Protected and Exclusive Areas in Franchising

By Michael H. Seid, Joyce Mazero

You must understand what, if any, protections your franchise agreement provides for your site and the surrounding area. You need to understand the concepts of territorial exclusivity and encroachment before — not after — you sign your franchise agreement.

Suppose you open a franchise on the corner of Fifth and Main. Some years later, another franchisee from the same system opens a franchise on Fourth and Main. The new franchise is so close that you can see your customers going in and out of the new location. That’s what is called encroachment. Whether encroachment is allowed depends on your franchise agreement.

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

Your franchise agreement may grant you an exclusive or protected area. Say your franchisor has granted you an exclusive 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 to open closer than a mile from your store.

Your franchise agreement provides you with a protected territory. Encroaching from another franchisee- or company-owned location opening in your protected territory may be allowed. Your franchisor may also sell products in other locations — such as a supermarket or a convenience store — in your protected territory.

With an exclusive territory, encroachment can occur through Internet sales (if customers can buy through e-commerce the same products you sell) or catalog sales (from catalogs mailed into your market). It can also happen if your franchisor’s affiliate allows others to offer similar products and services in your neighborhood under a different business name. It depends on what the franchise agreement says about your territorial protection.

Some franchise agreements state that a franchisor or its affiliate may sell items through other channels of distribution (like catalog or online sales) or establish other units under different names and trademarks in direct competition with a franchisee. Because e-commerce sales don’t require the establishment of a location, they may not legally be encroachment unless specified. Never assume you have rights not provided in the agreement.

One of the reasons you chose to be part of a branded system is that 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’re part of a weak brand with little penetration and you’re unable to advertise sufficiently. Good franchisors try to achieve a balance to create brand recognition in the marketplace and, therefore, create more demand for the products and services of the franchised brand so that everyone in the chain can benefit.

You need to know — before you sign the franchise agreement — whether the franchisor will be able to open locations in your market area. Your co-author Joyce Mazero, lead franchise attorney at Gardere Wynne Sewell LLP in Dallas, Texas, cautions: Contracts normally tell you what the franchisor is granting, such as the right to operate a site, but sometimes don’t plainly tell you what it’s 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’re getting is just as important as what you’re not getting.

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