How safe is your Franchise Territory? The Courts have now decided.
The Courts have recently discussed the importance of a franchisor protecting their franchisee’s territorial rights in an exclusive territory. Where a franchisee has an exclusive territory, the Courts decided that there is a positive obligation that a franchisor does not itself compete in that territory or allow other franchisees to compete.
Until now, there have been very few territorial cases in the Courts brought by Franchisees because of the legal costs and potential damage to the working franchise relationship.
The two most recent decisions being, Video Ezy International Pty Ltd v Sedema Pty Ltd  NSWSC 143 (Video Ezy Case) and RPR Maintenance Pty Ltd v Marmax Investments Pty Ltd  FCA 409, (RPR Case) recognised the franchisee’s exclusive territory and awarded damages against the franchisor.
The Courts have reinforced the value in the exclusive territory of a franchisee.
Can a franchisor compete on-line with their traditional ‘bricks & mortar’ franchisees?
In the Video Ezy Case, the Supreme Court on appeal, agreed with the Local Court’s decision that Video Ezy (franchisor) breached a franchisee’s exclusive territory by allowing Blockbuster and EzyDVD (as related entities of the franchisor) to engage in online sales and subscriptions of movies and DVDs in a franchisee’s territory. The franchisor argued that it was not in breach of the exclusive territory because it had not physically entered into the franchisee’s territory and establish a ‘brick and mortar’ store to directly compete against the franchisee.
The Court ruled:
The distinction suggested between the operation of a ‘bricks and mortar’ business and on-line trading is illusory…. The contractual documentation reasonably affords an interpretation that the restrictive covenants and the exclusivity provisions were intended to protect either party from either conducting a competing business in the hire and sale or hire of video products. It would have been no different had [the franchisor] commenced operating a business of the sale or hire of video products by mail order, at a market stall or out of the back of a truck in the territories. It would be an affront to the reasonable person on the ‘Bondi bus’ to suggest that it was the common understanding of the parties that [the franchisor] could sell or hire video products by mail order or at a market stall or the back of a truck in the territories. So it would be to suggest that the TiVo movie service and ezydvd.com.au on-line businesses were any different.
The Court also held that in addition to the breach of the terms of the franchise agreement, the franchisor was in breach of an implied term to act in good faith against the franchisee by failing:
- (a) to remain loyal to the franchisee and to comply with certain standards of conduct;
- (b) to act reasonably in relation to the promise of exclusivity in the territories;
- (c) to not compete against the franchisee in respect to a rental or retail business;
Can a franchisor allow franchisees to compete against each other within an exclusive territory?
In the RPR Case, the franchisee (RPR Maintenance Pty Ltd) complained to the franchisor over a 2 year period, (Spanline Weatherstrong Building Systems Pty Ltd) that its neighbouring franchisee (Marmax Investments Pty Ltd), was poaching jobs in its franchised territory in the South Coast of NSW.
The franchisor maintained that it would not tolerate other franchisees poaching jobs in another’s territory and would take necessary steps to prevent this occurring. However the Court found that the franchisor had done a ‘side deal’ with the neighbouring franchisee in July 2009, allowing them to perform work within the franchisee’s exclusive territory in certain circumstances, but the franchisor never told the affected franchisee of this ‘side deal’. The Court was critical of the deficiencies in the franchisor’s investigations into the complaints made by the affected franchisee.
The franchisor argued that there was no breach of the exclusive territory provisions when the neighbouring franchisee did not establish a showroom to sell the ‘Spanline’ products in the franchisee’s exclusive territory, nor did the neighbouring franchisee directly advertise in the exclusive territory. The Court decided that under this particular franchise agreement, the exclusive territory included the activities of selling and installing the franchisor’s product and did not simply rely on whether a showroom was established in the franchisee’s territory.
The court also held the franchisor had an implied term of good faith and fair dealing towards the franchisee. The franchisor was ordered to pay for the lost profits that the franchisee had missed out on, by losing the sales and profits to the neighbouring franchisee, even though the franchisor did not receive or benefit from the profits.
Lessons learnt and things for franchisees and franchisors to consider
The Courts have now sent a strong message to franchisors that if they do not preserve their franchisee’s exclusive territories, then a franchisor may be liable for lost profits, whether or not they received those profits. Careful consideration now needs to be given in light of these recent Court decisions:
For Online Sales
1. With franchisors now competing with online sales, franchisors need to review existing franchise agreements to establish whether they can compete online, against the interests of their franchisees, when and if they have granted exclusive franchise territories.
2. Franchisors may need to implement internal mechanisms to identify which customers in particular territories they can and cannot sell and market to online, depending upon whether particular customers reside within a franchisee’s exclusive territory.
3. When entering into new franchise agreements, franchisors will need to carefully draft exclusive territory clauses with appropriate carve-out provisions, if they wish to exclusively sell online to customers within their franchisees’ exclusive territories. This may also affect the ability for a franchisee to market and sell on-line.
For Competing Franchisees
4. There is a positive obligation for franchisors to take active steps to prevent neighbouring franchisees from operating within another franchisee’s exclusive territory. Franchisors should properly investigate and address any complaints raised by a franchisee.
If you are a franchisor or franchisee and you have questions about your rights in respect to your exclusive territory or franchise agreement then you should seek advice of your specialist franchise lawyer.
Nick Birbas, is a partner at Newhouse & Arnold Solicitors and an Accredited Specialist in Business Law who specialises franchise law for franchisors and franchisees.
For more information contact Nick Birbas on 02 9922 1100 or email on email@example.com