Waiting for Courts To Help in Internet-Based Franchise Encroachment?

Customarily, franchise agreements delineate an owner's exclusive right to sell to a particular locality.

But, as is the case when the Internet is involved, the ubiquitous tool's communications capabilities have blurred franchise-location boundaries through novel low-cost marketing opportunities for commercial enterprises.

While Internet-based franchise encroachment is rampant, courts are reluctant to interfere with the contracts that gave rise to the franchise relationship.

Where Encroachment Occurs

Some Internet communications do not result in Internet franchise encroachment, such as e-mails sent by a franchisee to existing customers. Untargeted Internet commercial communication, though, such as through Internet sites like Google Ad Word marketing and spam, habitually results in franchise encroachment.

On the whole, a franchise agreement authorizes a commercial entity to use others' trademarks and other proprietary information in exchange for royalties. A franchise agreement typically limits said use to a particular location. In the past,
the difficulties associated with franchise encroachment were, as a rule, based on a contractual finding that one franchisee had a claim to some exclusive territory into which the franchisor has made use.

Today the most commonly related problem to franchise encroachment is associated with the misuse of the Internet ' i.e., use of the Internet by franchisors that results in marketing to customers within and outside their franchise area.

Contract Elements

Most franchisees sell goods that are protected from competition by trademarks and proprietary information. That being the case, a franchise owner's threat of competition comes not from substitute products, but from fellow franchisees. Franchisees seek to make their individual units as profitable as possible, and their franchise agreements do not require concern for the welfare of fellow franchise owners.

A franchise agreement usually grants territorial exclusivity. To do so, it may detail a territorial-confinement policy that limits where a franchisee may solicit or make sales ' by restricting the franchisee's fixed business location as well as perhaps prohibiting its marketing via other methods (e.g., Internet sales) to customers outside the franchisee's territory.

Territorial Rights

If a franchisee's exclusive territorial rights are violated, that franchisee not only has contractual remedies, but also, in some states, statutory rights against the offending franchisor. These statutes prohibit the encroachment on exclusive territories by a franchisee, but there is little case law on these statutes.

Generally, a franchisee can obtain an injunction against any party that violates an exclusivity clause. Most recently, these franchise laws are being used to outlaw a fellow franchisee from competing unfairly with the franchisee within a reasonable area.

Geographical Boundaries

Franchise agreements use geographical boundaries for the demarcation of territorial rights, but the protocols that allow the Internet to work are not capable of recognizing geographical boundaries. For use of such e-commerce mainstays as credit cards, and electronic and third-party delivery systems, many goods and services need not be geographically specific. That means that even if a franchise agreement grants exclusive territories, the franchisor or another franchisee may be able to sell products and services without violating the terms of the franchise agreement to limit its operations to a particular location.

Disclosures

The lack of disclosure of the possibility of an Internet market competitor alone has been used as a cause of action related to encroachment.

Several lawsuits against chain franchises supported claims that the defendants were engaged in deceptive trade practices by showing the company's circular, claiming that it was neither necessary nor useful.

At First, Internet Marketing Examinations Avoided

Initially, courts sidestepped the Internet marketing issue. In Armstrong Business Services, Inc. v. H&R Block, 96 S.W.3d 867, 874-79 (Mo. Ct. App. 2002), the Missouri Court of Appeals refused to address the franchisees' challenge to H&R Block's Internet service programs while it upheld the franchisor's right to let a franchise agreement expire.

Subsequently, in Franklin 1989 Revocable Family Trust v. H&R Block, Inc., a three-member American Arbitration Association panel upheld H&R Block's right to sell its Internet service in a franchisee's territory without compensating the franchisee. The panel found that this Internet service did not unreasonably intrude on Franklin's bricks-and-mortar operations and thus, the franchisor's Internet sales to customers residing in Franklin's territory did not contravene the exclusivity granted in Franklin's agreements.

Some Judicial Progress

The court in Pro Golf of Florida, Inc. v. Pro Golf of America, Inc., No. 05-71380, 2006 WL 508631 (E.D. Mich. Mar. 1, 2006), found that unless a franchise agreement specifically addressed Internet transactions, Internet encroachment claims should be precluded under the territorial-exclusivity provisions contained in most franchise agreements. While the language in the agreement was silent as to the specific issue of Internet sales, the court in Pro Golf of Florida applied the black-letter commercial law to the actual contract language, rather than attempt to rewrite the parties' bargain to govern an unanticipated development.

To prevent Internet encroachment, franchisees should contractually bind the franchisor to bar, reduce or financially account for Internet encroachment. Franchisees might also have a cause of action if they are not warned about the possibility of Internet encroachment.

Trying FTC Regulations

It may also be argued that Federal Trade Commission (“FTC”) disclosure requirements, 72 Fed. Reg. 15,444 (Mar. 30, 2007) (codified at 16 C.F.R. pts. 436-37 (2009)), require franchisors to disclose the possibility of Internet encroachment in order to help prospective franchisees “avoid harm” while choosing in which franchise to invest.

If Internet encroachment is not prohibited by the franchise agreement, then franchisors are well advised to state that the franchisee has not been given an exclusive territory. This disclosure allows the potential franchisee to understand better the nature of the franchise relationship. Such disclosure will reduce or eliminate several causes of action.

Conclusion

Appropriate and timely disclosure of Internet marketing competition by a franchisor is advised to minimize, or even eliminate, encroachment-related litigation. Franchisors must state that the franchisee may face competition from the franchisor, other franchisees or other channels of Internet distribution that the franchisor does not control.

Franchisors are neither responsible for, nor need to prevent, Internet marketing competition. Court decisions have upheld the franchisor position that, absent an express contractual provision, franchisees cannot expect protection from every means of competition, including Internet-based encroachment. A franchisor, though, must fully disclose the nature of Internet marketing competition or be prepared to resolve the legal difficulties for its failure to do so.

Customarily, franchise agreements delineate an owner's exclusive right to sell to a particular locality.

But, as is the case when the Internet is involved, the ubiquitous tool's communications capabilities have blurred franchise-location boundaries through novel low-cost marketing opportunities for commercial enterprises.

While Internet-based franchise encroachment is rampant, courts are reluctant to interfere with the contracts that gave rise to the franchise relationship.

Where Encroachment Occurs

Some Internet communications do not result in Internet franchise encroachment, such as e-mails sent by a franchisee to existing customers. Untargeted Internet commercial communication, though, such as through Internet sites like Google Ad Word marketing and spam, habitually results in franchise encroachment.

On the whole, a franchise agreement authorizes a commercial entity to use others' trademarks and other proprietary information in exchange for royalties. A franchise agreement typically limits said use to a particular location. In the past,
the difficulties associated with franchise encroachment were, as a rule, based on a contractual finding that one franchisee had a claim to some exclusive territory into which the franchisor has made use.

Today the most commonly related problem to franchise encroachment is associated with the misuse of the Internet ' i.e., use of the Internet by franchisors that results in marketing to customers within and outside their franchise area.

Contract Elements

Most franchisees sell goods that are protected from competition by trademarks and proprietary information. That being the case, a franchise owner's threat of competition comes not from substitute products, but from fellow franchisees. Franchisees seek to make their individual units as profitable as possible, and their franchise agreements do not require concern for the welfare of fellow franchise owners.

A franchise agreement usually grants territorial exclusivity. To do so, it may detail a territorial-confinement policy that limits where a franchisee may solicit or make sales ' by restricting the franchisee's fixed business location as well as perhaps prohibiting its marketing via other methods (e.g., Internet sales) to customers outside the franchisee's territory.

Territorial Rights

If a franchisee's exclusive territorial rights are violated, that franchisee not only has contractual remedies, but also, in some states, statutory rights against the offending franchisor. These statutes prohibit the encroachment on exclusive territories by a franchisee, but there is little case law on these statutes.

Generally, a franchisee can obtain an injunction against any party that violates an exclusivity clause. Most recently, these franchise laws are being used to outlaw a fellow franchisee from competing unfairly with the franchisee within a reasonable area.

Geographical Boundaries

Franchise agreements use geographical boundaries for the demarcation of territorial rights, but the protocols that allow the Internet to work are not capable of recognizing geographical boundaries. For use of such e-commerce mainstays as credit cards, and electronic and third-party delivery systems, many goods and services need not be geographically specific. That means that even if a franchise agreement grants exclusive territories, the franchisor or another franchisee may be able to sell products and services without violating the terms of the franchise agreement to limit its operations to a particular location.

Disclosures

The lack of disclosure of the possibility of an Internet market competitor alone has been used as a cause of action related to encroachment.

Several lawsuits against chain franchises supported claims that the defendants were engaged in deceptive trade practices by showing the company's circular, claiming that it was neither necessary nor useful.

At First, Internet Marketing Examinations Avoided

Initially, courts sidestepped the Internet marketing issue. In Armstrong Business Services, Inc. v. H&R Block, 96 S.W.3d 867, 874-79 (Mo. Ct. App. 2002), the Missouri Court of Appeals refused to address the franchisees' challenge to H&R Block's Internet service programs while it upheld the franchisor's right to let a franchise agreement expire.

Subsequently, in Franklin 1989 Revocable Family Trust v. H&R Block, Inc., a three-member American Arbitration Association panel upheld H&R Block's right to sell its Internet service in a franchisee's territory without compensating the franchisee. The panel found that this Internet service did not unreasonably intrude on Franklin's bricks-and-mortar operations and thus, the franchisor's Internet sales to customers residing in Franklin's territory did not contravene the exclusivity granted in Franklin's agreements.

Some Judicial Progress

The court in Pro Golf of Florida, Inc. v. Pro Golf of America, Inc., No. 05-71380, 2006 WL 508631 (E.D. Mich. Mar. 1, 2006), found that unless a franchise agreement specifically addressed Internet transactions, Internet encroachment claims should be precluded under the territorial-exclusivity provisions contained in most franchise agreements. While the language in the agreement was silent as to the specific issue of Internet sales, the court in Pro Golf of Florida applied the black-letter commercial law to the actual contract language, rather than attempt to rewrite the parties' bargain to govern an unanticipated development.

To prevent Internet encroachment, franchisees should contractually bind the franchisor to bar, reduce or financially account for Internet encroachment. Franchisees might also have a cause of action if they are not warned about the possibility of Internet encroachment.

Trying FTC Regulations

It may also be argued that Federal Trade Commission (“FTC”) disclosure requirements, 72 Fed. Reg. 15,444 (Mar. 30, 2007) (codified at 16 C.F.R. pts. 436-37 (2009)), require franchisors to disclose the possibility of Internet encroachment in order to help prospective franchisees “avoid harm” while choosing in which franchise to invest.

If Internet encroachment is not prohibited by the franchise agreement, then franchisors are well advised to state that the franchisee has not been given an exclusive territory. This disclosure allows the potential franchisee to understand better the nature of the franchise relationship. Such disclosure will reduce or eliminate several causes of action.

Conclusion

Appropriate and timely disclosure of Internet marketing competition by a franchisor is advised to minimize, or even eliminate, encroachment-related litigation. Franchisors must state that the franchisee may face competition from the franchisor, other franchisees or other channels of Internet distribution that the franchisor does not control.

Franchisors are neither responsible for, nor need to prevent, Internet marketing competition. Court decisions have upheld the franchisor position that, absent an express contractual provision, franchisees cannot expect protection from every means of competition, including Internet-based encroachment. A franchisor, though, must fully disclose the nature of Internet marketing competition or be prepared to resolve the legal difficulties for its failure to do so.