Protecting weaker franchisees against franchisor encroachment
An asymmetrical franchise relationship would permit a franchisor to behave opportunistically towards weaker franchisees in the form of encroachment. What is franchisor encroachment, and why does it matter?
To illustrate: Company A has developed a restaurant franchise business offering various Thai dishes. After successfully establishing its business, Company A licenses B to open a restaurant franchised unit on Breestraat in Leiden. Suppose B has generated massive sales of Khao Soi Kai, a curried noodle soup with chicken, one of the Thai dishes offered by B’s restaurant. In this respect, Company A may opportunistically engage in traditional or non-traditional encroachment upon B’s business to reap undue gains.
On the one hand, Company A may open a new company-owned franchise restaurant or license C to open a new franchised restaurant in the close vicinity of B’s restaurant; for example, those outlets may be opened just across the street. On the other hand, Company A may launch its own website allowing customers to order dishes of Khao Soi Kai, which will be delivered to the customers who reside in B’s business area. These encroaching practices unavoidably trigger intra-brand competition, thereby reducing B’s sales volume from the operation of a franchised business. Ultimately, these forms of franchisor encroachment would inflict undue financial loss on B, a franchisee. Thus, one would wonder how B can be protected against this type of opportunistic practice by the rules of law.
Approaches to regulating franchisor encroachment
The approaches to regulating franchisor encroachment can be twofold.
The first approach is contractual. Legal systems with an underlying principle of freedom of contract would allow a franchisor and a franchisee to conclude a franchise contract with a so-called ‘exclusivity clause’. Under the provisions, the franchisee will be granted an exclusive area of operating a franchised unit. Furthermore, the franchisor will be prevented from cannibalising the franchisee’s exclusive territory by, for example, licensing new franchised stores to open in that location or engaging in online sales resulting in the delivery of products to customers in that location. However, I believe that regulating franchisor encroachment through the terms of a franchise agreement is not pragmatically feasible because a franchisor with superior bargaining power typically introduces the contract terms in its favour. For example, a franchisor may offer a franchise agreement with the reservation of the right to compete with a franchisee in an exclusive area.
The second approach is regulatory. In the USA, five American states, namely, Hawaii, Indiana, Iowa, Minnesota, and Washington, regulate geographical encroachment by a franchisor by the rules of franchise relationship law. The nature of the franchise law rules can vary. For instance, Iowa regulates franchisor encroachment through liability rules; a franchisor will be liable for damages if it geographically encroaches upon an incumbent franchisee’s business. In my view, this regulatory approach aligns with the goal of protecting weaker franchisees against franchisor opportunism because franchise legislation can offer mandatory rules that cannot be excluded or deviated from by the use of a franchisor’s bargaining power. Accordingly, these mandatory rules would provide the franchisees with extra-contractual protection for their interests in operating a franchised business.
Proposals for regulating franchisor encroachment
Therefore, I propose that legal systems regulate franchisor encroachment by the anti-encroachment rule of franchise-specific law to protect a franchisee’s legitimate interests in operating a franchised business in a particular marketing location. In my opinion, the anti-encroachment rule should not prohibit franchisor encroachment in the first place, as the franchisor may have legitimate reasons to do so, such as the flexibility to change marketing strategies that would benefit franchisees in a franchise system. However, the rule should lay down a normative framework that prevents a superior franchisor from unfairly encroaching upon the franchisees’ business.
Based on the ideas mentioned above, I suggest that the anti-encroachment rule permits the franchisor to encroach upon the franchisee’s business on the condition that the franchisor remedies financial detriments suffered by the franchisee due to the franchisor’s encroachment. Strictly speaking, I propose that legal systems formulate franchise-specific law rules providing that the franchisor may traditionally or non-traditionally compete with the franchisee in a reasonable area of the franchisee’s business provided that the franchisor has offered the franchisee the right of first offer or has offered reasonable compensation or other forms of consideration to offset, in whole or in part, lost profits to be caused by franchisor encroachment.
Many businesses have been active in electronic commerce. In the franchising context, some franchisors may operate their transactional website that enables customers to order products online. This online sale practice may encroach upon the franchisee’s business, reducing the franchisee’s sales volume because products may be delivered from the franchisor directly to the customers who reside in the franchisee’s marketing area. According to my proposal, the franchisor may engage in such activity provided that the franchisor has offered the franchisee reasonable compensation for the potential loss of income or other forms of remedy for the lost revenue. In the latter case, the remedial forms may vary. A franchisor may agree that a franchisee equally shares revenues generated from the sale of products delivered by the franchisor in the franchisee’s reasonable marketing location.
Chalermwut Sriporm wrote his PhD thesis entitled ‘Franchising Legal Frameworks: A Comparative Study of the DCFR, US Law and Australian Law Regarding Franchise Contracts’ at Leiden Law School, Leiden University.