Navigating the Franchise Landscape in Malaysia

In recent years, franchising has emerged as a dynamic and popular business model globally, which enables companies and businesses to expand their brand presence while offering entrepreneurs an unparalleled opportunity to operate under recognized brands with proven business system, concept, expertise, support and know-how of the well-established brands. In particular, the franchise industry in Malaysia experiences significant growth and adoption rates, with more and more business owners contemplating expansion locally and internationally through franchising.

The franchise industry in Malaysia is governed by the Franchise Act 1998 (“Act”) and comes under the purview of the Franchise Development Division of the Ministry of Domestic Trade and Costs of Living. The Act mandates registration of franchise prior to making an offer for sale of franchise or commencing franchise business in Malaysia and requires compliance with specific terms of agreement imposed by the Act and provisions governing the conduct of parties to franchise agreements. Failure to comply with the Act can result in severe legal consequences. As such, it is imperative for companies and businesses seeking expansion into or in the Malaysian market to navigate and understand the legal framework of the Malaysian franchise industry and the potential implications of failing to comply with the legal requirements.

Definition of franchise

The Act defines “franchise” as a contract or an agreement (either expressed or implied, and whether oral or written) between two or more persons by which:

1. the franchisor grants to the franchisee the right to operate a business according to the franchise system determined by the franchisor;
2. the franchisor grants to the franchisee the right to use a mark, or a trade secret, or any confidential information or intellectual property, owned by or relating to the franchisor (including intellectual property licensed to the franchisor);
3. the franchisor possesses the right to administer continuous control over the franchisee’s business operations in accordance with the franchise system; and
4. in return for the grant of rights, the franchisee may be required to pay a fee or other form of consideration.

In order to constitute a franchise, the agreement must fulfil all four cumulative conditions stipulated above.

Registration of franchise

A foreign entity who intends to sell a franchise in Malaysia or to any Malaysian citizen is required to obtain the approval of the Registrar of Franchise (“Registrar”) under Section 54 of the Act (“Section 54 approval”) and register its franchise under Section 6 of the Act (“Section 6 registration”) before making an offer to sell the franchise to any person. After the foreign franchisor has obtained Section 54 approval and Section 6 registration, it can sign the franchise agreement with its franchisee(s). Thereafter, the franchisee of the foreign franchisor will be required to register the franchise under Section 6A of the Act before commencing the franchise business.

A local franchisor is also required to obtain Section 6 registration before operating a franchise business or offering for sale of its franchise to any person. A franchisee who has been granted a franchise from the local franchisor will be required to register the franchise under Section 6B of the Act (“Section 6B registration”) within 14 days from the date of signing of the franchise agreement.

A franchisee who intends to operate as a master franchisee has to obtain a separate Section 6 registration before granting a sub-franchise to any person. Similarly, a sub-franchisee who has been granted a sub-franchise from the master franchisee is required to obtain Section 6B registration within 14 days of the franchise agreement being signed.

In order to be eligible for registration as a franchisor (whether foreign or local) and a master franchisee, the relevant entity must have been operating the business to be franchised for at least 3 years. In addition, the franchisor (both foreign and local) must have registered (or at least applied to register) its trademark which is relevant to the franchise business, in Malaysia.

All applications for registration of franchise are to be submitted to the Registrar via the online portal (MYFEX 2.0) which was launched on 28 July 2022 (in place of the old portal (MYFEX)) together with payment of the prescribed fees. Under the online portal, applications for Section 54 approval and Section 6 registration by foreign franchisor are consolidated into one single application. Further, applications for registration of franchisee (and sub-franchisee) are to be submitted by the franchisor (and master franchisee) using the franchisor’s (and master franchisee’s) account which is registered on the online portal.

Post-registration obligations

After a franchisor (both foreign and local) has registered its franchise, it will be required to comply with the following obligations:

1. if there is any material change to the disclosure documents, franchise agreement, operation manual, training manual and other additional information or documents submitted with the application (except the audited accounts, financial statements and the reports), to apply for the Registrar’s approval to amend the documents under Section 11 of the Act via the online portal with payment of the prescribed fee;
2. to provide a copy of the franchise agreement and documents (including amendments thereto which have been approved by the Registrar (see item (a) above)) to the franchisee at least 10 days before the franchisee signs the franchise agreement or after the amendments to the documents have been approved by the Registrar, whichever is applicable;
3. to submit annual report (containing the updated disclosure documents and, if applicable, the financial statement of promotion fund (see item (d) below)) to the Registrar via the online portal within 6 months from the end of each financial year of the franchise business;
4. if a franchisee is required to make any payment to a promotion fund for the promotion of franchise, to submit a financial statement of the promotion fund (which has been endorsed by a registered public accountant) to the Registrar (together with the annual report (see item (c) above) within 30 days after the conclusion of the last financial term; and
5. to display the registration of franchise in a conspicuous position at the place where the business is carried out.

The post-registration obligations set out above will apply to a master franchisee with regard to its relationship with a sub-franchisee.

A franchisee (and sub-franchisee) who has been registered under the Act will only be required to comply with item (e) above.

Renewal of franchise registration

The registration of a franchise is valid for a period as prescribed by the Registrar. Currently, the prescribed period of validity is 5 years.

A franchisor may, within 30 days from the expiration of its registration, apply to the Registrar for renewal of its franchise registration via the online portal with payment of the prescribed fee.

Consequences of non-compliance

Failure to register a franchise presents a two-pronged risk to a franchisor. The first is that it amounts to an offence under the Act exposing the franchisor to monetary penalties and imprisonment, and the second is the risk that the franchisee would seek to nullify the agreement on the ground of illegality for failure to comply with the Act.

Upon conviction of an offence for non-registration of franchise, 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 of up to RM100,000 or imprisonment for a term not exceeding 1 year or both for the first offence, and a fine of up to RM250,000 or imprisonment for a term not exceeding 3 years or to both for a second or subsequent offence.

For all other offences under the Act where no penalty is expressly provided (such as non-registration of franchisee and non-compliance with post-registration obligations), a fine of between RM10,000 and RM50,000 will be imposed on a body corporate for the first offence, and a fine of between RM20,000 and RM100,000 for a 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 (collectively, “general penalty”).

Where a franchisor is convicted of an offence which attracts general penalty, the court may also make the following orders:

1. declare the franchise agreement between the franchisor and any franchisee to be null and void;
2. order that the franchisor refunds any form of payment which he has obtained from any franchisee; or
3. prohibit the franchisor from making any new franchise agreement or appointing any new franchisee.

If an offence is committed by a body corporate, a director, manager, secretary or other similar officer of the body corporate or was purporting to act in any such capacity, or was in any manner or to any extent responsible for the management of any of the affairs of such body corporate, or was assisting in such management, will be deemed guilty for that offence committed by the body corporate unless, having regard to the nature of his functions in that capacity and all circumstances, he is able to prove that:

1. the offence was committed without his knowledge, consent or connivance; and
2. he had taken all reasonable precautions and had exercised due diligence to prevent the commission of the offence.

Apart from the above, the franchisee may file an action in the High Court to nullify any agreement made between the parties in respect of a franchise on the ground of illegality under Section 24 (read with Section 2(g)) of the Contracts Act 1950 in that the franchisor contravened the Act for failing to register its franchise, and seek to restore and recover all payments made to the franchisor pursuant to the agreement which was tainted with illegality under Section 66 of the Contracts Act 1950. It appears from case law that the courts tend to rule in favour of the franchisees (see Khor Yiap Seng v Soo Geok Ki & Ors [2023] 1 LNS 571 (HC); Janet Ooi Hui Meng v STC Management Sdn Bhd & Anor [2021] 8 CLJ 952 (HC); Tea Delights (M) Sdn Bhd & Anor v Yeap Win Nee & Anor [2015] 1 LNS 936; SP Multitech Intelligent Homes Sdn Bhd v Home Sdn Bhd [2010] MLJU 1845). In these cases, the franchisors were ordered to refund all payments and benefits received under the agreement to the franchisees.

The franchise alternative – licensing

Franchising is often confused with the concept of “licensing”, which is governed purely by the Contracts Act 1950 and commonly adopted as an alternative to franchising, as both concepts share certain similarities. The confusion arises from the fact that both business models involve the grant of certain rights to the other party for a fee or other form of consideration. Hence, a licence agreement could easily satisfy conditions (a), (b) and (d) above. The key distinction between these two business models lies in the extent and level of control exerted over the other party’s business operations. A franchise model allows the franchisor to retain a strict degree of continuous control over the franchisee’s business operations, dictating the specific manner in which the business must be carried out. On the contrary, in a licensing model, there is minimal to no operational control of how the licensee’s business must be conducted but supervisory control over use of trademark, other intellectual property and the standard and quality of goods and services associated with the mark would be permissible.

While the Act does not define “continuous control” nor does it stipulate the extent or degree of operational control which renders an agreement a franchise, there are cases where the Malaysian courts have considered the issue of whether an agreement is a mere licence or a disguised franchise and shed light on what could amount to continuous operational control over the business.

The case of Janet Ooi Hui Meng (supra) concerned an agreement for the establishment and management of a school involving linguistic studies and training services under the “Shane” brand. Notwithstanding having terminated the agreement, the plaintiff (franchisee) sought, inter alia, to have the agreement declared void and unlawful due to non-registration of the franchise. The defendants argued that the agreement was not for a franchise but a mere licence for the plaintiff to use the “Shane” brand. The High Court, in allowing the plaintiff’s claim, held that the agreement satisfied all four elements of franchise and that failing to register the franchise prior to operating the franchise business rendered the agreement void and unenforceable under Section 24 (read with Section 2(g)) of the Contracts Act 1950. The High Court, in finding that there was exercise of continuous control, took into account the fact that there was requirement for the plaintiff to operate the business in strict compliance with the first defendant’s (franchisor) business policies and operation manuals and that the first defendant retained various rights and control over the plaintiff’s business operations, such as right to decide the location of the centre, right to conduct of inspections and monitoring exercises on the plaintiff’s accounts and operations at any time and for ensuring compliance, power to sanction the plaintiff in the event of any breach, control over designs and specifications required under the brand, control over hiring and staffing and right to dictate how the business operations are to be carried out, including dictating on payment arrangements with students.

Similarly, in a recent case of Cheah Yee Chen & Ors v Safeway Solutions Sdn Bhd & Ors [2023] 6 CLJ 841, the High Court found that the agreements for conducting brand development programs for children which were labelled as “licence agreements”, were in reality franchise agreements as all four elements that connote a franchise were prevalent throughout the terms of the agreements. These include maintaining standards, operating manual, uniformity of operations, source of products used, promotions, inspection and audit by the first defendant (franchisor) and payment obligations. The High Court rejected the defendants’ contentions that the various “freedoms” the plaintiffs (franchisees) were given negated any notion of control. These include the freedom to select location, arrange schedules, conduct promotion and advertising activities, arrange their financial affairs and recruit teachers and students. While the plaintiffs were given a certain degree of latitude and flexibility in these affairs, they were all still required to operate within the framework of the first defendant’s overall control and permissible limits, as well as the dictates of the terms of the Agreements. Furthermore, any deviation from the first defendant’s dictates could result in termination. As such, the agreements were declared null and void for being in breach of the Act due to non-registration of the franchise.

It is noteworthy that the courts, when determining the true nature and effect of an agreement, are guided to adopt an objective approach whereby regard must be had to the factual matrix forming the background of the contract in determining the objective and aim or purpose of the transaction (see Janet Ooi Hui Meng (supra); Kwan Chew Holdings Sdn Bhd v Kwong Yik Bank Bhd [2007] 2 CLJ 127 (CA)). Therefore, in considering whether an agreement constitutes a franchise, the courts are not bound by the label or description of agreement but will look beyond the label to analyse the substance in the agreement. Even if an agreement is not entitled “franchise” contract or is labelled as “licence agreement” or the word “franchise” does not feature at all in the document, it would still amount to a franchise if the agreement satisfies all four conditions that connote a franchise (see Khor Yiap Seng (supra); Dr HK Fong Brainbuilder Pte Ltd v SG-Maths Sdn Bhd & Ors [2018] 11 MLJ 702 (HC); [2021] 1 MLJ 549 (CA); Munafsya Sdn Bhd v Proquaz Sdn Bhd [2013] 2 CLJ 189 (HC)). What is crucial to be determined is whether the agreement contains terms that fall within the definition of a franchise under the Act.

Conclusion

The franchising landscape in Malaysia is heavily regulated where franchisors are subject to stringent obligations imposed by the Act. For businesses and brand owners looking to expand their footprint into new markets or regions and exploring franchising as a mode of expansion, it is crucial to understand the legal framework which revolves around franchise registration in Malaysia. Apart from procuring relevant franchise registration, it is vital to develop a comprehensive and legally compliant franchise agreement that protects the interests of both franchisor and franchisee while outlining their rights and obligations.

Given the fine line between franchising and licensing, businesses and brand owners contemplating expansion through licensing should carefully evaluate the terms of agreement to avoid falling within the franchise regime which is regulated under the Act. The line is, however, difficult to define as it involves deliberation between placing obligations on the licensee to do certain acts for protecting the licensor’s trademark and other intellectual property and associated goodwill and reputation under a licence, and controlling how the licensee carries out its business in a franchise. As such, businesses and brand owners should be mindful of this line as there are serious legal consequences for disguising a franchise as a licence and failing to comply with the Act.

This article is not intended to be legal advice. For further information on the above or if you have any questions on intellectual property, franchising or TMT matters, please contact Lee Lin Li.

Lee Lin Li
Partner
T: +603 2050 1898
linli.lee@taypartners.com.my

Chong Kah Yee
Senior Associate
T: +603 2050 1831
kahyee.chong@taypartners.com.my