It is common in franchising systems and agreements to see references to "territories". Sometimes prospective franchisees misunderstand the references to territories in a franchise agreement and the context in which these references are made.
In this article, I will outline the different types of territorial provisions that I have come across and what benefits, if any, they offer franchisees. In doing so, I will examine some of the different types of franchise systems and explain what I believe are the underlying reasons for the franchisor inserting provisions relating to territories.
Before proceeding with this analysis, readers should be reminded of the Franchising Code of Conduct disclosure document provisions relating to territories.
A franchisor must, in its disclosure document, disclose:
1. Whether the franchise being offered for sale is for an "exclusive" or "non-exclusive" territory or whether the franchise being offered for sale is limited to a particular site.
2. Whether, within the territory the subject of the proposed franchise agreement:
a. Other franchisees may operate a business that is substantially the same as the
franchised business;
b. The franchisor or an associate of the franchisor may operate a business that is substantially the same as the franchised business;
c. The franchisor or an associate of the franchisor may establish other franchises that are substantially the same as the franchised business;
d. The franchisee may operate a business that is substantially the same as the franchised business outside the territory of the franchise;
e. The franchisor may change the territory of the franchise.
3. The policy of the franchisor, or an associate of the franchisor for the selection of the territory in which the franchised business is too operate.
4. Details of whether the territory (or site) to be franchised has 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.
Hence the Franchising Code of Conduct contemplates many circumstances in which territories may operate in a franchising context.
Types of Territorial Provisions
1.
Exclusive Territory for Franchisee
It is quite common to see franchise agreements where the franchisor agrees not to establish a competing business or allow another franchisee to establish a competing business within a defined territory.
This is often a good selling point for a franchisor because a franchisee will be attracted by the fact that he or she will have the franchise brand to themselves within their territory.
Whilst it is common to see agreements like these, it is equally common to see territory size quite small. For example, in a retailing context, the territory might be limited to a strip retail shopping precinct or a particular level of a regional shopping centre.
Franchisees faced with these types of agreements must consider the location of their likely customer base and factor into their assessment of the franchise the impact on sales of another franchise opening just outside the territorial boundary (just as they should consider other competitive factors).
In granting an exclusive or protected territory, the franchisor is effectively relying on the appointed franchisee to achieve the required market penetration in the territory granted. A franchisor will not want to limit his or her opportunity to sell franchises by making territories too large. Despite this, some franchisors are happy to do so, but protect themselves with provisions allowing them to dissect the territory of the franchisee is not meeting pre-determined performance criteria.
Master franchises traditionally cover large territories and franchisors need to be sure that the master franchisee is "working its territory" by selling sufficient numbers of unit franchises. Master Franchise Agreements often provide that if franchise sales targets are not met, exclusivity is lost.
Exclusive territory agreements also often restrict the ability of a franchisee to market outside the territory. This sometimes causes problems where a franchisee might want to place an advertisement in a local newspaper that circulates in many franchised territories. Usually, in such a case, a franchisor would not permit such advertising, unless the other franchisees within the territory agreed to be part of the campaign.
These types of restrictions are also generally supported by prohibitions on franchisees maintaining their own website.
2.
Non-Exclusive Territory for Franchisee A non-exclusive territory is one where other franchisees or the franchisor may conduct business within the franchised territory.
It is common with these types of agreements for the territorial limitation to affect franchisees more in terms of marketing (see above).
Some of the service based franchise systems will allocate a territory to a franchisee and when allocating work (usually coming through a call centre) will give the franchisee in the territory where the work is to be performed a right of first refusal. If the franchisee is too busy or is unable to perform the work within his 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 person may use a particular brand home cleaning franchise, form a good relationship with a particular franchisee, then move their residence to outside that franchisee's territory.
The customer may insist that the same franchisee clean their house. Rather than losing the customer, the franchise agreement may allow the original franchisee to clean the customer's house in another franchisee's territory. Where a franchisee is granted a non-exclusive territory he or she will usually be permitted to work outside the territory, within the rules and guidelines contained in the franchise agreement. In addition, such franchisees will usually not be restricted in performing work in areas which are not the subject of existing franchises.
3.
Territories limited to the Site Sometimes I have seen franchise agreements flooded with wonderful territorial protection for a franchisee, only to find in the Schedule that the territory is limited to the site at which the franchised business is located - in other words a "Claytons" territory.
There is nothing legally wrong with these types of agreements, but they can easily mislead the unwary franchisee.
Territorial Encroachment
A poorly drafted franchise agreement can often give rise to disputes between the franchisor and the franchisee and between neighboring franchisees.
I recall seeing one franchise agreement defining territories by reference to municipal boundaries. When the municipal boundaries changed, it meant that one franchisee was technically no longer able to service its biggest customer. This became complicated when the franchisee who gained the benefit of the municipal boundary change refused to allow the original franchisee to encroach into his territory to service the original client.
I could hear the franchisor say "if only the territorial boundaries had been better defined - by references to roads". After much angst, that dispute was settled with the franchisor having to put his hand in his pocket.
Then there was the franchise agreement whereby work was directed to a franchisee through a Telstra 13 number. The location of the incoming call determined which franchisee the call was directed to. Imagine the problems that arise if the 13 system moves out of alignment with the territorial boundaries.
Also, what happens if I ring the 13 number from my office in Mount Waverley to organise for work to be done at my home in Hawthorn? The Mount Waverley franchisee takes the call and although he might be contractually bound to refer the job to the Hawthorn franchisee, he may choose to take his chances, go over the territorial boundaries and hope that he is not caught.
Then there is the example of the franchisor deciding to sell goods on the internet through its website in circumstances where the franchise agreement provides exclusive territorial rights to the franchisees. Unless the franchisee agreement reserves this right to the franchisor, it will be breaching the exclusive territorial rights of franchisees by selling goods or services into the exclusive territories of those franchisees.
Conclusion
Franchisees must initially carefully read the franchisor's Disclosure Document, particularly items 8 & 11. But do not stop there. The Disclosure Document does not define your relationship with the franchisor - the Franchise Agreement does this. You must:
1. Read the Franchise Agreement carefully
2. Determine whether territorial protection is essential for the business venture and be prepared to walk away if you believe it is essential and the franchise system does not offer adequate protection
3. Look at the territorial boundaries and be satisfied that they are accurately defined, so there can be no argument
4. Understand what territorial restrictions might be imposed on you, as a franchisee (for example, marketing outside your territory)
5. Understand what forms of encroachment might be reserved to the franchisor (for example, internet sales or an ability to split the territory or re-define boundaries) Finally franchisees should not consider that territorial protection is the ultimate protection from competition. Clearly if the concept is a successful concept, others will copy and very often this cannot be legally prevented. There is always the risk that a more cashed up competitor will open business across the road.
This article appears courtesy of
Mason Sier Turnbull.
15-Aug-2007