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Many retail
franchise companies may soon find themselves in conflict
with their franchisees over the enticing opportunities
offered up by the internet.
The
potential for conflict 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 of them 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 -- for
example by requiring them to sign one-sided agreements
benefiting only the franchisors when existing agreements
come up for renewal, or perhaps before.
Instead,
franchisors should step carefully to ensure that they share
the opportunities of e-commerce with their franchisees,
putting the promise of internet business within the reach of
both parties.
Like many
other 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 that their plans conflicted with existing agreements
giving their franchisees exclusive rights to operate within
specific territories, thus shielding them from competition
not only from other franchisees but also from their own
franchisors.
Geography
is crucial to franchise retailers of perishables such as
pizzas and hamburgers, which must locate near their
potential customers to do business. It is less important to
retailers of nonperishable products such as books, CDs,
computers, electronic supplies, and the like, which can
locate wherever they have access to good transportation.
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The
"exclusive territory" provisions in many older agreements,
signed before the advent of e-commerce, commonly prevent
franchisors of both perishable and
nonperishable goods from competing against their franchisees
in their protected territories at all. 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. In one recent legal ruling, for example, the
decision went entirely in favor of the franchisor, freeing
it up to engage in e-commerce. Another protected the
exclusive territories of franchisees by permitting the
franchisor to sell in protected areas via the internet only
if it funneled all orders through local franchisees.
There are probably hundreds of older, often vague agreements
now in force in Southern California and very possibly more.
These agreements cover a wide variety of franchise
businesses ranging from gift retailers to pet suppliers, and
the parties to these agreements must work carefully through
a number of difficult issues if they want to continue doing
business together.
As a rule franchisors do not leave franchisees much room to
negotiate the terms of their agreements upon renewal. In
fact, most can require franchisees to accept the terms of
the franchisor's "then current" agreements upon renewal --
meaning the agreements used by the franchisor when signing
up new franchisees.
In essence, this can make renewing a franchise agreement a
take-it-or-leave-it proposition for franchisees. For
franchisors, it may constitute a temptation to take
advantage of their strength by reserving for themselves the
right exclusively to engage in e-commerce.
State law in California contains many provisions protecting
franchisees, but not when |
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it comes to sharing the promise of e-commerce. For example,
California requires that franchisors get the approval of the
state Department of Corporations for any uniform franchise
offering circulars they propose to use in this state.
California law also requires that franchisors get the
department's approval for any "material modifications" to
existing agreements before presenting them to franchisees. These may include new
provisions reducing or enlarging the rights or obligations
of either franchisor or franchisee, including new or
increased royalties or fees or, to be sure, rights to engage
in internet commerce.
For the most part, however, these are bureaucratic burdens;
the Department of Corporations seeks to police aggressive
franchisors, but it typically does not withhold approval. It
does require that franchisors clearly disclose the impact of
any material changes so that franchisees understand them.
Even so, franchisors often have the upper hand when renewing
existing agreements. Most require franchisees to show that
any leaseholds material to their franchise operations run
concurrently with the agreement, which can last as long as
20 years. Many require retail franchisees to refurbish their
outlets as a condition of renewal, making them look
new-built, and to undergo training to keep up with current
business practices. Many reduce the exclusive territory
available to the franchisee or increase the royalties or
fees payable to the franchisor; some require the payment of
a renewal franchise fee.
Because these requirements can involve big financial
outlays, they may provoke disputes that can threaten the
relationship between franchisor and franchisee. Indeed, in
the franchise business as in any other, financial disputes
between the parties can wreck any undertaking, particularly
when the parties both seek to pursue the benefits of
e-commerce.
Many such disputes loom in the near future as the franchise
industry adjusts to e-commerce. Clearly, franchisors and
franchisees 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, specializing in franchise law. He may be
reached at
bkurtz@barrykurtzpc.com,
818-728-9979.
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