Franchising case updates in Malaysia

22 March 2018
Lee Lin Li

Franchising in Malaysia is a regulated industry governed by the Franchise Act 1998(“Act”), and regulated by the Franchise Development Division (“Registrar”) of the Ministry of the Domestic Trade Cooperatives and Consumerism (“MDTCC”). The Act applies to any franchised business operating or to be operated in Malaysia. Regulation requires registration of the franchise and compliance with specific terms of agreement required by statute prior to offering for sale or sale and commencement of the franchise business in Malaysia. It is vital for businesses to be aware of the potential implications of failing to adhere to the rules, and the courts’ overall approach in franchise-related cases.

A franchisor who fails to obtain register a franchise prior to operating a franchise business or offering for sale of its franchise commits an offence. If an offence is committed by a body corporate, a director, manager, secretary or other office bearer acting in similar capacity or assuming management responsibility for the body corporate may be held personally liable for that offence unless he can show that it was committed without his knowledge, consent or connivance and he had taken all reasonable precautions and exercised due diligence to prevent the commission of the offence.

The decision to prosecute lies with the public prosecutor. In addition to a fine and imprisonment, during sentencing, the court may also declare the franchise agreement null and void and order that the franchisor refund payments obtained from the franchisee, or prohibit the franchisor from making any new franchise agreement or appoint any new franchisee.

A recent decision concerning franchising was delivered by the high court in La Kaffa International Co Ltd v Loob Holdings Sdn Bhd and another [2017] 1 LNS 1234; [2017] MLJU 1234 on the issue of construction of Section 26(1) and 27(1) of the Act. The dispute between both parties involved the “Chatime” bubble tea franchise which was to be resolved through arbitration in Singapore.

On 5 January 2017, La Kaffa International Co. Ltd (“La Kaffa”) terminated its master franchisee arrangement for the brand “Chatime” under its Regional Exclusive Representation Agreement (“RERA”) with Loob Holding Sdn Bhd (“Loob Holding”), which had 24 more years to go. Among others, La Kaffa is alleging that:-

1. There is a decrease in Loob Holding’s number of orders for raw materials, including milk tea powder, cocoa powder and Polypropylene (“PP”) cups and it was discovered that Loob Holding has been procuring 3rd party raw materials;
2. Loob Holding has been delaying and rejecting La Kaffa’s request to exercise its rights to inspect and audit the books as provided by the RERA;  and
3. Despite repeated demands, Loob Holding has failed to comply with the terms of RERA and/or failed to make payment of, amongst others, the purchase of raw materials from the Plaintiff.

After the split, Loob Holding set out to transform and rebrand its 161 Chatime outlets to “Tealive”. This prompted La Kaffa to file a suit against Loob Holding for infringing the provisions of the Act and breach of contract. Pending the disposal of the case in arbitration proceedings, both parties filed applications for interim injunctions under Section 11(1) of the Arbitration Act 2005 in the KL high court.

La Kaffa (plaintiff) sought, among others :-

1. to restrain the Loob Holding (defendant) including its directors, their spouses and immediate family and its employees (Related Parties) from carrying business which is identical or similar to Chatime franchise business under Section 27(1) of the Act; and
2. to prohibit them from disclosing, using and converting confidential information procured from the plaintiff under Section 26(1) of the Act.

Should the judge find in favour of La Kaffa, all Tealive outlets will have to cease operations immediately pending disposal of the suit. The issue in the case was whether the written guarantees under Sections 26(1) and 27(1) of the Act which purport to bind the Related Parties were incorporated into the franchise agreement. The High Court, in construing the provisions, has adopted a strict interpretation in favour of the Related Parties and was of the view that the guarantees were not incorporated into the franchise agreement. Alternatively, even if it was assumed that the provisions have incorporated the guarantees into the franchise agreement, the court is not bound to grant interim injunctions as it is a matter of discretion. In this case, in the absence of any guarantee being given to the plaintiff, there was no question to be tried in respect of whether the defendant has breached the provisions.

Further, the high court found that the balance of convenience lies against the granting of the interim injunction in view that it carries a higher risk of injustice than a refusal of the interim injunction. As such, La Kaffa’s claim was refused. It remains to be seen how the court will apply the non-competition and confidentiality provision which has not been tested before.

The interpretation of “exclusion clauses” and “entire agreement clause” in franchise agreements was discussed recently in the Court of Appeal decision of Chiropractic Specialty Centre Sdn Bhd v Orthorelief & Care Sdn Bhd [2017] 1 LNS 1573. The appellant had appealed against the judgment of the high court which refused to set aside the arbitrator’s award in relation to the franchise agreement.

The respondent in the court of appeal was the claimant in the arbitration proceeding. The parties had entered into a franchise agreement and upon the representation of the appellant, the respondent had purchased several machines. The respondent later discovered that the representations made by the appellant were false. In the arbitration proceeding, the respondent sought rescission of the agreement and restitution for the value of the machines. The allegation was denied by the appellant and the appellant cited the respondent’s inability to operate the machines correctly as the reason for the machines’ failure. The appellant also counterclaimed against the respondent seeking damages for tarnishing the appellant’s reputation, mishandling the equipment, violating the appellant’s intellectual property rights and breaching the franchise agreement.

Upon the conclusion of the arbitration proceeding, the arbitrator partly allowed the respondent’s claim. The appellant, dissatisfied with the arbitrator’s award applied to the high court to set aside the award pursuant to Section 37 and 42 of the Arbitration Act. The application was dismissed by the high court.

In its appeal at the court of appeal, the appellant claimed that the high court erred in law and in fact in dismissing the appellant’s application. The issue raised by the appellant before the court of appeal was whether misrepresentation will have the protection of exclusion clauses and entire agreement clause of the franchise agreement wherein the clauses expressly negate any representation that is not expressly set out in the agreement itself.

In its judgment, the court of appeal held that representation and misrepresentation are not one and the same in the legal sense. The court cited Inntrepreneur Pub Co v East Crown Ltd [2000] 2 Lloyds Rep 611 where it was held that “An entire Agreement clause does not preclude a claim for misrepresentation, for the denial of contractual force to a statement cannot affect the status of a statement as a misrepresentation..”

The court was of the view that clauses in an agreement cannot operate to exclude or nullify the effect of misrepresentation, fraud and deceit. Even if the clauses are included in the agreement, it would be unenforceable on the ground of public policy depending on the facts and gravity of impropriety of the clause in the contract. Although Malaysia does not a statute governing unfair contract terms such as the English Unfair Contract Terms Act 1977, the Malaysian courts have maintained the rule of law to arrest oppressive conduct through the concept of “public policy” consideration.

In view that the award given by the arbitrator was not patently unjust or unconscionable or manifestly unlawful, the court of appeal held that the high court was correct not to intervene and set aside the award. The appeal was accordingly dismissed with costs.

If a business falls within the definition of a franchise, it is important to adhere to the requirements of the Act. Apart from bringing greater protection to Malaysian businesses, the Act is intended to bring about cohesiveness to Malaysian businesses whilst encouraging entrepreneurship, innovation and economic growth. Failure to comply is an offence attracting penal and civil economic consequences. For further reading on cases illustrating the importance of abiding by the requirements of approval and registration under the Act and the courts’ approach, please see our franchise briefing The Long Read: A Tea Dilemma .

If you have any queries or require more information, please feel free to get in touch with us.

Lee Lin Li
Partner
Tay & Partners
linli.lee@taypartners.com.my