TERRITORY – DO YOU REALLY KNOW WHAT YOU ARE GETTING?

 

Most franchise systems in Australia and New Zealand 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.

 

 

Most franchise systems in Australia and New Zealand 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 territorial 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 be a master franchisee appointed for a particular state and that master franchisee would 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 …

 

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.”

 

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.

 

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.

 

In conclusion, great care must be taken in relation to territory.  Franchisees must know what they are getting in relation to a territory or area.

 

 

 

Stewart Germann founded Stewart Germann Law Office (SGL) in 1993 as a boutique law firm at Auckland, New Zealand, specialising in franchising, licensing and business law.

Stewart has over 40 years’ experience in franchising law and acts for franchisors in New Zealand, Australia, USA and the UK. SGL also act for franchisees and provides legal advice. Stewart has spoken at franchising conferences in New Zealand, Australia, Italy, South Korea and USA and he was on the Board of the Supplier Forum of the International Franchise Association (“IFA”) for 6 years until March 2007. Email: stewart@germann.co.nz | Web: www.germann.co.nz