Knowing what is and isn't your territory helps new franchisees
avoid problems, say Stewart Germann and Clive Neifeld
If you're buying a franchise, it pays to know before you make the
decision exactly what your obligations will be under the franchise
agreement, and exactly what the obligations of the franchisor are
too. That way, you'll understand what you must and must not do,
what you do and don't have the right to expect, and what should
and should not happen. If you understand those points clearly, the
chances of a dispute arising within the franchise further down the
track are lessened considerably.
Accordingly, when you have selected a franchise which you want
to pursue, you must carry out what is called due diligence. This
will involve obtaining a copy of the disclosure document and franchise
agreement from the franchisor and going through it both yourself
and with your legal and financial advisors. They will help ensure
that you go into your new business with the best possible chance
One of the key elements which you must examine during this process
is that of territory - the specific area within which you as the
franchisee will be able to conduct the franchised business. Will
it be just the St Lukes Shopping Centre? Will it be a territory
covering an area defined in yellow on a map to be attached to the
franchise agreement? Will there be a non-exclusive territory or
no territory at all? If there is no territory, how does the franchisor
prevent a 'free for all' situation with numerous franchisees conducting
their own separate business with no demarcation line?
The issue of territory is therefore a very important one for careful
consideration. As franchising lawyers, we find territorial issues
are one of the main areas in which disputes arise. These stem mainly
from franchisors trying to allow new franchisees to operate franchises
either within what the existing franchisee thought (rightly or wrongly)
was his own particular territory, or offering the right to open
a second franchise to a new franchisee within the same territory
because the existing franchisee is under-utilising the territory.
This article considers various permutations of territory and highlights
the key areas to consider when a prospective franchisee is considering
the franchise agreement and its ramifications.
Although there are cases where territories are not appropriate (see
below), in the majority of cases a franchisor will divide up New
Zealand into concise and separate territories which will be allocated
to each new franchisee. These territories will be carefully defined
on separate maps and a typical clause in the franchise agreement
will 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
In our opinion, some franchisors make the mistake in the early
days of giving franchisees too big a territory. This may appear
attractive to the buyer and therefore make a franchise easier to
sell, but it can lead to problems in the future. If a franchisee
does not or cannot service the full area and therefore exploit it
to its maximum potential, there will be a gap in the market in the
area which will encourage the growth of competition. At the same
time, the franchise will be restricted in its growth.
While a franchisor might recognise the problem of having granted
too large a territory, if a map is attached to the franchise agreement
which clearly delineates the territory's boundaries then the franchisor
cannot alter that contractual arrangement without agreement by the
franchisee. As you can imagine, in most cases that is by no means
an easy thing to do.
It is therefore the case that some franchisors cover their position
by reserving in the franchise agreement the right to 'take back'
part of the territory by redefining the boundaries during the term.
This may apply if in the future (perhaps when the system has become
established) the territory is not, or has become incapable of, being
serviced to 'maximum potential'. Such a provision may be framed
in the franchise agreement as an absolute right or in the franchisor's
discretion (reasonable or otherwise). While this is not necessarily
unreasonable, a franchisee should beware 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 of
kilometres] radius from the premises."
Exclusivity of Franchise
What a franchisee always 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 clause which we have come
across in one or two franchise agreements which gives certainty
and which is clear and unequivocal 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 to the proposed operator of the proposed
franchise. The existing franchisee, subject to meeting all new
franchisee criteria, shall be offered a 21 day first right of
What can be seen with 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 above
clause usually runs on and says the following:
"If the franchisor considers the franchisee is capable
of operating the proposed franchise 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.
It is important that both parties act in good faith towards each
other. The subject matter of the territory, regardless of how a
clause may be drafted, is always a crucial consideration and it
is absolutely essential for a prospective franchisee not to enter
the franchise with the wrong idea about the territory and its boundaries.
One franchisor for whom we act retains the right to put a second
franchisee in the first franchisee's territory should there be reasonable
grounds for doing so. However, in such a case the franchisor agrees
to share the initial franchise fee payable by the second franchisee
on a 50/50 basis with the original franchisee. The relevant clause
has been drafted to read as follows:
"The franchisor shall have the right to appoint an additional
franchisee in the territory if the franchisor reasonably determines
that existing demographic data or actual comparative evidence
or other reasonably based financial assertions indicate that there
is an opportunity for an additional franchise in the territory
without detracting substantially from the business conducted by
the franchisee, in which case 50% of any franchise premium gained
by the franchisor from the sale of such new franchise shall be
paid to the franchisee."
We assert that the main principle which should flow through the
right of a franchisor to appoint an additional franchisee within
the original franchisee's territory should be one of reasonableness
and fairness. It is quite wrong to punish an existing franchisee
who is working extremely hard merely by saying that there is room
for another franchisee.
The franchisee may also be a 'forward thinker' and anticipate the
possibility of owning more than one franchise. In this event, and
depending on circumstances, it may be convenient to have adjacent
or neighbouring territories. If that is the case, the franchisor
may be amenable to the inclusion in the franchise agreement of an
option in favour of the franchisee to take an additional territory
(bounding on the original territory) upon notice being given to
the franchisee by the franchisor of its requirement for a new outlet
to be opened in the adjacent territory. Failing exercise of that
option within a specific period, the franchisor itself would then
be able to open the outlet in that territory or offer the territory
to a new franchisee.
As we mentioned earlier, some franchise systems prescribe no territories
whatsoever. In some cases, retail franchises are defined by location
(such as a specific shopping mall). The creation of a new mall or
roading network locally may change the dynamics of an area. Vehicle-based
franchises may have defined areas for marketing purposes, but the
realities of, say, having a customer with locations in another territory
may mean working in another's marketing area. Some businesses, such
as mortgage broking, may be so heavily dependent on referrals for
lead generation that even to have defined marketing territories
would be unfairly restrictive.
Where no territory - or no exclusive territory, at least - is granted,
franchisees may be understandably concerned about the potential
for 'saturation' of the area of a new franchisee's proposed operation
- ie. how far is the new franchisee going to travel to get business?
This is especially relevant in the case of a new system where there
are no actual (as opposed to hypothetical or anticipated) figures
to justify a viable business.
The logical reaction for a franchisee is to request a limit on
the number of franchisees to operate in a wider area. Although this
can also be counterproductive because it may stultify the establishment
of and/or the growing of brand awareness to the public, it can work.
For example, the Auckland area is often divided into, and granted
by reference to, five territories - North, East, South, West and
Central Auckland. If the alternative 'no-territory' option is utilised
then a franchisor may say, effectively: 'Go for it all over Auckland!'
Invariably, what happens in this latter case is that franchisees
want to work areas reasonably near to where they live. However,
this would not preclude a franchisee who lives on the North Shore
from servicing a customer who lives at West Auckland if the job
is worth battling the traffic for. Also, relatives and friends of
a particular franchisee may want to be looked after by that particular
person, regardless of where he or she might live.
Know The Rules
In summary, territories or the lack of them is an interesting area
of franchising which, in our opinion, will rear its head more and
more often as franchising matures in this country. The territorial
provisions in longer-standing franchise agreements are often a basis
for dispute, and in a traditional franchise agreement there are
often good grounds for franchisees to jump up and down. Too often
a franchisor in the early years has granted franchises which have
attached too large an area or territory to the franchise and the
franchisor is now suffering as a result.
A franchisor must be fair to each particular franchisee but must
also abide by the provisions of the franchise agreement. For new
franchisors, note that it is easier to give a person a limited area
and to agree to widen it if the business is succeeding than to give
a person a large area and to take it away or subdivide it if the
territory is not being utilised to its maximum potential.
The lessons for potential franchisees are:
- Take professional advice from experienced franchising lawyers.
- Analyse the area you are being granted for strengths and weaknesses.
- Seek confirmation in writing where verbal assurances are given
(eg. 'We are only going to appoint 20 franchisees throughout Auckland').
- Know what you are getting into in relation to all aspects of
the franchise agreement but particularly in relation to
This article first appeared in Franchise New Zealand magazine
- see www.franchise.co.nz
for more information.