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Bulletin

Is the Territorial Exclusivity Clause Now Obsolete?

Fasken
Reading Time 5 minute read
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Overview

Franchising bulletin

A territorial exclusivity clause in a franchise agreement grants the franchisee a form of exclusivity to operate a franchise of the franchisor's network in a territory delimited in the agreement.

Although, on the surface, such a clause seems simple to draft (do we not just need to describe the territory and stipulate that the franchisee is exclusive in it), experience in franchising shows that, over time, it can raise several important issues.

First, it is very important to describe very clearly and precisely the territory to be covered by the exclusivity, which is not always as easy as one might think. For example, does a territory delimited by street names include both sides of each adjacent street? In the case of a territory described by municipality names, what happens if the boundaries of a municipality change, for example as a result of a municipal amalgamation? Over the years, we have therefore seen several major disputes between franchisors and franchisees resulting from insufficiently clear and precise drafting of the territory covered by the exclusive rights granted to the franchisee.

Secondly, the nature of the exclusivity granted to the franchisee must also be clearly defined.

In this regard, there are two main categories of exclusivity: operating exclusivity and location exclusivity.

Operating exclusivity gives the franchisee the exclusive right to operate, for the duration of the franchise agreement, a franchised business within the territory defined in the agreement. As we will see below, this is a form of exclusivity which may raise several questions.

Location exclusivity is somewhat more limited. It gives the franchisee the exclusive right to establish a franchised business in a physical (“brick and mortar”) location situated within the contractually defined territory. Unlike operating exclusivity, however, it does not give the franchisee the exclusive right to operate a franchised business in that territory. Thus, the franchisor and other franchisees may also do business in that territory by advertising, providing services or delivering goods, provided that they do not establish a physical location.

In some cases, there is also a third form of exclusivity, namely the use of the franchisor's trademarks. As the name suggests, this exclusivity gives the franchisee the exclusive right to use the franchisor's trademarks in the territory defined in the agreement.

Until the early ‘90s, almost all franchise agreements contained territorial exclusivity provisions.

However, as we all know, the world of commerce and business is constantly changing in all sectors of activity.

Thus, in a growing number of circumstances, territorial exclusivity provisions, which were intended to protect the franchisees’ investments, have begun to constitute obstacles to the healthy development of networks.

First, several franchisors found that the exclusive territories granted to their first franchisees were too large, which limited the development of their network in markets that the exclusive franchisees were not able to develop sufficiently, thus leaving the field open to competitors of the network.

Secondly, due to significant population growth or new developments in a territory (such as a major shopping mall, an important residential project or a new commercial district), territories that were well defined at the time of signing the agreement also became obstacles to network development, again to the benefit of their competitors.

Thirdly, franchisors who have granted their franchisees territorial exclusivities have been prevented from carrying out projects or entering into transactions that benefit their network, including, among others:

  • Converting to their franchise concept independent or affiliated establishments of other networks located in a territory for which a franchisee had been granted exclusivity;
  • Acquiring an independent business or a business affiliated with another network;
  • Acquire a competing or complementary network;
  • Establishing and operating, or allowing a franchisee to establish or operate, a network facility in a non-traditional location (e.g., inside a big-box store, grocery store, airport, train station, hospital, university, arena, sports centre, business, etc.) or in connection with special events (e.g., an exhibition, trade show, fair, or major cultural or sporting event).

At the same time, some franchisors were also faced with significant questions regarding the territorial exclusivities already granted to franchisees when they wanted to develop, or acquire, other franchise concepts or launch modified versions (for example, an express format, a counter service establishment, a kiosk or a combination franchise) of their existing concepts.

In order to deal with such issues, many franchisors have decided to no longer grant territorial exclusivities to their franchisees, while others have attached various limitations, exclusions and exceptions to such exclusivities.

More recently, with the increasingly rapid evolution of technology and modes of distribution of services and products (even more so since the onset of the COVID-19 pandemic), new important issues have been added to the already long list of challenges posed by territorial exclusivity provisions granted to franchisees.

Among these new issues, we find, at the top of the list, important questions raised by:

  • The delivery of products by the franchisor, by one or more franchisees or through external businesses and platforms specialized in delivery;
  • The offer, promotion and sale of products or services made online or by telephone;
  • The promotion and sale of products or services through social networks;
  • Ghost kitchens (where products from multiple restaurant chains are prepared at a single location for delivery purposes only), and
  • Sites that promote and sell the products or services of multiple companies (such as, for example, Amazon, Panier bleu, Etsy and many others).

Also, several sectors of activities are experiencing a phenomenon of integration. We therefore find more and more franchisors wishing to develop or acquire additional banners, which also often raises important questions regarding the territorial exclusivities granted to franchisees of their banners or of banners they wish to acquire.

These new issues mean that, in many sectors of activities, the physical location of a franchise network's establishments plays an increasingly less important role in the sales, revenues and profitability of the franchisor and its franchisees.

As a result, many franchisors now have to revise the mechanisms aimed at protecting their franchisees and their investments in order, at the same time, to maintain the profitability of their franchises and allow the network to take full advantage of opportunities that continue to evolve and change.

For many franchisors, this reflection will involve replacing the territorial exclusivity provisions with new mechanisms of collaboration between franchisors and franchisees that are better adapted to the new market realities, as well as the implementation of new mechanisms for the distribution of investments, costs, revenues or profits of certain initiatives that cannot be attached to a single franchised establishment.

Fasken has all the experience and resources necessary to help you draft complete and adequate agreements that protect your rights while avoiding potential pitfalls.

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