Territorial Disputes Over Internet May Arise at Franchises

Entrepreneur's Notebook
by Barry Kurtz

Many retail franchise companies may soon find that opportunities offered by the Internet create a new source of conflict with their franchisees.

This stems from the "exclusive territory" provisions in many older franchise agreements, including a number due to come up for renewal in Southern California over the next few years. These provisions may not permit franchisors to engage in electronic commerce, with the result that, just as many face limits on growth in a faltering economy, they also risk trouble with their franchisees if they try unilaterally to expand into e-commerce.

The solution, however, is not for franchisors to try to block franchisees from engaging in e-commerce altogether. Instead, franchisors should ensure they share the opportunities of e-commerce with their franchisees, putting the promise of Internet business within the reach of both parties.

Like many old-economy industries, franchisors sought to grasp the potential of the Internet to revolutionize retailing in the mid-1990s. Many franchisors of retail goods, however, found plans conflicted with existing agreements giving franchisees exclusive rights to operate within specific territories.

Geography is crucial to franchise retailers of perishables such as pizzas and hamburgers, which must locate near their potential customers to do business. The "exclusive territory" provisions in many older agreements, signed before the advent of e-commerce, commonly prevent franchisors from competing against their franchisees in their protected territories. But most existing agreements either do not make it clear which party has the right to sell over the Internet or, because they say nothing on the subject, may lead franchisors to think that they can do so, even in competition with their franchisees.

If they want to continue doing business together, the parties to these agreements must decide whether one or the other will have the exclusive right to engage in e-commerce or whether they will share the opportunity, and if so, under what terms. The alternative is to allow the legal system to decide for them, very possibly with unhappy consequences to both parties.

California law does contain provisions protecting franchisees, but not when it comes to sharing the promise of e-commerce. The state requires franchisors to get approval from the Department of Corporations for any "material modifications" to existing agreements before presenting them to franchisees.

Even so, franchisors often have the upper hand when renewing existing agreements. Most require franchisees to show that leases material to their franchise operations run concurrently with the agreement, which can last as long as 20 years.

Many disputes loom in the near future as the franchise industry adjusts to e-commerce. Clearly, franchisors and franchisees alike must avoid trampling on each other because it is in the interest of each that the other prosper.



Barry Kurtz is of counsel to the law firm Greenberg & Bass LLP, Encino. He may be reached at bkurtz@greenbass.com.

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