocating work (usually coming through a call centre) will give the franchisee in the area where the work is to be performed the first right to that work. If the franchisee is too busy or is unable to do the job within the territory, the franchisor is permitted to allocate the work to another franchisee.
Service-based franchise systems also often contain provisions whereby the customer’s wishes are honoured. For example, a customer may use a particular franchisee for its garden maintenance and form a good relationship that particular franchisee. The client may move to outside the territory but insist that the same franchisee maintain their garden. Rather than losing the customer, the franchise agreement may allow the franchisee to continue to service the client even though they are situated in another franchisee’s territory.
Where a non-exclusive territory exists, the franchisee will usually be permitted to work outside the territory subject to compliance with the rules and guidelines contained in the franchise agreement and/or the Operations Manual. Also, such franchisees will usually not be restricted in performing work in areas which are not the subject of existing franchises.
Territorial encroachment arises where the territorial rights of a particular franchisee are infringed by a neighbouring franchisee working or conducting business within the territory of the first mentioned franchisee.
This causes anger and discontent within the network and usually a huge headache for the franchisor.
Some franchise agreements define territories by reference to municipal boundaries or postcodes. When the municipal boundaries or postcodes change, so too will the boundary of the franchisee, and this may mean that the franchisee can no longer service some customers.
The internet also does not sit well with territorial provisions. The “world wide web” is truly worldwide, meaning that a franchisor or any franchisee could theoretically market to the whole world through the internet. Franchisors need to decide whether other franchisees or even the franchisor will be permitted to compete through internet sales.
Many franchise agreements reserve the right of the franchisor to sell via the online strategies. In some cases profits are shared with affected franchisees, in others, the franchisor retains all profits.
Franchise agreements may contain exceptions to a franchisee’s exclusive territory. For example, a franchisor may be allowed to sell the products available in the franchised business from non-branded retail outlets in a franchisee’s exclusive territory (e.g. supermarkets). A franchisor may also be permitted under the franchise agreement to operate or allow other franchisees to operate mobile or temporary franchises inside a franchisee’s exclusive territory (e.g. at sporting events).
It is critical that franchisors obtain legal advice about territory provisions and that these are included in their franchise agreement to reflect the franchise model. It is important to get this right from the outset as taking away any exclusivity previously granted will be difficult.
The Franchising Code of Conduct (‘the Code”) requires franchisors to give a prospective franchisee a “Disclosure Document” in a prescribed form. In addition, the franchisor must provide the franchise agreement in the form in which it is to be executed by a franchisee at least 14 days before the franchisee enters into a franchise agreement or pay any non-refundable money. Although the legal position in respect of a territory is ultimately governed by the terms of the franchise agreement, the Code requires franchisors to disclose in their Disclosure Document certain information about territories in order to assist franchisees to understand their rights better.
The information required is as follows:
- Whether the franchise is for an “exclusive” or “non-exclusive” territory or whether the franchise is limited to a particular site.
- Whether within the territory the subject of the proposed franchise agreement:
- other franchisees may own or operate a business that is substantially the same as the franchised business;
- the franchisor or an associate of the franchisor may own or operate a business that is substantially the same as the franchised business;
- the franchisor or an associate of the franchisor may establish other franchises that are substantially the same as the franchised business;
- the franchisee may operate a business that is substantially the same as the franchised business outside the territory of the franchise;
- the franchisor may change the territory or site of the franchise.
- The policy of the franchisor or an associate of the franchisor, for the selection of the territory in which the franchised business is to operate.
- Details of whether the territory (or site) to be franchised has, in the previous 10 years, been subject to a franchised business operated by a previous franchise granted by the franchisor and, if so, details of the franchised business, including circumstances in which the previous franchisee ceased to operate.
- Details of whether the franchisee, the franchisor or an associate of the franchisor or other franchisees may make goods or services available online.
It is evident from the above disclosure obligations that regulators of the franchise sector see prior disclosure of matters pertaining to territories as critical. It is, therefore, important that the franchisor knows what territory model they wish to adopt right from the outset.
MST Lawyers has an experienced team of franchising lawyers who can assist you with any questions about franchisors’ obligations under the Code. For more information, please contact our Franchising Team by email or call +61 3 8540 0200.