How to Avoid Encroachment in Franchising - dummies

How to Avoid Encroachment in Franchising

By Consumer Dummies

One thing that gets people talking in franchising is encroachment. You need to understand this concept before, not after, you sign your franchise agreement. Suppose that your franchisor has granted you a protected territory stretching one mile around your location or for a specific trade area outlined on a map. The franchisor then is prohibited from allowing another franchisee or company‐owned location from opening closer than one mile from your store or within the boundaries.

With that agreement in hand, you open a franchise on the corner of Fifth and Main. A year or five years later, another franchisee from the same system opens a franchise on Fourth and Main. The new franchise is so close you can see your customers going in and out of the new location. That’s encroachment.

As in this example, encroaching can come from another franchisee or company‐owned location opening in your protected territory. But it can also happen if the franchisor begins to sell products in other locations — such as a supermarket or a convenience store within your protected territory. It can also happen if the franchisor allows others to offer the same services you sell in your neighborhood.

Encroachment can also occur through catalog sales (from catalogs mailed into your market) or through the Internet, if customers can buy through e‐commerce the same products you sell in your location. It depends on what the franchise agreement says about your protected territory and whether the franchisor can sell its products over the web.

Encroachment is like someone stepping on your toes — only the person doing the stepping is your franchisor, who you thought was your partner. Ouch, that can hurt! On the other hand, you don’t want to be the only one of your brand in the market. Left all alone, you will be vulnerable to competitors who will have no problem with opening next door to you, especially if you are part of a weak brand with little penetration and unable to advertise sufficiently.

Good franchisors try to achieve a balance to create brand recognition in the marketplace and therefore more demand for the products and services of the franchised brand so that everyone in the chain can benefit.

Obviously, encroachment can potentially have an adverse impact on your business. Carefully examine the language of your franchise agreement. Are you getting a protected territory, or do you have no territorial rights? If your franchise grants you only a site address franchise (your protected territory is no bigger than the four walls of your store), the franchisor could conceivably establish other locations nearby that will compete with you.

Some contracts specifically state that a franchisor may establish other units and/or sell items through other channels of distribution in direct competition with a franchisee. Because Internet sales don’t require the establishment of a location, e‐commerce may not legally be encroachment, unless specified in the agreement. Don’t assume you have rights not provided in the agreement.

You need to know — before you sign the franchise agreement — whether the franchisor will be able to open locations in your market area. Joyce G. Mazero, lead franchise attorney at Haynes & Boone in Dallas, Texas, cautions, “Contracts normally tell you what the franchisor is granting, such as the right to operate a site, but don’t always plainly tell you what it is not granting — such as no right to exclusivity outside of the site, no right to conduct business on the Internet, and no right to prohibit the franchisor or another franchisee from operating from a site close to your site. What you are getting is just as important as what you are not getting.”

Don’t rely on a franchise salesperson’s statements about what the system generally does or doesn’t do regarding its locations. Even if the salesperson makes sense when saying that the franchisor would never open a location so close to you that it would adversely affect your business, get the necessary language in writing in the franchise agreement (as with everything else that’s important).

Even where the franchise agreement allows the franchisor to establish new locations close to an existing franchisee, some franchisors establish procedures — adopted internally or with their franchisee advisory councils — to review the impact of encroachment on existing units.

If the encroachment seems that it will cause a prolonged and material adverse impact, they may decide not to allow the development of the new location. If the encroachment appears that it will cause a minor or temporary impact, they may allow the unit to be developed but may also assist the affected franchisee to make up for the lost sales.

Other franchisors simply cite the terms of the affected franchisee’s agreement and allow the unit to open — regardless of the extent of the impact.

Find out what the franchisor’s policies and practices are concerning protected territories and encroachment impact before signing the franchise agreement. Read your franchise agreement; speak to other franchisees in the system, and talk to your attorney.