Let's say you buy a retail or service franchise in your community. A competing franchise operates in town but does not pose a significant threat to your business.

A few years later, you receive notice that your franchise and the competing franchise have merged, or that one franchise has acquired the other, so that you and your competitor are now operating "under the same roof." Your competitor is now using your trademarks, receiving local and national advertising support from your franchise's marketing fund (perhaps with dollars you contributed to the fund), and receiving corporate support from your franchise within the same territory that formerly was yours exclusively. Is there anything you can do about it?

Sadly, under most franchise agreements, the short answer is "Not much." Franchises are prohibited by federal antitrust law from guaranteeing you exclusive rights within your territory. There is nothing you can do to prevent mergers and acquisitions of giant franchise companies, as no franchise will give you a "veto" over its ability to acquire or merge with whomever they please. If you complain, the response is likely to be something like "Hey, you were competing with that other unit before, and you are still competing with that other unit, so nothing really has changed." Well, yes, but...

Franchises, especially those in troubled industries, are merging left and right these days, so this is not merely an academic problem for lawyers to worry about. Your franchise agreement should clearly state what will happen if the franchise merges or combines with another franchise that has operating units within your territory.

Let's look at three actual franchise agreements and see how these franchises deal with the problem:

Franchise No. 1. This franchise says that in the event of merger with another franchise, it will either shut down any competing unit located within your territory or give you the opportunity to purchase it at fair market value. This sounds fair at first blush, but the decision is clearly up to the franchise, not you, whether the acquired unit is shut down or sold to you. Also, "fair market value" will almost certainly be determined by the franchise, not by you. What if you don't have the money? Then the acquired unit stays "in your face."

Franchise No. 2. This franchise says that in the event of a merger, it will, if you so request, terminate your franchise agreement and refund the initial franchise fee. If you are like most people who buy into franchises, you want to create a "legacy"--a family business you can pass on to your children. This agreement denies you that opportunity. If you exercise your right to sell out, all you will get back is a refund of your franchise fee (without even an adjustment for inflation). Your franchise, meanwhile, is either continued by your franchise company or "sold" to the newly acquired competitor (perhaps at a bargain price--you will never know), who will reap the rewards from your years of hard work building the business.

Franchise No. 3. This franchise says that in the event of a merger, it will pay you a "reverse royalty" equal to a percentage of the gross sales of the competing unit that was acquired in the merger or combination. Again, this seems fair, in that you are being given a piece of the competing unit's sales as compensation for any loss of business you may suffer. Just one question: What happens if the other franchise offers this same deal to its franchisees? You then could have a situation where you are getting a piece of the other unit's sales, and the other unit is getting a piece (perhaps a bigger piece) of your sales.

There is no perfect solution to this problem. If your franchisor is willing to negotiate this point with you (many won't), try to get them to agree that, in the event of a merger or combination with another franchise, it will:

  • not create any new franchises within your territory or expand the lines of business of any franchise unit acquired in the merger if doing so will have a "material adverse affect" on the value of your franchise;
  • reduce your royalty fee to compensate for any increased competition from an acquired unit;
  • continue to operate the acquired unit under the trademarks it used prior to the merger, so that the public will not confuse its brand with yours; and
  • repurchase your franchise for its fair market value (determined by independent appraisal) at the time the merger took place, if your gross sales decline by a significant percentage within a short time after the merger (for example, by more than 10 percent within one year).

Cliff Ennico is host of the PBS television series MoneyHunt and a leading expert on managing growing companies. His advice for small businesses regularly appears on the "Protecting Your Business" channel on the Small Business Television Network at www.sbtv.com. E-mail him at cennico@legalcareer.com.