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Significance of territorial exclusivity rights of franchisees

India has increasingly attracted global brands to establish their franchise arrangements in the country to benefit from the ever-expanding Indian market. Indian enterprises have also adopted franchise business models to expand in to the vast Indian territories. Typically, under a franchise model the franchisees benefit from the established business systems of the franchisors under a licensing arrangement with the right to use the trade mark and brand of the franchisors, and open franchise outlets for distribution of the products/services of the franchisor, in consideration of payment of franchise fees and/or royalties to the franchisor.

One of the significant area that needs specific evaluation by a franchisee is the right to be granted an exclusive territory of operation to the exclusion of the right of the franchisor to set up other franchisees. Exclusive territorial rights grant a franchisee an assurance of an almost ‘monopolistic rank’ for a particular brand in the territory on an exclusive basis. This exclusivity could be specific to a particular time period or a particular range of products or could be unconditional throughout the term of the arrangement. Typical exclusivity clauses are tied up with certain milestone achievement failing which the exclusivity could automatically drop out of the arrangement. Nevertheless, exclusivity is an important negotiation point that assures the franchisee that it will get the benefits of the entire customer base in his protected territory to the exclusion of other competing franchisees and thereby augment his chances of success. This exclusive area of operation not only allows the franchisee to focus on service delivery without competition from the other competing franchisees but also diminishes any chances of negative impact owing to ‘not so satisfactory’ experience of the customers from other franchisees of the same product/service in the territory. With the focus on delivery of service/product, exclusive franchisee usually benefit with better growth prospects, consolidation and market share.

However, franchisors are usually quite reluctant to grant exclusive territorial rights to a franchisee as it diminishes optimum monetization of their products and services and restricts their right to add new franchise outlets in the area. Further, a non-exclusive arrangement insulates the franchisors from the risk of potential complacency and underperformance by the franchisee. It is also easier to place another franchisee near an underperforming one, than to terminate its arrangement with an underachieving franchise.

Grant of exclusive territorial rights are therefore seen in situations where:

(a)            the franchisor is of a relatively small and unknown brand, thereby requiring a lot of initial investment in marketing and promotion of the brand by the franchisee, necessitating the requirement of a protected and exclusive area of operation for such franchisee; or

(b)           the franchisee is a well-established entity, and the franchisor looking to open up a new territorial base for its products, has sufficient confidence in the credentials of the franchisee and does not foresee underperformance; or

(c)            the franchisee is granted an all India master franchisee with a right to sub-franchisee across India. This arrangement absolves the franchisor from the day to day coordination with multiple franchisees and retains his relationship with the master franchisee but with right to receive royalty from sub-franchisees as well.

Sometimes, these exclusive territorial rights are also limited to particular ‘test’ period, and continuance of exclusivity is dependent on achievement of certain pre-determined milestones by the franchisee, thereby protecting the franchisor to an extent from the risk of non-performance.

However, if a franchisee has successfully negotiated exclusive territorial rights for itself, it should be wary of possibility of competitors of the franchisee entering his territory through ‘donut holes’ avenues in this digital age, such as sale through non-traditional, alternate channels of distributions over e-commerce websites. One way of minimising this risk (to an extent) could be insistence on a provision obligating the franchisor to include a clause within its agreements with other franchisees restricting sale of products/services (through retail or e-commerce outlets) to the area granted to such franchises. Another important provision worth negotiating is the minimum exclusive period with rational milestones in the first few years of the setup, which may gradually increase after a few years prior to bringing an automatic exclusivity drop period.

That said, exclusive franchises often come with additional strings attached like an increased franchise fee/royalty formulation, and when it comes to the more established brands, such exclusive rights may not even be on the negotiating table. However, in today’s business milieu, where franchise models are increasingly being adopted by both Indian and global brands as a way to access and develop new markets, it has become imperative for franchisees to strategically consider the need to mark an exclusive territory of operation upfront to assure a growth gestation period, keeping the nature of the brand and the scope in the market in mind.