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Territory — Do you really know what you are getting?

31 August 2018 - By Stewart Germann

A key part of franchising is for a franchisor to be able to offer some sort of territory to their franchisees. Most franchise systems in New Zealand and Australia rely on specific territories. A potential franchisee who has selected a franchise system and obtained a copy of the disclosure document and franchise agreement from the franchisor must look carefully at the territories available and what is being offered by the franchisor.

By territory I mean a specific area within which the franchisee will be able to conduct the franchised business. If the business will be conducted in a shop in a shopping mall then will the territory just be the surrounds of the shopping mall? Will it be a territory covering a reasonable area which will be defined on a map to be attached to the franchise agreement? Will there be a non-exclusive territory or no territory at all, and, in consequence, “a free for all” within which numerous franchisees will be conducting their own separate businesses with no demarcation line?

The issue of territory is a very important one for consideration. As a franchising lawyer, territorial disputes and issues have increased in recent years and the main problem comes from franchisors allowing new franchisees to operate franchises either within what an existing franchisee thought was its own particular territory, or offering the right to open a second outlet to a franchisee within the same territory because the existing franchisee is under-utilising the territory or underperforming.

Concise territory

In the majority of cases, a franchisor will have divided up New Zealand into concise and separate territories which will be allocated to each new franchisee. In the case of Australia there will be often a master franchisee or franchisees for New South Wales or Queensland or Victoria and then the master franchisees will appoint unit franchisees in each particular location. Territories should be carefully defined on maps and a typical clause in the franchise agreement may be as follows:

“The franchisor grants to the franchisee a franchise to establish and carry on a business within the territory as set out in the Schedule and delineated in red on the map attached and to carry on the business within the territory using the methods and techniques developed by the franchisor …”

An illustration of little model shops

This type of clause gives certainty to a franchisee by way of a map being attached to the franchise agreement with the boundaries of the territory clearly defined. There can be no doubt as to the boundaries of the territory which a franchisee is contracting by way of execution of the franchise agreement and payment of the initial franchise fee. In my opinion, some franchisors make the mistake in the early days of giving franchisees too big a territory which a particular franchisee does not service and exploit to its maximum potential.

Some franchisors may wish to cover their position by reserving in the franchise agreement the right to take back part of the territory in the future (perhaps when the system has become established) by re-demarcation of the boundaries during the term. This may be framed as an absolute right or in the franchisor’s discretion (reasonable or otherwise) that the territory is not being (or has become) and/or may not be capable of being serviced to its maximum potential. A franchisee should be aware of a blanket sole discretionary right which may be drafted as follows:

“The franchisor shall have the right at any time during the term to reduce the territory if in the franchisor’s opinion the franchisee is not maximising or is unlikely to be able to maximise business exploitation of the territory.”

A possible way out of the above is for the franchisee’s lawyer to suggest inclusion of an amendment along the following lines:

“… provided that the franchisor shall not be entitled to reduce the territory to an area within a [insert number] kilometres radius from the premises.”

Exclusivity of franchise

What a franchisee requires in entering into a franchise arrangement is certainty. There must be certainty as to the upfront franchise fee payable, certainty as to the ongoing service fees or royalties payable together with advertising levies and, most importantly, certainty in relation to the territory. A possible clause to consider is along the following lines:

“If the franchisor or the franchisee identify the opportunity to establish a further franchise in the territory ('the proposed franchise') then the franchisee shall be considered prior to any third party as the proposed operator of the proposed franchise. The existing franchisee, subject to meeting all new franchisee criteria, shall be offered a 14 day first right of refusal.”

What can be seen from this type of clause is a clear indication that the franchisee has not been given an exclusive territory, but will be considered first and foremost should the franchisor wish to open another outlet in the territory. However, an important caveat for the franchisor is whether the existing franchisee has been operating the business in such a way that gives confidence to the franchisor that the existing franchisee will be able to manage more than one outlet in the territory. Because of this important fact, the clause quoted above usually continues and says the following:

“If the franchisor considers the franchisee is capable of operating the proposed franchise in addition to the franchisee’s commitment(s) under its then existing franchise agreement(s), it shall notify the franchisee in writing and the franchisee shall indicate its willingness to accept the proposed franchise. The final decision as to the suitability or otherwise of the franchisee to operate the proposed franchise shall rest solely with the franchisor. If the franchisee declines within 14 days to accept the proposed franchise, then the franchisor shall be free to either itself open a new store within the territory or allow a new franchisee to open a new store within the territory.”

As can be seen above, the clause is explicit, clear and unambiguous but it is essential in all cases for the proposed franchisee to have independent legal advice from a lawyer experienced in franchising.

Alternative clause

Another way is to confirm that the franchisee has not been granted an exclusive territory but to combine that provision with a right of first refusal by a franchisee should a franchisor wish to establish another franchise outlet within the territory, and such a clause would read as follows:

“The franchisee acknowledges that it has not been granted an exclusive franchise territory but that it has been granted the right to carry on a business at the premises. The franchisor agrees that it shall give the franchisee a first right of refusal (provided the franchisee is in full compliance with all of its obligations pursuant to this agreement) to purchase another franchise it may propose to offer in respect of the establishment of another [insert brand name] outlet at a site which is within the area as specified in the Schedule ('the Territory') on no less advantageous terms than the proposed franchise offer to any third party. The franchisee shall then have fourteen (14) days from the receipt of notice of such offer to notify the franchisor by notice in writing whether or not it wishes to accept the offer. If it wishes to accept the offer then it must agree to open the new [insert brand name] outlet within ninety (90) days of acceptance.”

No territory franchises

Some franchise systems prescribe no territories whatsoever. There is a difficulty here for the initial franchisee who should be concerned about saturation of the area of the franchisee’s proposed operation – ie, how far is the franchisee going to travel to get business? This is especially relevant when in the case of a new system there are no actual (as opposed to hypothetical or anticipated) figures to justify a viable business. The logical reaction would be to request a limit on the number of franchisees to operate in the area although this can also be counterproductive because it may stultify the establishment of and/or the growing of brand awareness to the public.

Is it fair to appoint franchisees within a city area which may be divided into (say) five separate areas, and to say to 20 franchisees – “Go and conduct your business all over the city as you have no specific boundary except to ensure that any business conducted is within that city”? I consider the answer must be no. However, this would not preclude a franchisee who lives in one part of the city from servicing a customer who lives in another part of that city. Also, relatives and friends of a particular franchisee may want to be looked after by that particular person, regardless of where he might live.

Summary

Territories or the lack of specific territories is a fascinating topic in franchising. A franchisor must be fair to each particular franchisee but must also abide by the provisions of the franchise agreement and also what is stated in the disclosure document. Too often a franchisor in the early years has granted a franchise to a franchisee and has given too large a territory. It is true that it is easier to give a person a limited area and later to agree to enlarge it if the business is succeeding than to give a person a large area and later take it away or subdivide it if the territory is not being utilised to its maximum potential. The key aspect for potential franchisees is always – know what you are getting into in relation to all aspects of the franchise agreement but, in particular, in relation to the territory.


Stewart Germann stewart@germann.co.nz is a partner at Stewart Germann Law Office. Listed in the International Who’s Who of Franchise Lawyers, he has over 35 years’ experience in franchising law and acts for many franchisors and franchisees in New Zealand and overseas.

Last updated on the 31st August 2018