Within Item 12, the franchisor must disclose if the franchisee will be awarded a protected territory, whether or not the territory is protected, how the territory will be determined, and instances where the franchisor reserves the right to operate within the franchisee's territory.
For franchisors in the process of selling a franchise, offering territories that appeal to prospective franchisees is critical.
From territory size to rights and exclusivity, franchisee candidates want to know what they’re getting into before investing in a franchise – and how much competition they should expect to contend with while operating their business. Because of that, Item 12 of the Franchise Disclosure Document (FDD) should communicate everything a prospective franchisee needs to know about territories to weigh the potential benefits and risks of buying a franchised business.
In this article, we’ll explore the information franchisors must disclose about territory rights, protections and restrictions in Item 12 to make sure franchisee candidates have the information they need to feel confident about investing in your franchise.
Under the federal Franchise Rule, franchisors must disclose whether the franchise opportunity being sold is specific to a location or if the location of the franchised business may be selected after the franchise sale with the approval of the franchisor. This information can help prospective franchisees weigh the potential advantages and drawbacks of their future business’s location.
Because territory size can impact local competition, it’s important to let prospective franchisees know how large (or small) their territory will be. Within Item 12, franchisors must disclose the minimum size of the territory being offered. If the franchise agreement grants a specific territory, the franchisor must disclose that fact along with the methods used to determine the territory’s size and definition under the franchise agreement.
For territories of undefined size, franchisors must disclose the minimum territory size granted in Item 12. For disclosure purposes, the minimum territory size is typically determined by assigning a particular set of zip codes or defining a specific radius around the franchised business’s location, or by using another similarly specific designation.
In addition to details about the franchise location and territory, franchisors must disclose the terms and conditions under which the franchisor would approve the relocation of the franchised business, or the franchisee’s establishment of additional franchised locations.
Franchisee Rights and Restrictions
According to 16 CFR § 436.5(l), franchisors must also disclose the rights and restrictions of franchisees related to territories. This includes territory options, rights of first refusal and rights to acquire additional franchises. These disclosures must also include information about restrictions imposed on the franchisee related to soliciting or accepting orders from customers outside of the franchisee’s designated territory. When disclosing such restrictions, franchisors must remember to address the franchisee’s rights to utilize other distribution channels, including but not limited to the Internet and other direct marketing efforts, to make sales beyond his or her territory.
Franchisor Rights and Restrictions
In addition to the rights and restrictions of franchisees, Item 12 must also disclose information about the franchisor’s territory rights and restrictions. This includes disclosing whether the franchisor has the right to solicit or accept orders from customers within the franchisee’s territory and whether the franchisor may utilize distribution channels including but not limited to the Internet or other sales or marketing platforms to sell products under the franchisor’s principal trademarks or other trademarks not included in the franchise agreement. Additionally, the franchisor must disclose any fees the franchisor must pay to the franchisee for soliciting sales or orders within the franchisee’s territory.
Within Item 12, franchisors must disclose whether they grant exclusive territories to franchisees. In circumstances where a franchisor does grant exclusive territory rights, the franchisor must disclose:
Whether the territory’s exclusivity is contingent on specific requirements such as sales, market penetration or another contingency;
Any circumstances under which a franchisee’s territory could be modified by the franchisor and the effect those alterations will have on the franchisee’s rights; and
Any other conditions related to a franchisee maintaining exclusive territory rights.
Franchisors must also disclose the franchisor’s rights if the franchisee fails to comply with the disclosed conditions of exclusivity.
In situations where a non-exclusive territory is offered, the franchisor must include a mandatory statement in Item 12 disclosing that fact, along with its potential ramifications for the franchisee. Under the amended Franchise Rule, the required non-exclusive territory disclosure statement must state: “You will not receive an exclusive territory. You may face competition from other franchisees, from outlets that we own, or from other channels of distribution or competitive brands that we control.”
Because the potential for competition is an important consideration for prospective franchisees, franchisors must disclose whether they operate, or plan to operate, any other business or franchise offering under a different trademark that offers goods or services similar to those that will be sold by the franchisee. If so, the amended Franchise Rule requires franchisors to disclose details about that brand or its plans within Item 12 including information about the brand’s locations and offices, trademarks, ownership, resolution of conflicts between systems and a timetable for plans if applicable.
Territory rights and restrictions can make or break the sale of a franchise. It’s critical for franchisors to keep territories competitive while ensuring the territory-related terms of their franchise agreement and FDD disclosures are legally compliant. When developing Item 12, it’s important to work with a seasoned franchise attorney to make sure you’re franchising the right way.