Tay Partners

InsiderTAPS (6 April 2017)

The Long Read
The Tea Dilemma

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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:-

  • 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;
  • 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
  • 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 Franchise Act 1998 and breach of contract. La Kaffa has also applied for an interlocutory injunction to restrain Loob Holding from furthering its alleged unlawful acts which is set to be heard by the KL high court on 29th of May 2017. Should the presiding judge find in favour of La Kaffa, all Tealive outlets will have to cease operations immediately pending disposal of the suit.

The franchise industry in Malaysia is 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 operated or to be operated in Malaysia.

It is important for enterprises to be aware that franchising is a regulated industry in Malaysia where regulatory approval or registration and specific terms of agreement are required by statute prior to offering for sale or sale and commencement of the franchise business in Malaysia. This includes being acutely aware of the potential implications of failing to adhere to the rules, and the courts’ overall approach in franchise-related cases.

A foreign franchisor is required to obtain the Registrar’s approval before it sells or makes an offer to sell its franchise in Malaysia. Only after the approval may the foreign franchisor take steps to sell its franchise in Malaysia. After the franchise agreement is signed, the Malaysian franchisee is required to register its franchise business before commencement of operations. Additionally, if the franchisee subsequently enters into an agreement to act as a master franchisee, it must obtain a separate registration as a master franchisee before it may sub-franchise in Malaysia. It is noteworthy that a foreign enterprise is only eligible to apply for approval after completing a minimum of 3 years operation of the franchised business

A Malaysian franchisor is also required to register its franchise with the Registrar before it makes any offer to sell its franchise, unless it is exempted by the Minister. Similarly, a Malaysian franchisor is only eligible to apply for registration after completing a minimum of 3 years operation of the franchised business in Malaysia. A franchisee must register its franchise business with the Registrar within 14 days of the franchise agreement being signed.

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. A body corporate will be liable to a fine of up to RM250,000 for a first offence, and up to RM500,000 for a second or subsequent offence. An individual will be liable to a fine not exceeding RM100,000 or imprisonment of up to 1 year or both for the first offence, and a fine of up to RM250,000 or imprisonment up to 3 years or to both for a second or subsequent offence.

For all other offences under the Act for which no penalty is expressly provided, a fine of not less than RM10,000 and not more than RM50,000 would be imposed on a body corporate for its first offence, and a fine between RM20,000 and RM100,000 for its second or subsequent offence. An individual will be liable to a fine of between RM5,000 and RM25,000 or imprisonment of up to 6 months for the first offence, and a fine of between RM10,000 and RM50,000 or imprisonment of up to 1 year for a second or subsequent offence.

Examples where the general penalty applies include circumstances where the franchisor fails to refund the balance of initial fees (after deducting the reasonable expenses incurred for preparing the franchise agreement) to the franchisee following termination of the franchise agreement during the cooling off period, franchisee failing to give non-disclosure and non-competition guarantees to the franchisor or either party failing to comply with the terms and conditions of such guarantees.

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.

On another economic scale, there is a significant cost impact for failing to register a franchise under the Act. The franchise agreement is at risk of being held null and void ab initio by reason of illegality. The franchise agreement will still be void even if there is an approval for registration, but the approval comes after the commencement of franchise agreement: SP Multitech Intelligent Homes Sdn Bhd v Home Sdn Bhd [2010] MLJU 1845. In SP Multitech, the plaintiff franchisee operated a retail smart home concept chain store franchise. It entered into a franchise agreement with the defendant franchisor to operate the business on 15 October 2001. When the plaintiff was offered the franchise business, the business had not been registered with the Registrar of Franchise. The application to register the franchise business was only approved 5 months later, on 22 March 2002. The plaintiff also alleged that defendant had failed to submit a copy of the disclosure documents to it at least 10 days before the plaintiff signed the agreement as required under the Act.

An action was filed in the high court against the defendant for breach of sections 6 and 15 of the Act. The plaintiff prayed for a declaration that the franchise agreement is unlawful and void ab initio and for restitution in the form of refund of all payments and benefits received by the defendant. The defendant argued that it was the parties’ intention that the agreement would commence after the registration of the franchise business and that the plaintiff was aware all along that an application to register the franchise was pending approval at the time the agreement was signed. The defendant further argued that notwithstanding this knowledge, the plaintiff had carried out its obligations under the agreement.

The issue before the high court was whether the franchise agreement is null and void ab initio by reason of illegality for failure to register the franchise prior to making an offer to sell the franchise and for failure to provide disclosure documents to the plaintiff.

The court held that the franchise agreement is tainted with illegality as the defendant had contravened the provisions of the Act. The court ordered that all payments made or benefits given to the defendant be refunded to the plaintiff. In coming to this decision, the court took into account the fact that the plaintiff had made a number of payments to the defendant after the agreement was made but before the approval was granted and concluded that both parties had intended for the business to commence on 15 October 2001 when the franchise agreement was signed.

On the defendant’s assertion that plaintiff was aware the application to register the business was pending and nevertheless had continued to carry out the business, the court held that the issue of waiver and estoppel is inapplicable in cases of illegality and section 28 of the Act provides that waiver of compliance with any provisions in the Act is void.

Noraimi bt Alias v Rangkaian Hotel Seri Malaysia [2009] 9 MLJ 475, another high court decision came to a completely antithetical conclusion. In Noraimi, the defendant franchisor entered into franchise and premises management agreements with the plaintiff franchisee on 18 April 1995 for the plaintiff to manage the hotel chain ‘Seri Malaysia’. The initial term of franchise was for 8 years, from 21 January 1995 until 21 January 2003. The agreement provided for a renewal of the franchise for a further term of 8 years subject to terms and conditions. The term of franchise was extended for another 3 years in 2003. Subsequently, the defendant informed the plaintiff that both agreements which had expired on 21 January 2006 would not be renewed.

The plaintiff sued the defendant for breach of both agreements and claimed that the non-renewal of the agreement was a breach of the franchise agreement and a violation of the safeguards under the Act. The defendant asserted that the franchise had simply come to an end and decided not to renew it. The defendant also claimed that the Act is not applicable since the agreements were made prior to its coming into force.

The issue before the high court was whether the non-renewal of the franchise was a breach of agreement by the defendant or an exercise of a right conferred on the defendant under the terms and conditions of the franchise agreement.

The court held that:

The Act is applicable as its application is not dependent on when a franchise agreement is made. Contractual agreements must be read subject to the Act and give way where there is conflict and found support for this in section 61 of the Act which provided that franchises granted or sold prior to the coming into force of the Act are required to be registered within a grace period of 12 months from the enforcement date of the Act.
The extension of the term of franchise by 3 years merely meant the agreement had been mutually varied and the other terms and conditions of the agreement would continue to apply.
The expiration of the franchise agreement was a reason for termination as provided under the franchise agreement but not for the refusal to renew. Therefore, the defendant’s refusal to renew on the ground that it had expired was invalid as it violated the terms of the franchise agreement.
The court noted that under Section 32 of the Act, it is an offence not to renew and extend a franchise term without compensation in two circumstances, namely (i) the franchisee is barred by or the franchisor has refused to waive the operation of a restraint of trade clause in the franchise agreement six months before expiration of the agreement; or (ii) the franchisee has not been given at least six months’ notice of the franchisor’s intention not to renew the franchise (second circumstance being held applicable in this case).

Whilst the court recognised that the franchise business is required to be registered under the Act and on the facts, there was no registration; it did not find that the franchise agreement was illegal and therefore null and void. Instead, the court went on to apply the provisions of the Act and held that there was indeed a breach of the franchise agreement and the provisions of the Act. The plaintiff was awarded damages calculated on the net profit per month of the plaintiff for a term of five years for which the agreement should have been renewed.

The defendant then appealed against the decision. The court of appeal in [2011] 1 LNS 1918 were unanimous that the 3 year extension to the original 8 years did not affect the plaintiff’s right to the renewal of the franchise after the expiry of extended period. The court of appeal agreed with the judgment of the high court, as well as its award of damages and interest – the sum of RM27,500 per month for a period of two years together with interest at the rate of 4% per annum from 21 January 2006 to the date of judgment and thereafter at 8% per annum to date of realisation and a further sum of RM 27,500 per month for the balance period of three years without interest. The appeal was then dismissed with costs of RM50,000.

In a more recent case, Tea Delights (M) Sdn Bhd v Yeap Win Nee [2015] MLJU 673 the appellants appealed to the high court against the decision of a sessions court who declared the franchise agreement void ab initio. This case concerns yet another bubble tea franchise “COMEBUY”. The high court held that the first defendant who claimed to be the master franchisee in Malaysia and the second defendant, the director and representative of the first defendant, had a duty to register the franchise. The defendant’s failure to do so rendered the franchise agreement void ab initio. The high court stated that in such circumstances, no court will lend its aid to enterprises who failed to register the franchise prior to commencement of the business. The high court also cited section 66 of the Contracts Act 1950 and held that the failure to register the franchise also meant that the plaintiffs were free to make a claim for restitution. The franchise business in this case was a non-starter and significantly, it did not matter that the plaintiffs only brought a claim after the business failed.

These are some cases illustrating the importance of abiding by the requirements of approval and registration under the Act. The courts’ approach appears to lean in favour of franchisees.

If a business falls within the definition of a franchise, compliance with the Act is paramount. The Act is intended to bring greater protection to Malaysian businesses and to encourage entrepreneurship, innovation and economic growth. It regulates various aspects of franchising. Failure to comply is an offence attracting penal and civil economic consequences.

Tay & Partners Franchising Practice

Our franchising practice provides a comprehensive coverage of franchising and licensing services to clients by combining the synergies of lawyers with advisory, dispute resolution background and experience together with intellectual property specialisations. We regularly advise clients on regulatory, compliance and transactional issues across sectors such as food and beverage services, hotel services, education, financial services, business networking services, fast-moving consumer goods and luxury goods. In many of these projects, we have worked with international counsel in providing a robust, practical and commercially-oriented approach to franchising and licensing in the local and international sectors. We also play an active role in providing our feedback in response to public consultations launched by the Malaysian Registrar of Franchise and hope to help shape Malaysia’s developing franchise law framework.

Should you have any queries on the above or for more information on Tay & Partners Franchising Practice, please contact us at:

Lee Lin Li
+603 2050 1898