For many franchisees, territorial protections are essential to their profitability. Facing competition from multiple businesses serving potential clients or customers both in person and remotely, franchisees need to know that they will not face additional competition from within their own brands.
As we have discussed previously, not all territorial protections are alike. In fact, some franchise “territories” don’t provide any protection at all and instead limit where franchisees have the right to advertise. But, even when a franchisee has clear territorial rights, this doesn’t necessarily mean that the franchisee will be free from intra-brand competition.
What Franchisees Need to Know About Territorial Encroachment
Encroachment is a persistent issue in franchising. While many franchisors grant protected or exclusive territories to their franchisees, many franchisors also infringe on their franchisees’ territorial rights. In most cases, territorial encroachment involves one of three main scenarios:
- The franchisor competes directly in a franchisee’s protected or exclusive territory, either through a brick-and-mortar location or through online sales;
- The franchisor grants an overlapping territory to another franchisee; or,
- A franchisee starts advertising or serving clients or customers in another franchisee’s territory, and the franchisor declines to intervene.
While these are three very different scenarios, they all have similar consequences for franchisees that are forced to deal with encroachment: Sales wane, profitability declines, it becomes harder to make royalty and advertising fund payments while still making payroll, and eventually, they find themselves at risk of default.
So, what is a franchisee to do?
Franchise attorney Jeffrey M. Goldstein recently a franchisee in Iowa who was forced to respond to its franchisor’s efforts to encroach. The franchisor, a truck and equipment manufacturer, developed a new proprietary engine that it believed would require additional service locations. As a result, it recommended that our client, the franchisee-dealer, open an additional dealership at a particular location. Our client chose an alternate location due in part to the fact that it could not find a suitable facility in the franchisor’s desired area. Subsequently, the franchisor sought approval from the Iowa Department of Transportation (DOT) to grant a franchise for its desired location to a different franchisee—and the DOT (and an administrative law judge (ALJ)) approved.
The DOT and ALJ based their decisions on a specific provision of the Iowa Code. Under Section 322A.4 of the Iowa Code:
“No franchiser shall enter into any franchise for the purpose of establishing an additional motor vehicle dealership in any community in which the same line-make is then represented, unless the franchiser has first established in a hearing held under the provisions of this chapter that there is good cause for such additional motor vehicle dealership under such franchise, and that it is in the public interest.”
It is important to note that this provision is specific to vehicle dealerships, and special laws apply to vehicle dealerships in many other states as well.
After reviewing the evidence, the DOT and ALJ determined that despite the fact that the new franchisee would compete with our client in the same “community,” there was “good cause” to allow the franchisor to grant a new franchise for the additional location. Our client appealed, and after the intermediate court reversed, the Iowa Supreme Court vacated the intermediate court’s opinion. Rather than focusing on our client’s entire 71-county territory, the Iowa Supreme Court instead focused on the 23 counties where the new franchisee would be competing as the relevant “community.” Focusing on this area specifically, the Iowa Supreme Court found that good cause existed to grant an additional franchise—despite recognizing that our client would face intra-brand competition as a result.
In a sharp dissent, Justice McDonald wrote that the majority’s efforts to protect the franchisor’s interests were misguided. Noting that “[n]umerous other states have enacted identical or substantially identical statutes,” Justice McDonald acknowledged that the purpose of these statutes is to address “[t]he unequal bargaining power between franchisees and franchis[ors].” In concluding that our client should not face intra-brand competition in its territory, Justice McDonald wrote that “[b]y ignoring the legislature’s own definition of ‘community,’ the majority actually undermines the purpose of the statute—to protect a franchisee against franchis[or] infringement in the ‘franchisee’s area of responsibility as stipulated in the franchise.’”
What Should Franchisees Do When Faced with Territorial Encroachment?
For franchisees that are dealing with territorial encroachment, the first place to look is their franchise agreement. To make informed decisions, franchisees need to have a clear understanding of their contractual rights. How does the franchise agreement define their territory? Are there any carve-outs or conditions? In the event of encroachment, can the franchisee go straight to court, or must the franchisee pursue alternative dispute resolution (ADR)?
But, while a franchisee’s franchise agreement is the first place to look, it is not the last. In many cases, state law will come into play as well. If not an industry-specific law like the vehicle dealership laws that exist in many states, then maybe a state franchise law that requires franchisors to act in good faith and deal fairly with their franchisees. Of course, the courts’ interpretations of these laws matter too, and it will be important to engage an experienced franchise attorney who can help you determine what contractual, statutory and common law rights you have available.
Ultimately, a franchisee’s rights in any encroachment situation will depend on the specific facts and circumstances involved. In any case, as a franchisee, it will be worth speaking with an experienced franchise lawyer to learn about your options. Informed decision-making is critical, and whether you need to pursue ADR under your franchise agreement, assert your rights under a state franchise law or find another way to deal with your situation, an experienced franchise attorney will be able to help you choose the best path forward.
Request a Free and Confidential Consultation with Franchise Attorney Jeffrey M. Goldstein
If you need to know more about your legal rights as a franchisee facing encroachment, we invite you to get in touch. To request a free and confidential consultation with franchise attorney Jeffrey M. Goldstein, please call 202-293-3947 or inquire online today.