If you’re purchasing a franchise, it’s important to consider whether your franchisor will grant you an exclusive territory to operate your business. Furthermore, if your franchisor does grant you an exclusive territory, you need to consider the commercial viability of such territory. In any case, this factor should be an essential consideration for every prospective franchisee. But, do all franchisees get an exclusive territory? The short answer is no. However, there are several important factors to consider regarding territories. Let’s take a look at these in more detail.
What is an Exclusive Territory Clause?
An exclusive territory lets you operate the business in a designated area where you can solicit customers, clients or members. For example, if you’re running a gym that works on a membership basis, it’s likely that you can only market and accept memberships within the radius of your territory. Likewise, the clause will generally guarantee that no other franchisee can market or accept memberships in your area. However, in some franchise systems, territories can overlap with one another. It is also important to note that exclusive territories are often subject to change upon renewal or transfer of the franchise agreement. Territories may also be reduced if you don’t meet certain conditions in the agreement such as minimum performance criteria.
The franchisor will determine the exclusive territories according to factors such as:
- market type;
- geographical area;
- access; and
- population density.
The criteria adopted by the franchisor in creating the territory should be set out in the disclosure document given to you as a prospective franchisee. After receiving this document, and before purchasing the business, it’s good practice to undertake due diligence into the market viability of operating the proposed business in the nominated territory.
No Exclusive Territory
Not all franchise agreements grant you a right to an exclusive territory. In the case that you don’t have a right to an exclusive territory, a franchise agreement will typically state that your business operations are confined to specific premises. The specific premises is in a non-exclusive marketing area and cannot move without express written consent from the franchisor. Where there is no grant of exclusive territory, nothing stops the franchisor from opening another franchise close to your business at any point.
Depending on the type of business you are operating, you should consider whether another nearby franchise will have a detrimental impact on your franchise. With some businesses, the lack of an exclusive territory may not be especially worrying. Such businesses may be those with low or small client bases situated in a densely populated area. Conversely, it may be worrying for a business that relies on a broad customer base from a distinct geographical area. In this case, a future franchise grant could significantly reduce a customer base. You should carefully consider this before entering the franchise agreement.
Where your franchise agreement does not grant you an exclusive territory, you can negotiate to obtain a guarantee. Such guarantee can prevent any other franchisee opening within a certain radius of your premises. Alternatively, some franchise agreements will give you a first right of refusal on any location that may open in a proximity where there is no grant of exclusive territory. This clause prohibits the franchisor granting a nearby location to a third-party before giving you the option to operate the location.
Good Faith Obligations
The Franchising Code of Conduct (the Code) applies to all agreements between franchisors and franchisees. In particular, both parties are to act in good faith in their dealings with each other. While the Code does not explicitly define good faith, it can mean any conduct that is:
- unjust; or
- unreasonable in the circumstances.
A franchisee will rely on the exclusivity of the territory when considering whether to purchase the business. Accordingly, if the franchisor takes commercial advantage of the franchisee’s exclusive territory, this may amount to a failure to act in good faith. Additionally, this is a breach of the exclusivity clause. Therefore, a franchisor who infringes on a franchisee’s exclusive territory may not be acting in good faith.
Before purchasing a franchise business, carefully consider whether the franchisor will grant you an exclusive territory. The disclosure document should explain their decision. Ensure you understand the franchisor’s reasoning and conduct due diligence to determine the viability of the franchise. If you need legal advice about your rights when purchasing a franchise business, call LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.
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