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Franchise contracts and the franchisor/franchisee relationship
Franchise relationship laws
The Franchise Act 1998 (as amended by the Franchise (Amendment) Act 2012) (FA) is the most specific and relevant law. The contractual relationship of the parties would also be governed by the contractual terms of the franchise agreement and, accordingly, the provisions of the Contracts Act 1950 would be relevant. The Franchise (Amendment) Act 2020, which will make further amendments to the FA, was gazetted on 6 March 2020 but is not in force as at the date of the publication of this chapter.
Operational compliance
In order for the franchisor to ensure and enforce stringent compliance by franchisees with the operational compliance and standards of its franchise system, the franchisor would usually incorporate provisions such as inspection with or without prior notice, audit rights, a mystery shopper programme and reporting requirements in the franchise agreements. In the event a franchisee fails to meet the required standards, the franchisor would give the franchisee a specific time frame to remedy the failure, failing which the franchisor may be entitled to terminate the franchise agreement. In addition, the franchisor should ensure that the operations manual, policies and procedures for other operational compliance and standards are incorporated into the franchise agreements by reference.
Other mechanisms may include the installation of web-based accounting and point of sale systems to enable the franchisor to monitor the franchisee’s compliance closely without having to inspect the outlet physically. It is also important for the franchisor’s team members to visit the outlets periodically to keep the franchisees on their toes, and continuously support and train the franchisee on the job to improve performance.
Amendment of operational terms
Although a franchisor may not unilaterally change the terms of the franchise agreement without the prior consent of the franchisees, the franchisor may state in the franchise agreement that the contents or terms of the operations manual may be updated, varied or amended by the franchisor from time to time and they must be adhered to by the franchisee.
Any material changes to the disclosure documents after the registration of the franchise should be submitted for approval by the Franchise Development and Direct Sales Division of the Ministry of Domestic Trade and Consumer Affairs (MDTCA). Such material changes may cover operational terms and standards of the franchise business and franchise system.
Other laws affecting franchise relations
The Contracts Act 1950 also affects the franchise relationship. In addition, the provisions of the Competition Act 2010 should be taken into account.
Policy affecting franchise relations
As well as the policies expounded by the Franchise Development and Direct Sales Division of the MDTCA, other government policies such as the Distributive Trade Guidelines may have an impact on the franchise industry and franchise relationship.
The National Franchise Development Master Plan (PIPFN) 2021–2025, which is currently being developed by the MDTCA, aims to boost local and overseas franchise businesses as well as increase franchise sales value by 2025. The PIPFN 2021–2025 is expected to be launched by June 2021. This five-year strategy is part of the post-covid-19 recovery plan to revive the franchise industry which had been adversely affected by the various movement control orders and their variations (MCO, CMCO) imposed to curb the covid-19 pandemic.
In addition to the MDTCA, the Malaysian Franchise Association (MFA) – which was formed to support the implementation of government programmes to promote entrepreneurship through franchising – serves as a useful resource centre for current and prospective franchisors and franchisees, as well as for the media and public. The MFA provides input and liaises with government departments and agencies on matters concerning franchising. In addition to setting guidelines and standards of ethical practice among its members, it serves as a forum through which the expertise and experiences of members may be exchanged. The MFA also conducts seminars, exhibitions and educational programmes on franchising.
The Perbadanan Nasional Berhad (PNS) is an agency under the Ministry of Entrepreneur Development and Cooperatives with the mandate to lead the development of Malaysia’s franchise industry. The PNS aims to develop the franchise industry while increasing the number of franchise entrepreneurs through its expertise in providing quality services and products. The PNS plays a pivotal role in identifying and acquiring foreign franchises and launching them in Malaysia, and acquires master franchisee rights to famous foreign brands such as Gloria Jean’s Coffee. The PNS also provides financial assistance to bumiputra entrepreneurs (that is, entrepreneurs from an indigenous origin in Malaysia) venturing into franchise businesses via equity investment and franchise business financing. The PNS has also set up a franchise academy to conduct various franchise-related training programmes. The PNS also provides guidance and special schemes for franchisors and franchisees in Malaysia.
Termination by franchisor
A franchisor may only terminate a franchise relationship under certain circumstances prescribed by the FA that would have been incorporated into the franchise agreement. For instance, section 31 of the FA provides that no franchisor may terminate a franchise agreement before the expiration date, except for good cause.
Good cause includes:
Good cause also includes – without the requirement of notice and an opportunity to remedy the breach – instances in which the franchisee:
In addition, section 32 of the FA may restrict the franchisor’s ability to terminate a franchise relationship, in that a franchisor commits an offence if it refuses to renew a franchise agreement or extend a franchise term without compensating a franchisee either through repurchase or by other means at a price to be agreed between the franchisor and the franchisee, after considering the diminution in the value of the franchised business caused by the expiration of the franchise where:
Notwithstanding these provisions of the FA, a franchise term may be terminated before the expiry of the minimum term of five years in the following circumstances:
Nothing in the FA precludes the franchisor from taking over and operating the business formerly operated by the franchisee after the franchise agreement has been terminated or has expired.
Termination by franchisee
Section 31 of the FA expressly provides for good cause circumstances in which a franchisee may terminate a franchise relationship.
A franchise agreement must provide for a cooling-off period of not less than seven working days during which the franchisee has the option to terminate the agreement and be refunded all monies paid to the franchisor, save for reasonable expenses incurred by the franchisor in preparing the agreement (sections 18(4) and 18(5) of the FA).
A franchisee may also terminate the franchise agreement before the expiry of the term with the mutual consent of the parties (section 33 of the FA).
Renewal
Most, if not all, franchise agreements contain renewal provisions and conditions for renewing the franchise agreements. In addition, there are provisions in the FA that regulate the renewal and non-renewal of franchise agreements. If the parties agree that there will be no change to the terms of the franchise agreement during the renewal period, it will be sufficient for the parties to execute a side letter without having to enter into a fresh agreement for the renewal term.
Refusal to renew
The franchisor may refuse to renew the franchise agreement with a franchisee if:
Unless the franchisor is able to establish any of the above circumstances, it appears in section 32 of the FA that the franchisor must renew the franchise agreement for another period if the franchisee has applied for such renewal. Apart from the renewal of the franchise agreement, it should also be noted that the franchise agreement must be extended by the franchisor if the franchisee gives notice to extend the franchise agreement. Such an extended term must contain conditions that are similar or not less favourable than the conditions in the current franchise agreement. The term ‘another period’ in this provision seems to suggest that the extended period for a franchise agreement based on similar or not less-favourable terms is limited to one additional term from the initial term.
Transfer restrictions
Yes, provided that such restrictions are contained in the franchise agreement.
Fees
Although there is no express provision in the FA or any other law affecting the nature or amount of fees, there is a general provision in the FA that provides that a franchisor and a franchisee, in their dealings with one another, shall avoid:
In addition to the above general provision, if a franchisor requires the franchisee to pay the franchise fee before signing the franchise agreement, including a payment that is part of a franchise fee, the franchisor must state in writing the purpose of the payment and the conditions for use and refund of the monies. If the franchise agreement is terminated during the cooling-off period, the franchisor must refund all monies, including the initial fees paid by the franchisee, after deducting the reasonable expenses incurred to prepare the franchise agreement for the franchisee. The franchisor is committing a criminal offence if it fails to do so.
If the fees or other charges imposed by the franchisor are, in the opinion of the Registrar of Franchises, unreasonably or unjustifiably high, the Registrar may seek further information or explanations from the franchisor before the application or registration is approved or granted.
Usury
The amount of interest charged on overdue payments should not be excessively high or it may not be recoverable.
Foreign exchange controls
There is no restriction on payments by a franchisee to a foreign franchisor in the franchisor’s domestic currency (foreign currency) subject to withholding tax on royalty payments derived from within Malaysia.
Confidentiality covenant enforceability
Yes, they are enforceable. In addition, section 26(1) of the FA provides that a franchisee must give a written guarantee to a franchisor that the franchisee, including its directors, the spouses and immediate family of the directors (as inserted by the Franchise (Amendment) Act 2012) and its employees may not disclose to any person any information contained in the operation manual or obtained while undergoing training organised by the franchisor during the franchise term and for two years after the expiration or earlier termination of the franchise agreement. Failure to provide such a written guarantee or to comply with the guarantee provided is an offence. Apart from being an offence under the FA, in the event of the franchisee breaching confidentiality obligations, the franchisor may commence civil proceedings or proceedings regarding breach of the franchise agreement.
Good-faith obligation
Under the provisions of the FA, it is provided that a franchisor and a franchisee must act in an honest and lawful manner and endeavour to pursue the best franchise business practice of the time and place. Nevertheless, failure to comply with these provisions is not an offence.
Franchisees as consumers
There is no law (including the Trade Descriptions Act 2011 and Consumer Protection Act 1999) that treats franchisees as consumers for the purposes of consumer protection.
Language of the agreement
Disclosure documents and franchise agreements may be in English. The Registrar of Franchises (ie, the Franchise Development Division of the MDTCA) expects a translated copy of the franchise agreement in Bahasa Malaysia to be submitted for approval by the franchisors or master franchisees.
Restrictions on franchisees
Pursuant to the FA, there are various restrictions in relation to these provisions in the franchise contracts, including but not limited to:
While the FA does not impose any restrictions on the franchisees regarding soliciting other franchisees’ employees, it is common for the franchisor to insert such a restriction in the franchise agreement to ensure that its other franchisees will not encounter such challenges in having their employees being solicited by other franchisees. This provides the franchisor with an option to terminate the franchise agreement of a franchisee found to be soliciting employees of other franchisees.
Competition law
The Malaysian Competition Act 2010 (CA) came into force on 1 January 2012. The Malaysia Competition Commission (MyCC) is an independent body established under the Competition Commission Act 2010 to enforce the CA. MyCC issued numerous guidelines that came into force in 2012, including the Guidelines on Anti-Competitive Agreements and Market Definition (both came into force in 2012) as well as on Intellectual Property Rights and Competition Law (came into force in April 2019) that set out a non-exhaustive list of factors and circumstances that MyCC may consider in deciding whether certain agreements are anticompetitive. These guidelines are non-exhaustive and not a substitute for the CA or any regulations made thereunder and may be revised should the need arise. In applying these guidelines, the facts and circumstances of each case will be considered. MyCC has indicated that it has plans to issue specific guidelines dealing with franchise agreements, but no specific timeline has been given.
The CA prohibits two broad categories of anticompetitive activities: ‘anti-competitive agreements’ and ‘abuse of a dominant position’. A franchise agreement, which is a vertical agreement, would be prohibited by the CA if it has the object or effect of significantly preventing, restricting or distorting competition in any market for goods or services (section 4(1) of the CA). To this end, MyCC will not just examine the common intentions of the parties to an agreement but will also assess the aims pursued by the agreement in the light of the economic context of the agreement. If the object of an agreement is highly likely to have a significant anticompetitive impact, then MyCC may find the agreement to have an anticompetitive object. If an anticompetitive object is not found, the agreement may still breach the CA if there is an anticompetitive effect. In general and as a starting point, MyCC will adopt the following basis for assessing whether an anticompetitive effect is ‘significant’. Anticompetitive agreements will not be considered significant if (paragraph 3.4 of the Guidelines on Anti-Competitive Agreements):
The CA does not apply to agreements that comply with legislative requirements. Thus, if certain provisions in the franchise agreements are inserted to comply with the FA (for example, the provision against the franchisee in conducting a similar business during the franchise term and for two years thereafter), arguments could be made that they are not anticompetitive.
Apart from these guidelines, there are no decisions that would be instructive as to how MyCC or the Malaysian courts would consider various contractual restrictions in franchise agreements. In applying these guidelines, the facts and circumstances of each case will be considered.
Courts and dispute resolution
The Malaysian legal system is based substantially on the English legal system and the principles of common law. English judicial decisions and other Commonwealth judicial decisions are considered by the Malaysian courts, but only as a persuasive rather than conclusive authority. Although Malaysia is federally constituted, its judicial system is a single-structured system consisting of superior and subordinate courts. The superior courts are the High Court of Malaya, the High Court of Sabah and Sarawak, and the Court of Appeal. The subordinate courts are the magistrates’ courts and the sessions courts. The Federal Court is the highest judicial authority in Malaysia and is the final court of appeal.
The law offers equal protection for foreigners and foreign-owned companies. Commercial disputes may be resolved by arbitration. Malaysian law gives effect to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. Unlike arbitration, which enjoys statutory recognition (the Arbitration Act 2005 came into force on 15 March 2006, repealing the Arbitration Act 1952 and the Convention on the Recognition and Enforcement of Foreign Arbitral Awards Act 1985), there is no statute providing for dispute resolution by way of mediation, as is found in some other jurisdictions. Nevertheless, in recent times mediation has been increasingly encouraged as an alternative mechanism for dispute resolution.
The Registrar of Franchises (ie, the Franchise Development and Direct Sales Division of the Domestic Trade and Consumer Affairs) has also increasingly encouraged franchisors and franchisees to adopt mediation clauses in franchise agreements.
Arbitration – advantages for franchisors
Arbitration is often promoted and considered as better and more efficient than litigation when resolving franchise disputes, saving both money and time. Arbitration’s rules of evidence and procedures are more relaxed and simple, which usually means it takes less time and less money to bring a franchise dispute to resolution.
It is particularly attractive for foreign franchisors, as the proceedings and documents can be conducted in English. In addition to flexibility regarding the choice of arbitration location, hearing dates can be scheduled around the needs and availability of the parties involved, unlike trial dates, which are fixed by the courts and beyond the control of those involved. Arbitration proceedings are generally held in private, and parties keep the proceedings and terms of the final resolution confidential.
Despite its many benefits, arbitration may not always be the best option. In certain circumstances, it may have various drawbacks and shortcomings that do not exist in litigation. The costs may be higher than anticipated, as the arbitrators’ fees, administrative fees and other expenses to be borne by the parties are higher than those incurred in litigation. The arbitrator’s decision-making power is more discretionary and flexible than that of a judge and the hearing is private, meaning the ramifications of choosing a wrong or unskilled arbitrator could be more serious. The less well-defined rules and fewer procedural safeguards adopted in arbitration may sometimes result in mistakes. Owing to the arbitrator’s final and binding decision being generally unappealable (except in special circumstances), the decision can result in serious and unfortunate repercussions for one of the parties involved.
In addition, the Registrar of Franchises (ie, the Franchise Development and Direct Sales Division of the Domestic Trade and Consumer Affairs) has increasingly encouraged franchisors and franchisees to adopt mediation clauses in franchise agreements.
National treatment
Under the current practices of the Registrar of Franchises (ie, Franchise Development and Direct Sales Division of the Ministry of Domestic Trade and Consumer Affairs), foreign franchisors are only required to seek franchise approval under section 54 of the FA whereas local franchisors and local master franchisees are required to register as franchisors under section 6 of the FA.
However, under the Franchise (Amendment) Act 2020 (which has yet to come into force as at the publication date of this chapter), in addition to the requirement under section 54 of the FA, foreign franchisors will be required to obtain approval under section 6 of the FA before they are able to make an offer to sell the franchise to any person in Malaysia. While it is still unclear as to whether the foreign franchisors will be able to apply for sections 54 and 6 applications simultaneously or consecutively, this amendment in essence means the foreign franchisors will have to undertake a more tedious process than previously required. Based on the current checklist of information required for the section 6 application, it seems that the foreign franchisor may have to submit more extensive information regarding business operation, management, staff, marketing strategy, business projections, and the submission of training and operation manuals as well as the franchise agreement in the national language. Additional fees may also be incurred for the additional registration.
LEXOLOGY (Wong Jin Nee & Teo – Jin Nee Wong & Siau Kee Pua)
