Granting Exclusive Territory Rights in Franchise Agreements

Author: cfinkelstein@dalelessmann.com

Date: JUN 12th, 2012

Topic: Industry Experts

Determining an exclusive territory is one of the most important questions for a franchisor to consider and a franchisee to consider negotiating. Franchisees are eager to protect as broad a territory for themselves as possible with as few restrictions as possible so as to ensure that the franchisor will not cannibalize the franchisee's business by over-saturating too small a territory with franchises of the same brand. Franchisors certainly want to empower franchisees by providing them with an exclusive territory of a sufficient enough size to give that franchisee a sense of proprietorship, while at the same time exercising enough control to provide for flexibility during future growth of the system and ensuring they are not handcuffed to a top territory with an underperforming franchisee.

Ultimately, the decision as to whether a franchisor will grant an exclusive territory or not depends on the maturity of the franchise system itself. New franchisors will have a tough time attracting franchisees if their unestablished brand is not willing to provide the carrot to franchisees of a protected territory.

The decision of whether and how to grant an exclusive territory is also largely dependent on the type of business and the industry within which it operates. A large franchise system with many locations will likely be less willing to provide exclusive territories since its growth depends on having as many franchise locations in as many sites as possible than a more unique or niche brand, which bases its growth on maintaining some cache and not becoming superfluous on every corner.

From a franchisor's perspective, it is generally never advisable under most every circumstance, to grant an exclusive territory to a franchisee that is condition-free. Many first-time franchisors who are eager to sign up as many franchisees as quickly as possible and expand their brand as aggressively as possible may not always appreciate at the outset how the liberal grant of exclusive territories without strings attached may impact on them later when the franchisee fails to perform. This freewheeling granting of exclusive territories will almost certainly be regretted by a franchisor who finds that, several months or years into the term of a franchise agreement, the franchisee has utterly failed to perform and meet sales expectations.

As a result, performance criteria can be a very helpful control mechanism in binding a franchisee to certain targets as a condition of maintaining its territory. The franchisee's failure to satisfy those criteria can act as triggers for a franchisor to reduce or eliminate the scope of protection regarding the territory so that prime locations are not being held hostage by an underperforming franchisee.

A franchisor can also maintain some control in granting an exclusive territory by reserving rights for itself with respect to the goods and services which may be offered from within the territory.

First, the franchisor can and should reserve the right to sell, or grant others the right to sell, products and services via alternative channels of distribution from within the franchisee's protected territory. Second, the franchisor can and should reserve the right to operate, or grant franchise rights to other third parties to operate, additional brands owned and controlled by the franchisor. Third, the franchisor may wish to consider reserving the right to operate, or grant others the right to operate, franchises of the same brand as that being offered to the franchisee at non-conventional locations within the franchisee's territory, such as movie theatres, amusement parks, hospitals, zoos, sports stadiums and arenas, casinos, highway service centres and so forth.

Accordingly, there is no one-size-fits-all approach when it comes to the drawing up and granting of exclusive territories. The decision to grant one will depend on a number of factors, but the imposition of a reasonable number of conditions for the franchisee to retain that exclusive territory may be advisable and should be properly described in the franchise agreement and disclosure document.