REGULATORY REGIME FOR THE FRANCHISE INDUSTRY IN MALAYSIA


Franchising has become a growing sector in Malaysia and an expansion strategy for the business of Malaysian companies. It has allowed the Malaysian companies to transform, expand and develop their business and brand throughout the world. In 2017, the franchise industry contributed RM27 billion to Malaysian gross domestic product (GDP) and it is expected to contribute an 8% growth to the Malaysian GDP in 2018 and RM35 billion by 2020.[1]

Before the enactment of Franchise Act 1998 (the “Act”), franchising in Malaysia was generally governed by contractual principles. Due to the absence of complex statutory provisions or guidelines, the parties are freely to negotiate the terms of their franchising arrangement with a higher degree of flexibility.

The Act was gazetted on 31 December 1998 and came into force on 8 October 1999. Its main objective is to govern and standardise the operations and regulations of the franchise industry in Malaysia. The Act was then amended by the Franchise (Amendment) Act 2012 which came into force on 1 January 2013 (“the Amendment Act“). 

REGULATORY AUTHORITY RESPONSIBLE FOR ENFORCING FRANCHISING LAWS

The responsibility of enforcing franchising laws and regulations in Malaysia falls on the Franchise Development Division of the Ministry of Domestic Trade, Co-Operatives and Consumerism (MDTCC), which is headed by the Registrar of Franchises (“Registrar”).

APPLICATION OF FRANCHISE ACT 1998

The Act applies to the sale and operation of any franchise in Malaysia.[2] The sale of a franchise is deemed to be in Malaysia where an offer to sell or buy a franchise, is made and accepted within or outside Malaysia; and which the franchised business is operated or will be operating in Malaysia.[3]

WHAT AGREEMENT IS REQUIRED TO COMPLY WITH FRANCHISE ACT 1998?

The Act provides a comprehensive and extensive definition of a franchise. Generally, a franchise is an agreement by which the franchisor grants the franchisee the right to use its trade mark or intellectual property and operate the franchisee’s business according to the franchisor’s franchise system. Further, it allows the franchisor to maintain the right to administer continuous control over the franchisee’s business operations to ensure compliance with the franchise system. In return for the grant of rights, the franchisee pays a fee or other form of consideration to the franchisor. 

REGISTRATION OF FRANCHISOR

Before any franchisor can sell a franchise, a franchisor must be registered with the Registrar. There are two categories of franchisor registration under the Act, which are the registration by:

  1. a foreign franchisor intending to sell its franchise in Malaysia or to Malaysian citizens; and
  2. a Malaysian franchisor before offering to sell its franchise to any party.

 1. Foreign franchisor

Section 54 of the Act requires all foreign franchisors intending to set up franchises or sell a franchise in Malaysia or to any Malaysian citizen to obtain prior approval from the Registrar. Hence, the approval from Registrar must first be obtained before the foreign franchisor commences any negotiations with prospective Malaysian franchisees to sell a franchise in Malaysia. The Registrar may approve, impose conditions on or refuse such application. This suggest that the requirements for foreign franchisor registration under Section 54 are rather fluid, leaving the details of any conditions to be imposed at the discretion of the Registrar.

2. Malaysian / Local franchisor

Section 6 of the Act requires a local franchisor or a master franchisee of a foreign franchisor to register its franchise with the Registrar before offering to sell its franchise to any party.

A local franchisor who fails to register his franchise commits an offence under the Act and is liable, in the case of a body corporate, to a maximum fine of RM250,000 for a first offence and RM500,000 for a second or subsequent offence. Failure to register may render the franchise agreement null and void for being unlawful.[4]

All applications for registration are to be made through the online franchise registration system, Malaysian Franchise Express (MyFEX). The franchisor is required to submit its application for registration together with all supporting documents, which include[5]:-

  1. the disclosure documents;
  2. a sample of the franchise agreement;
  3. operation manual,
  4. training manual;
  5. latest audited accounts, financial statements and the auditors’ or directors’ reports; and
  6. any other information required by the Registrar.

Notwithstanding the above, unless an exemption is granted, a franchisor must submit the audited accounts for the last six months of operation of a prototype outlet. [6] This indicates that a franchisor needs to have operated the franchise business for at least six months through self-owned outlets before granting or selling franchises. The franchisor is also required to register the franchisor’s trade marks (including service marks) in accordance with the Trade Marks Act 1976 before applying for registration of the franchise under the Act.[7]

REGISTRATION OF FRANCHISEE

The Act provides for a fairly balanced protection of franchisors and franchisees. With the Amendment Act coming into force, there is now a compulsory requirement for all franchisees to register their franchise.

1. Franchisee of a Foreign Franchisor

Upon entering into a franchise agreement with a local franchisee and prior to the commencement of operations, the franchisee of a foreign franchisor is required to make an application to register its franchise with the Registrar pursuant to Section 6A of the Act.

2. Franchisee of a Local Franchisor

Pursuant to Section 6B of the Act, a franchisee who is granted a franchise by a local franchisor is required to register the franchise with the Registrar within 14 days from the date of signing of the franchise agreement between the franchisor and the franchisee.

PRE-CONTRACTUAL DISCLOSURE

Once the registration of franchise is approved, a franchisor can enter into the franchise agreement with the franchisee. There is a compulsory requirement for the franchisor to submit to a prospective franchisee a copy of the franchise agreement and disclosure documents at least 10 days before the signing of the franchise agreement.[8] Failure to comply the above is an offence.[9]

FRANCHISE AGREEMENT

The Act mandates the inclusion of certain terms and conditions in the franchise agreement, whereby failure to comply renders the franchise agreement null and void.[10] The franchise agreement must be in writing and include certain provisions specified in the Act which shall include:-

  1. Cooling-off period of not less than seven working days which the franchisee has the option to terminate the agreement and obtain a full refund of all monies paid to the franchisor, save for an amount to cover expenses incurred by the franchisor to prepare the agreement;
  2. Duration of the franchise (minimum five years) and terms of renewal;
  3. Name and description of the product and business of the franchise;
  4. Territorial rights granted to the franchisee;
  5. Franchise fee, promotion fee, royalty or any related payment payable by the franchisee;
  6. Obligations of the parties;
  7. Franchisee’s rights to use and the description of the mark or intellectual property;
  8. The conditions under which the franchisee may assign the rights given under the franchise;
  9. Type and particulars of assistance provided by the franchisor; and
  10. Effect of termination or expiration of the agreement.

Further, the franchisor must establish a promotion fund to be managed under a separate account and used solely for the promotion of the subject matter under the franchise, if the franchisee is required to make any payment for the promotion of the franchise.[11]

GUARANTEES AND PROTECTION

The Act provides that the franchisee needs to provide a written guarantee not to disclose confidential information[12] or carry on any business similar to the franchised business[13], for the duration of the agreement and for a period of two years thereafter which extends not only to the franchisee but also its directors, employees and spouses and immediate family members of the directors.

The abovementioned non-disclosure clauses, non-compete clauses and restrictive covenants are generally upheld as contractual terms and enforceable for the duration of the agreement and a period of two years post-termination of the franchise agreement. They form an exception to contract law principles which generally hold a post-contract restraint of trade clause as void.[14] Breach of these covenants entitles the aggrieved party to sue for damages and specific reliefs and may also form the grounds of a complaint to the Registrar. Furthermore, the breach of restrictive covenants set out in the Act is tantamount to an offence under the Act.

In the recent case of La Kaffa International Co. Ltd (“La Kaffa”) v Loob Holding Sdn Bhd (“Loob”), La Kaffa, foreign franchisor of the ‘CHATIME’ franchise filed a suit against its master franchises in Malaysia, Loob and sought for several injunctions which include a prohibitory injunction in relation to the restraint of trade. In the High Court, the learned Judge dismissed the prayers relating to restraint of trade and only ordered the return of properties by Loob to La Kaffa. La Kaffa appealed to the Court of Appeal and the arguments involve the application of Section 27 of the Act which prevents a franchisee (including its directors, spouses, immediate family of the directors, employees) from carrying on business similar to the franchised business during the franchise term and for two years after the expiration or earlier termination of the franchise agreement.

The Court of Appeal ruled in favour of La Kaffa and is of the view that failure to grant the prohibitory injunction by the Judicial Commissioner is flawed which requires appellate intervention.[15] The Court of Appeal granted prohibitory injunction (prohibition to carry out “TEALIVE” business which is similar to “CHATIME”) against Loob on the grounds that the conduct of Loob, i.e. change the name of business ‘CHATIME’ and running the business under ‘TEALIVE’, is not only in breach of legal obligation relating to restraint of trade but also breach of franchise law which does not encourage criminal or tortious conduct of business and goodwill.[16] The Court of Appeal has also dismissed the stay application filed by Loob against the prohibitory injunction to allow “TEALIVE” to run its business pending the disposal of the appeal in the Federal Court.

The abovementioned case illustrates that when the parties have agreed not to do certain acts and the Act also provides for such protection, the court is obliged to give effect to ensure the salient terms of the franchise agreement as well as the Act is not breached.

TERMINATION OF FRANCHISE AGREEMENT

When introduced in 1998, the Act only prohibited the franchisee from terminating a franchise agreement before expiration of the franchise term. Following amendments made in 2012, a similar prohibition now applies to franchisors.[17] In any event, either party may not terminate a franchise agreement before the expiration date except for good cause as stipulated in the Act. ‘Good cause’ is defined to include failure of the franchisee or franchisor to comply with the terms of the franchise agreement or any other relevant agreement between the parties and their failure to remedy such breach within a specified period, which may not be less than 14 days.[18]

Termination without the requirement of notice and the opportunity to remedy the breach is also allowed in certain specified circumstances such as assignment of franchise rights for the benefit of creditors or a similar disposition of the assets to any other person, bankruptcy or insolvency, voluntary abandonment of franchised business, conviction of a criminal offence that substantially impairs the goodwill associated with the franchisor’s trade mark or other intellectual property or repeatedly fails to comply with the terms of the franchise agreement.[19]

CONCLUSION

The Act highly regulates the franchising industry as it does not only controls the terms of any franchise agreement but also implements a systematic scheme of registration for the franchisor, franchisee, franchise consultants and franchise brokers. Other than creating a regimented legal structure for the franchising industry in Malaysia, the Act brings with it certainty and greater protection for Malaysian businesses, particularly the small medium businesses. The establishment of the Registrar and the implement of MyFEX enables the government authority to monitor and access the information of the franchise industry. The active steps taken above will able to prevent unscrupulous parties to take advantage or exploiting any loopholes from the fast-growing franchise fraternity in Malaysia.

[1] http://www.mfa.org.my/newmfa/franchise-sector-to-provide-rm35b-to-gdp/

[2] Section 3(1) of Franchise Act 1998

[3] Section 3(2) of Franchise Act 1998

[4] SP Multitech Intelligent Homes Sdn Bhd v Home Sdn Bhd [2010] MLJU 1845

[5] Section 7 of Franchise Act 1998

[6] Guidelines for Franchise Registration at https://www.kpdnkk.gov.my/kpdnkk/wp-content/uploads/2017/05/Buku_Panduan_Pendaftaran_Francais.pdf

[7] Section 24 of Franchise Act 1998

[8] Section 15(1) of the Franchise Act 1998

[9] Section 15(3) of the Franchise Act 1998

[10] Section 18 of the Franchise Act 1998

[11] Section 22 of  the Franchise Act

[12] Section 26 of Franchise Act 1998

[13] Section 27 of Franchise Act 1998

[14] Section 28 of Contracts Act 1950

[15] Para 40, Grounds of Judgment, La Kaffa International Co. Ltd v Loob Holding Sdn Bhd, 27 June 2018

[16] Ditto

[17] Section 31 of Franchise Act 1998 and Section 19 of Franchise (Amendment) Act 2012

[18] Section 31(2) of Franchise Act 1998

[19] Section 31(3) of the Franchise Act