General Practice, Solo & Small Firm DivisionBest of ABA Sections

FALL 1997  

Franchising

Drafting Exclusive Territory Provisions in Franchise Agreements

Charles Modell

Start-up franchisors frequently must provide some territorial protection to prospective franchisees in order to sell franchises. Assuming your client must grant protected territories, what should be included in the contract to protect both franchisor and franchisee?

A typical radius provision for a full-service restaurant might read as follows:

The Franchisor hereby designates an area within two miles of the approved site of the [Restaurant] as the Franchisee’s exclusive area (the Exclusive Area). The Franchisor will not, during the term of this Agreement, license any other franchisee to operate an (XYZ) restaurant, or establish any company-owned (XYZ) restaurant, within the Exclusive Area.

What if two prospective sites are separated by natural boundaries or the sites are separated by physical boundaries that prevent travel between the two locations? To address these situations, the provision might be expanded:

 

This two-mile area shall be measured by the shortest route an automobile would travel.

But open issues remain. What if a river runs between two sites so that the second cannot be reached from the first by any direct means, but a bridge is later built between the two locations? The day the bridge opens, the second location will infringe upon the first. Clarification is needed:

This two-mile area shall be measured by the shortest route an automobile would travel when driving away from the parking space nearest to the front door of the [Restaurant], on routes open at the time the [Restaurant] initially opens for business.

This language clarifies measurement of the route but what if the first restaurant closes or relocates? Additional language is required:

If the [Restaurant] closes, then the Exclusive Area shall terminate. If the [Restaurant] is relocated, then this area shall be measured based on routes open at the time the new location initially opens for business and the former area shall no longer be part of the Exclusive Area.

This addition clarifies the franchisee’s exclusive territory. It does not, however, clearly state the franchisee’s rights outside that territory. Scheck v. Burger King (756 F. Supp. 543 (S.D. Fla. 1992)) held that language stating the franchisee had no exclusive territory was not sufficient to permit the franchisor to open another location a mile away. Since the contract did not specifically give the franchisor that right, the implied duty of good faith and fair dealing might be invoked to show the franchisor was acting unreasonably. A careful drafter should clarify that the franchisor retains the right to grant franchises or operate company-owned restaurants outside the protected territory:

The Franchisor may license others to operate an (XYZ) restaurant, or operate a company-owned restaurant, at any site located outside the Exclusive Area, even if that restaurant competes for customers within the Exclusive Area.

However, this still ignores future development of the system. Franchisors now operate multiple brands. To clarify these rights, add:

In addition, the Franchisor or its affiliates may license or operate other restaurants using trade names other than (XYZ), either within the Exclusive Area, or outside the Exclusive Area, even if such restaurants offer menu items similar to those offered in the Franchised Restaurant.

Recently, franchisors have developed nontraditional sites that can accommodate new units. If the drafter initially fails to except out such locations, the franchisor may have to pay for a future "carve-out." Another paragraph is therefore needed:

Notwithstanding the foregoing, enclosed malls, institutions (such as hospitals or schools), airports, parks (including theme parks), and sports arenas, shall be excluded from the Exclusive Area, and the Franchisor may open other (XYZ) restaurants, or franchise the right to open (XYZ) restaurants to other persons at any of these locations, regardless of where they are located.

If the franchisor uses this same form of contract for nontraditional locations, it must clarify the territory given to these franchisees:

If the [Restaurant] is located in an enclosed mall, institution, airport, park or sports arena, then the Franchisee’s Exclusive Area shall be limited to the confines of that mall, institution, airport, park or sports arena.

Franchisors are also finding new channels of distribution for their products such as catalogs, convenience stores, and snack bars. Franchisors must consider the impact these new channels of distribution will have on existing units. If their impact on existing franchisees will not be significant, and they wish to reserve the right to distribute their products through these additional channels of distribution:

The Franchisor may also sell (XYZ) branded products at other establishments (including, but not limited to, convenience stores, grocery stores and snack bars) within the Exclusive Area so long as such establishments do not principally identify themselves as "XYZ" restaurants.

The complete clause is far more detailed than the simple radius clause first envisioned, but it should give most franchisors flexibility to grow their systems while providing adequate protection to franchisees against traditional, and some nontraditional, forms of encroachment.

The Franchisor hereby designates an area within two miles of the approved site of the [Restaurant] as the Franchisee’s exclusive area (the Exclusive Area). The Franchisor will not, during the term of this Agreement, license any other franchisee to operate an (XYZ) restaurant, or establish any company-owned (XYZ) restaurant, within the Exclusive Area. This two-mile area shall be measured by the shortest route an automobile would travel when driving away from the parking space nearest to the front door of the [Restaurant], on routes open at the time the [Restaurant] initially opens for business. (If the [Restaurant] closes, then the Exclusive Area shall terminate. If the [Restaurant] is relocated, then this area shall be measured based on routes open at the time the new location initially opens for business and the former area shall no longer be part of the Exclusive Area.) The Franchisor may license others to operate an (XYZ) restaurant, or operate a company-owned restaurant, at any site located outside the Exclusive Area, even if that restaurant competes for customers within the Exclusive Area. In addition, the Franchisor or its affiliates may license or operate other restaurants using trade names other than (XYZ), either within the Exclusive Area, or outside the Exclusive Area, even if such restaurants offer menu items similar to those offered in the [Restaurant]. The Franchisor may also sell (XYZ) branded products at other establishments (including, but not limited to, convenience stores, grocery stores and snack bars) within the Exclusive Area so long as such establishments do
not identify themselves as "XYZ" restaurants.

Notwithstanding the foregoing, enclosed malls, institutions (such as hospitals or schools), airports, parks (including theme parks), and sports arenas, shall be excluded from the Exclusive Area, and the Franchisor may open other (XYZ) restaurants, or franchise the right to open (XYZ) restaurants to other persons at any of these locations, regardless of where they are located. If the [Restaurant] is located in an enclosed mall, institution, airport, park or sports arena, then the Franchisee’s Exclusive Area shall be limited to the confines of that mall, institution, airport, park or sports arena.

Unfortunately, no one is clairvoyant. It is, therefore, important to continually review and refine territoriality clauses to meet future challenges.

Charles Modell is a shareholder with Larkin, Hoffman, Daly & Lindgren, Ltd. in Minneapolis, Minnesota.

This article is an abridged and edited version of one that originally appeared in Franchise Law Journal, Fall 1996, (16:2).

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