What Do You Need To Know About A Franchise’s Exclusive Territory Clause?

Contents

A Franchise Agreement allows the franchisor to give the franchisee the right to carry on business using the franchisor’s name, brand and business systems. It is one of the essential legal documents you will need when franchising.

Along with what the parties are obliged to do in terms of fees and provision of goods or services, there is also space for the specification of where and how the franchisee can operate the business. This is where exclusive territories come in.

You can find out more about franchising and what documents are required to do so here.

A successful business is one where customers love the brand and see no reason to switch to competitors. However, what happens when the same brand operates with two different franchises in the same area?

This is where the exclusive territory clause allows the franchisee to protect their area of business while also allowing the franchisor to manage the brand and interactions between different franchises.

What Is An Exclusive Territory Clause?

An exclusive territory is a specified area where only one franchisee can conduct business. This essentially stops other franchisees or the franchisor from interfering with franchise operations within the designated exclusive territory.

The purpose of the exclusive territory clause is to codify the exclusive territory in which certain specific rights and limitations apply to the parties involved. It details what other franchisees, or the franchisor, can and cannot do within the area and essentially allows for controlled business expansion while protecting franchisee operations.

Example
Let’s say you were a franchisee for a florist and you operated in suburb A. Another franchisee or the franchisor of the flower shop should not be able to open shop in suburb A as long as this is specified in an exclusive territory clause.

The reason for its inclusion in a franchise agreement boils down to the complexity and wide range of options available in the operation of an exclusive territory. There are more aspects to it than just the specification of a geographical area.

It should cover aspects like:

Who has the right to market their product in the area
What obligations arise for the franchisor if the franchisee breaches the exclusive territory

There are even cases where territories can overlap. So, to avoid confusion, these clauses are an important component of franchise agreements.

Exclusive territory clauses can sometimes even help to prevent excessive litigation costs so it is important that they are drafted appropriately.

As A Franchisor, Why Should You Set Up Exclusive Territories?

There are a number of pros as to why you should set up exclusive territories.

Franchisees Get Along

As a franchisor, you would want to ensure that there is minimal friction between your franchisees and good relationships are maintained. An exclusive territory clause clearly defines the boundaries of operation from the start and helps with this.

For example, a clearly set out territory means that neighbouring franchisees would not quarrel over who gets which customers. Essentially, the clause allows easy and transparent division of areas and reduces the space for arguments by getting all parties on the same page from the get-go.

Proactive

You would want to ensure that your business expands in an efficient manner. Exclusive territories allow you to plan early and map out zones of operation so that your expansion can be done in a surgical manner.

It allows you to ensure that no areas are doubling up with two franchisees competing for customers and reduces waste of marketing and other resources.

Sense Of Security

Franchisees would feel protected when they have their own exclusive territory, meaning that you or other franchisees will not interfere with their operation. This is a great incentive to sign on new franchisees and retain existing ones, as there is no fear of customers being stolen.

Increased Demand

The success of territories would drive up franchise demand in the neighbouring territories. Having these zones set up allows targeted expansion in areas where there is good growth and avoidance of areas which are less lucrative.

However, exclusive territory clauses also have some limitations.

Reputation

Problems may arise if a poorly performing franchisee with less ambition and work ethic tarnishes the brand name in a certain territory. They may not even be able to service a lot of the demand for your business’s goods or service in the area.

An exclusive territory clause in this context prevents you from establishing another franchise to meet this excess demand. The clause may prevent you as the franchisor from expanding business in the area through partnerships with other businesses as the franchisee would prevent it. This would further deter interest from new franchisees to start business in areas near the exclusive territory.

Excessive Restraint

Defining areas strictly may reduce interest in new franchisees as they may feel that all the best areas for operation have been already taken. Furthermore, you will also be prevented from having a say in how these exclusive territories are run and catered for.

On the other hand, defining territories with more relaxed rules may cause more disputes between franchisees as this leads to a level of uncertainty.

Therefore, as a franchisor, it is important for you to get the correct wording in the exclusive territory clause so you can protect the wellbeing of your business. When done correctly, the clause will help your targeted expansion while limiting room from problems.

As A Franchisee, What Do Exclusive Territories Mean To You?

Similarly to the franchisor, this kind of clause has its pros and cons for franchisees.

So, what are some of the benefits?

Limited Competition

An exclusive territory can protect you from competing franchises. Essentially, within your territory, it can stop other franchisees from contacting potential clients and accessing your customer base. This is extremely important for businesses like gyms where the local customers are the main target market.

Reduced Marketing Costs

The clause can help reduce your marketing costs because you are the only franchise within the territory and hence, do not need to put out more marketing material to show how your services are better suited for consumers.

While you would need to still market your goods and services to compete against other businesses, you will save on competing against other franchisees within the business.

Nonetheless, there are still some limits to the clause.

No Obligation To Enforce The Clause

Unless stated in the franchise agreement, if another franchisee interferes in your territory, there is no obligation on the franchisor to take action against them.

Strict Rules

There may be rules in the exclusive territory clause preventing you from marketing outside of your territory. This limits the customer base you can access and limits growth. Furthermore, if a customer who is in another franchisee’s territory comes to you, you will probably need to contact the franchisor or other franchisee, and this can result in you losing the customer.

As you can see, it is important to ensure that the exclusive territory clause is well drafted, so your protections are clear. Aspects like who can market in the exclusive territory become extremely important in the future. If done right, this clause can prevent many issues that may arise down the line.

What Can I Do If A Dispute Arises?

One example of when disputes may arise is when there is a territorial encroachment in terms of other franchisees or the franchisor interfering with the exclusive territory through marketing or opening business there.

Online marketing is another grey area that can cause issues. For example, let’s say a franchisee attracts customers from another franchisee’s exclusive territory through online marketing.

In these situations, it is important to remember that franchises are subject to the ACCC’s Franchising Code of Conduct and there is a duty to act in good faith.

If there is a breach of the exclusive territory by other franchisees or the franchisor, there may be provisions in the agreement which require the franchisor to act.

For example, if customers from a different exclusive territory were reached through marketing encroachment, the franchisor may be required to ask the franchisee at fault to give the business back to the original franchisee.

Furthermore, if the issue cannot be solved this way, there are further options of through mediation and legal action. Recent changes to the Franchising Code of Conduct have also introduced more options for alternative dispute resolution and voluntary arbitration.

Talk To A Lawyer

At the end of the day, costly litigation and disputes should be avoided where possible. You can probably gauge the importance of exclusive territory clauses and how they can protect you when included in a franchise agreement.

You can contact our team at team@sprintlaw.com.au or give us a call on 1800 730 617 for a free, no-obligations consultation.

Naga Aditya Koneru

Aditya has experience in consulting, reinsurance, and government. He holds a double degree in Actuarial Studies and Laws from the University of New South Wales, and has a keen interest in public sector work.

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