Leela Baskaran provides a primer on franchising in Malaysia.

The recent public offering of 7-Eleven (one of the world’s most successful franchises) in Malaysia which was oversubscribed by almost 5 times illustrates that franchising is a thriving and lucrative industry in Malaysia. This together with the recently concluded Franchise International Malaysia 2014, the largest annual franchising exhibition and conference in South-East Asia made us think it would be timely to have a short article on the regulatory regime for the franchise industry in Malaysia.
 
WHAT IS THE LAW AND WHO ADMINISTERS IT?
 
The franchise industry in Malaysia is regulated by the Franchise Act 1998 (“the Act”) which came into force on 8 October 1999. The Act was amended by the Franchise (Amendment) Act 2012 which came into force on 1 January 2013 (“the Amendment Act”).
 
The Act is administered by the Franchise Development Division of the Ministry of Domestic Trade Cooperatives and Consumerism under which there are Development, Registration, Administration and Enforcement Units (the “Franchise Registry”).
 
WHEN DOES AN AGREEMENT COME WITHIN THE ACT?
 
The Act applies to the sale and operation of any franchise which is or will be operated in Malaysia regardless of whether the offer to sell or buy the franchise is made and accepted within or outside Malaysia.
 
So when is an agreement considered a franchise? What is the legal definition of a franchise? The Act provides a comprehensive definition of a franchise. Essentially, a franchise is an agreement by which the franchisor grants the franchisee the right to operate the franchisee’s business according to the franchisor’s franchise system and allows the franchisor to maintain the right to administer continuous control over the franchisee’s business operations to ensure compliance with the franchise system.
 
This is different from a license where there is no operating system imposed on the licensee or control over the way in which the licensee’s business is operated. It is partly for these reasons that there is more regulation of a franchise agreement as compared to a license agreement.
 
What is clear is that it does not matter what the title of the agreement is. As found by the High Court in the case of Munafsya Sdn Bhd v Proquaz Sdn Bhd [2013] 2 CLJ 189, it does not matter that the word franchise is not used anywhere in the agreement; the court will look at the terms of the agreement as a whole, the conduct of the parties and the background of the agreement to determine whether it is a franchise. In Dr Premananthan Vasuthevan v Permai Polyclinics Sdn Bhd [2013] 1 LNS 1048, the High Court found that notwithstanding the reference to the franchise fee in the agreement, there was no franchise system or exercise of continuous control over the franchisee’s business, and therefore no franchise agreement existed.
 
WHAT DOES A FRANCHISOR OR FRANCHISEE NEED TO DO?
 
Franchise system and intellectual property
 
A franchisor must first reduce his “franchise system” into writing in the form of operation manuals and training manuals. The franchisor also needs to prepare his disclosure documents which should include full particulars of his franchised business, a list of all fees and other financial obligations to be imposed on the franchisee, initial investments the franchisee needs to make, obligations of franchisee and franchisor, territorial and intellectual property rights to be granted to franchisee and financial statements of the franchisor. The franchisor is also required to register his trade marks (including service marks) before applying for registration of the franchise under the Act.
 
Register the franchise
 
Before selling or offering to sell the franchise to any person in Malaysia, the franchisor needs to register the franchise with the Franchise Registry. The main requirement when applying for registration is to provide full disclosure regarding the franchise. With the Amendment Act coming into force, there is now a compulsory requirement for all franchisees to register their franchise. All applications for registration are to be made through the online franchise registration system, Malaysian Franchise Express (MyFEX).
 
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, as illustrated in the case of SP Multitech Intelligent Homes Sdn Bhd v Home Sdn Bhd [2010] MLJU 1845 where the franchise agreement was found to be unlawful and void ab initio and the franchisor was ordered to refund all payments and benefits received to the franchisee.
 
The Amendment Act makes it an offence, subject to the same fines as set out above, for any person to assume or use the term “franchise” or any of its derivatives in relation to its business without approval of registration by the Registrar.
 
Proof of track record
 
One of the requirements when a franchisor applies for registration is that he must submit audited accounts for the last 3 years of operation of the franchised business which shows the successful operation of at least one outlet. Therefore, a franchisor needs to have operated the franchised business for at least 3 years through self-owned outlets before granting franchises. It is possible to apply for an exemption, although the grounds for exemption are not clear.
 
Timely provision of documents to franchisee
 
Once the franchisor has obtained registration, he can enter into the franchise agreement with the franchisee. There is a compulsory requirement for the franchisor to submit to the franchisee a copy of the franchise agreement and disclosure documents at least 10 days before the signing of the franchise agreement. Failure to comply is an offence.
 
THE FRANCHISE AGREEMENT
 
Mandatory provisions
 
The franchise agreement must be in writing and include certain provisions specified in the Act. Failure to include these provisions will render the franchise agreement null and void. For instance, the franchise agreement is required to include a cooling off period of not less than 7 working days during 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.  
 
The stipulated minimum term of a franchise agreement is 5 years. Where the franchisor requires the franchisee to make any payment for the purpose of the promotion of the franchise, 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.
 
The franchisee needs to provide a written guarantee not to disclose confidential information or carry on any business similar to the franchise business for the duration of the agreement and 2 years thereafter which extends not only to the franchisee but also its directors, employees and spouses and immediate family members of the directors. The prohibition against similar business overrides section 28 of the Contracts Act 1950 which (subject to specified exceptions relating to partnerships and sale of the goodwill in a business) renders any agreement which restrains a person from exercising a lawful profession, trade or business to be void to the extent of that restraint.
 
Any provision in a franchise agreement purporting to bind a franchisee or franchisor to waive compliance with any provision of the Act is void and unenforceable.
 
Conduct and operation of the franchise
 
A franchisor and franchisee are required to act in an honest and lawful manner, and pursue best franchise business practice in the operation of the franchise.
 
Termination of the franchise agreement
 
A franchise agreement may only be terminated for “good cause” as defined under the Act. An example of what constitutes a “good cause” is the failure by the franchisee or the franchisor to remedy a breach of the franchise agreement or any other relevant agreement entered into between them within the period (being not less than 14 days) stated in a written notice given by the non-defaulting party.
 
Notice and opportunity to remedy is not required in circumstances where the franchisor or franchisee makes an assignment of rights for the benefit of creditors or other similar disposition, becomes bankrupt or insolvent, voluntarily abandons the franchised business, is convicted of a criminal offence which 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.
 
Renewal and extension of a Franchise Agreement
 
The franchisor must renew or extend a franchise agreement where a franchisee applies for an extension by giving written notice to the franchisor no less than 6 months prior to the expiration of the franchise term, provided there is no breach of the existing franchise agreement by the franchisee. The franchise agreement is to be renewed on terms which are similar to, or no less favourable than, the terms in the existing franchise agreement.
 
It is an offence under the Act for a franchisor to refuse to renew a franchise agreement without compensating a franchisee either by a repurchase of the franchise or by other means at a price to be agreed between the franchisor and franchisee unless the franchisor (at least 6 months prior to the expiration date of the franchise agreement) (a) gives the franchisee written notice of non-renewal;  and (b) waives any provision in the franchise agreement which prohibits the franchisee from continuing to conduct substantially the same business under another trade mark in the same area subsequent to the expiration of the franchise agreement.
 
In Noraimi Alia v Rangkaian Hotel Seri Malaysia [2009] 9 CLJ 815 it was found that the non-renewal of the franchise agreement constituted an offence and the franchisee was awarded compensation for the loss of profits that she would have received for the period of renewal expected.
 
ANNUAL REPORT
 
The franchisor is required to submit an annual report to the Registrar in the prescribed form within 6 months from the end of each financial year of the franchise business. The Registrar may cancel the registration of the franchisor if the annual report is not submitted.
 
CONCLUSION
 
The Malaysian Government is keen to promote and grow the franchise industry as increased franchising would boost the economy and encourage entrepreneurship development among Malaysians. This is evidenced by the active steps taken by the Government, such as implementing MyFEX, holding the annual Franchise International Malaysia Exhibition and Conference, launching the franchise blue print and providing support to budding franchisees in the form of micro-franchise development schemes. The regulatory regime, through compulsory registration of franchised business and submission of annual reports, enables the Government to gather much needed information on the franchise industry in Malaysia and at the same time monitor and protect franchisees.