Q: What do I need to know about franchise territory rights

“Can my franchisor appoint another franchisee two kilometres away from me – I thought my location was exclusive?” …is a question you should know the answer to before you sign your franchise agreement.

One of the more significant things you purchase when you become a franchisee is the right to sell the products/services associated with the business within a specified territory.  That makes territorial rights clauses among the most important provisions in your franchise agreement.  This article will provide you with some guidance on what to consider when reviewing territorial rights provisions.

Read the FDD and the franchise agreement

Provincial franchise legislation requires franchise disclosure documents (“FDDs”) to include a description of:

  • any exclusive territory granted to the franchisee;
  • the franchisor’s policy as to whether the continuation of an exclusive territory depends on the franchisee achieving certain conditions and under what circumstances exclusivity may be altered; and
  • the franchisor’s policy on the proximity between an existing franchise and another franchisee, any other distributor using the franchisor’s trademarks, corporate-owned stores, and any franchises granted by the franchisor that distribute similar products under different trademarks.

Case law also suggests that if a franchisor is not granting any exclusive territory, that should be disclosed in the FDD as well.

Accordingly, and as a first step, you should spend the time required to carefully review the territory provisions in the FDD (and the proposed franchise agreement itself) and obtain legal advice so that you understand their impact.

Types of territories

Territories are typically demarcated by geographical boundaries, postal code areas, as being within a certain radius from the location or may be restricted to the building in which the franchise is located.  Just because your franchise agreement says you have a “territory,” however, does not mean you can assume it is exclusive.  Territorial rights come in many shapes and sizes, the most common of which are explained below.

Non-exclusive territory

If the franchisor grants you a non-exclusive territory, you have no assurance that the franchisor will refrain from competing against you by means of other franchisees or corporate-owned stores in your territory.

Exclusive territory

On the other hand, if the franchisor grants an exclusive territory to you, it agrees not to compete with you within your defined territory.  However, franchise agreements typically reserve to the franchisor the right to do specific things within your territory that do not violate your exclusivity and specify circumstances in which your exclusivity may be altered or revoked.  You will want to examine these provisions, examples of which are provided below, very carefully.  The nature and extent of your “exclusivity” often depends on the rights the franchisor reserves to itself.

Typical reservations of rights provisions

Some examples of the more common rights reserved by franchisors include the right to sell products/services within a franchisee’s exclusive territory:

  • to certain “house accounts,” or institutional customers, of the franchisor;
  • through alternate distribution channels, such as via the internet, mail order or telephone; and
  • in kiosks, temporary “pop up” locations, and other satellite locations (such as in stadiums, arenas, airports, and supermarkets).

Other examples include the right for the franchisor to use:

  • the system trademarks to identify products/services, promotional and marketing efforts or related items, and to identify products/services similar to those sold by the franchisee but made available through alternative distribution channels; and
  • other trademarks to market the same or similar products/services.

Reservation of rights clauses also typically make clear that the franchisor may establish or operate other franchise locations outside of the exclusive territory.

Typical requirements to maintain exclusivity

As noted above, franchisors also frequently impose various performance requirements when granting an exclusive territory.  For example, the franchisee may be required to achieve a minimum level of sales, failing which their exclusivity may be reduced or lost.  Alternatively, some agreements provide the franchisee with a right of first refusal if the franchisor decides the territory can support additional franchisees.  If the franchisee does not exercise this right, the franchisor is at liberty to offer the franchise to another and adjust the existing franchisee’s territory.

Some questions to think about

When considering the territorial rights provisions in an FDD or proposed franchise agreement, you will want to consider (among others) the following questions:

  • How is your territory demarcated? Is the territory appropriately sized and configured for your intended business? Are there any ambiguities in how your territory is defined that need to be clarified?  Can you negotiate the size of your territory (or your specific location within it) with the franchisor now, or when the agreement renews?
  • If you have an exclusive territory, can you realistically achieve whatever the requirements are to maintain that exclusivity going forward? Are you prepared to live with the consequences if you don’t?
  • If your territory is non-exclusive, do you trust the franchisor not to cannibalize your business by appointing additional franchises nearby?
  • What is the anticipated impact on your business of the rights reserved by the franchisor?
  • If you have a right of first refusal to establish another franchise, will you have the capital and other resources required to do so?
  • What are the franchisor’s current plans for territories adjacent to yours?
  • Does the agreement address what happens if the franchisor acquires another brand with franchisees in your territory?
  • How does the franchisor deal with encroachment disputes between franchisees (and you should also obtain details about any past encroachment or territory disputes between franchisees)?

We hope the above tips will assist you in better understanding the territorial rights provisions in franchise agreements.  Franchisors are sometimes willing to negotiate these provisions, and it is always best practice to ensure you understand your rights (and get answers to any questions you have about them) before signing the franchise agreement

Brad Hanna / Lauren Ray
Partner / Associate
McMillan LLP
Brad.Hanna@mcmillan.ca / Lauren.Ray@mcmillan.ca