Territory Franchise Agreement Explained
Territory Franchise Agreement ("TFA") is a franchise agreement for a defined territory. To some degree, all franchise agreements control the areas in which the franchisee will operate its franchised business. However, with a TFA, the franchisor will be raising those controls to be on a territory level. The franchisee will have a defined territory, with a defined population and number of businesses, and as long as the franchisee acts in good faith, the franchisor will not permit other franchises and/or affiliates from operating in that territory.
For example, if we have a pizza restaurant franchise system and a prospective franchisee has a territory that is 1 mile long and ½ mile wide, we know how many schools, churches, daycares, office buildings, etc. are in that territory. In exchange for consideration, such as the franchise fee or royalty, the Franchisor will agree that no other restaurant will be permitted in that defined territory . Going a step further, the franchise agreement is likely to tie the franchisee’s performance, such as sales of products and services, to that defined territory so that the franchisee must concentrate on marketing and expanding its restaurant business where the customer base is located.
Why is all of this important? Well, if a prospective franchisee were to try to "steal" a restaurant concept, such as pizza, without a TFA, at any point, the franchisor can grant another franchise, with no recourse to the initial franchisee because a TFA was not used to contractually bind the franchisee to a defined territory. Moreover, for the franchisor, it is very important to protect the business investment of the franchisee. If the TFA territory is not defined, the franchisee’s return on investment would be difficult to calculate, if not impossible.
What’s Inside A Territory Franchise Agreement
A territory franchise agreement typically contains the following key components to protect both parties:
Territorial Rights and Preserves
Clearly defined territorial rights serve as the bedrock of a territory franchise agreement. They stipulate the precise territory the franchisee has the right to operate within. This often includes the right to identify locations (including reserved locations) and solicit new customers, as well as the right to open multiple business locations in the territory.
Exclusivity Provisions
Every territory franchise agreement should include an exclusivity provision that gives the franchisee an exclusive right to market the franchisor’s goods and/or services within the territory. These provisions make it clear that the franchisor cannot later enter into a new agreement, with another franchisee or an affiliate, to allow someone else to conduct similar business within the franchisee’s territory. It also typically includes a right to request that the franchisor seek approval from the franchisee before agreeing to enter into a marketing agreement within the territory or otherwise distributing or licensing like goods or services within the territory.
Territorial Boundaries
These provisions describe all business locations that belong to the new franchisee. They set forth the specific geographic boundaries for the franchisee’s territory, as well as provisions governing how these territorial boundaries will be adjusted if a franchisor grants new agreements within the territory to other licensees. Requiring territorial boundaries allows franchisees to better assess their ability for success within the franchise.
Franchisee Advantages
These agreements benefit the Franchisee in several ways. The Franchisee is given a territory where they can conduct business without competition from other Franchisees of the Franchisor. This market exclusivity allows Franchisees to develop market share and concentrate their efforts over a large area without concern for competing Sergeants or other affiliates of the Franchisor.
In negotiating this agreement, the Franchisee can and should obtain from the Franchisor some general guidelines that will give the Franchisee a certain degree of authority in their own market. For instance, the Franchisee may be given the authority to set the prices for the services and/or products that they sell. Oftentimes a Franchisee will be given the authority to employ or terminate persons for either illegal or nondiscriminatory reasons. These are valuable delegation of responsibility. They are what make the Franchisee actually feel a sense of ownership in the business.
Depending on the distribution agreement that is executed between the Franchisor and Franchisee, the Franchisee may be able to expand business into adjacent territories as long as the those territories have not been sold to other Franchisee’s. With the option of expanding into adjoining territories, it is possible to build a virtual empire without any concern over competing business owners and to build a brand over the entire region. The agreement allows for such expansion by being written as a Franchisee and not as a Sub-Franchisor.
The Franchisee also receives support from the Franchisor as they begin their business. For instance, many Franchisors will provide training and an initial supply of business materials, marketing/advertising and advice about how to best promote their business. This is very beneficial to an inexperienced business owner as they are receiving excellent advice from a source that has extensive experience in the development of this business.
Franchisor Gains
As suggested above, the obvious advantage to you as a franchisor is that there are no worries about customers being served by another franchisee, or your services being provided to customers in any territory other than that contracted for. In addition, it is usually a requirement of all franchisees that the services that they provide must be consistent. This avoids the promotion of competing brands and diminishes confusion in the eyes of the customer. Each service that is sold by any franchisee becomes a collective service. It also offers a good level of exclusivity to the franchisor as new franchisees will be bought into a specific location , as opposed to absolute specific areas. From an expansion perspective, the franchisor can begin to consider expanding into having multiple sites, as opposed to having multiple businesses and outlets. Having multiple outlets can make the business appear a lot more prestigious and serious, and franchising is one of the quickest ways to grow a business and brand image. In addition, each territory can be licensed out, which provides the franchisor with a constant stream of revenue from all of the individual costs that go into developing a new franchise, and you benefit from the franchisee funding their own site, whilst you still maintain a low or no infrastructure.
Potential Pitfalls and Solutions
Territorial franchise systems may encounter some challenges that other types of franchising models do not, particularly when it comes to the size of the territory and market saturation. Franchisees in a territorial franchise may have a more difficult time with market saturation. This can happen when there is an overwhelming number of franchisees in one area, which creates significant competition among the franchisees. This often happens when franchisors don’t do proper market research before offering franchises—instead of determining the proper market size for their business, a franchisor might choose to go ahead and sell as many franchises as possible from the beginning. This problem can be exacerbated by royalty structures that provide franchisees with less of an incentive to safeguard their territory and more of an incentive to expand out of their territory in order to seek more profits. To maintain good relationships, and avoid creating hostility among franchisees, franchisors must set and monitor some kind of restriction on the number of franchisees allowed in a given territory. Additionally, the franchisor should impose some sort of restriction on franchisees from roaming into other franchisees’ territories. Another issue is territorial disputes. These can occur when a franchisee feels that the franchisor has not been upholding the promise of exclusivity in their territory, by allowing other franchisees to join the system in their territory or by opening more company-owned locations in their territory. Again, the franchisor should have policies in place that restrict this behavior, providing consistency and predictability. Finally, since most territorial franchise systems tend to be much more localized than other types of franchises, franchisees in these types of arrangements are more likely to face disadvantage due to local laws, such as zoning and licensing regulations. Franchisors should therefore make a policy to help franchisees navigate local laws and provide some resources to assist with these matters. This can be particularly important when dealing with potential expansion as the franchisee develops their business.
Legal Insights and Strategies
When entering into a territory franchise agreement, both the franchisor and franchisee should take the time to consult with an experienced franchise attorney. Franchise agreements are governed by both contract law and franchise law. The Franchisor’s experience and expertise in creating franchise agreements expresses itself most clearly through legal counsel. Correctly setting forth the rights and obligations of both parties is essential to a successful relationship. While many industry players and franchisors are tempted to use outdated agreements and clauses, or attempt to "find forms" online, engaging legal counsel is key to achieving both parties’ goals. A contract that clearly states important terms and provisions is essential to the sustainability of the relationship.
In an ideal world, a franchisor would take the contractual relationship in its own hands. However, this is not possible, as the franchisee is entering into a long-term relationship with the franchisor and must be properly informed. In certain circumstances a relationship exists even before a Franchise Disclosure Document ("FDD") is issued, and as such a franchisee is entitled to rely on the information supplied. State laws vary, but in some cases even the existence of a franchisee’s right of first refusal may need to be disclosed. In other cases, a franchisee’s relationship with the franchisor may be longer than per the current franchise agreement, as there may be an implied extension of the relationship . This may be due to an agreement related to supply chain or supplier relationships.
Franchisors must ensure that the terms of the agreement reflect the mutually agreed upon obligations and rights. For example, a franchisor cannot offer a renewal clause if it cannot or does not intend to allow franchisees to renew or stay on board for a set period of time. Many instances exist between franchisors and franchisees where the alternative understanding does not match with what the written documents state, but this cannot be permitted or condoned by either party.
But what happens if a franchisor does decide to part ways with a franchisee before the end of the relationship? Essentially, the concept of good faith and fair dealing implicitly exists in every agreement under Florida law, whether it is expressly stated or not. This means that both the franchisor and franchisee’s conduct during the term of the relationship must be fair, without malice or bad faith. This means that the parties may not engage in efforts to hurt the other party’s business. Both parties owe a duty of good faith at the start of the relationship, as well as throughout the life of the agreement.
Legal counsel will assist you in drafting, editing, and most importantly, analyzing the terms of your agreement, providing objective opinions, and representing you in the terms of the contract. As discussed above, the drafting and negotiation of a territory franchise agreement requires an overarching goal. This goal is to protect both parties and afford them the proper rights and remedies if things go wrong.