The franchisor-franchisee relationship in Malaysia

Legal restrictions on franchise contracts and the relationship between the parties

Are there specific laws regulating the ongoing relationship between franchisor and franchisee after the franchise contract comes into effect?

The 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.

What mechanisms are commonly incorporated in agreements to ensure operational compliance and standards?

In order for the franchisor to ensure and enforce stringent compliance by franchisee 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 POS (point of sale) systems to enable 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.

May the franchisor unilaterally change operational terms and standards during the franchise relationship?

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.

It should also be noted that any material changes to the disclosure documents after the registration of the franchise should be submitted for approval by the Franchise Development Division of the MDTCA. Such material changes may cover operational terms and standards of the franchise business and franchise system.

Do other laws affect the franchise relationship?

The Contracts Act 1950 also affects the franchise relationship. In addition, the provisions of the Competition Act 2010 should be taken into account.

Do other government or trade association policies affect the franchise relationship?

As well as the policies expounded by the Franchise Development Division of the Ministry of Domestic Trade and Consumer Affairs, other government policies such as the Distributive Trade Guidelines may have an impact on the franchise industry and franchise relationship. The Ministry of Domestic Trade and Consumer Affairs launched the National Franchise Development Blueprint 2012-2016 (NFDB), which is a long-term development plan to further develop the franchise industry. The NFDB has three objectives:

• to evaluate the franchise industry development based on main indicators (sales, employment and entrepreneur participation);
• to review current policy, strategy and development programmes; and
• to determine the direction of the national franchise industry towards the goal of Malaysia being the franchise hub in South East Asia by 2020.

The Malaysian Franchise Association (MFA) was formed in 1994 to support the implementation of government programmes to promote entrepreneurship through franchising. The MFA serves as a 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. As well as setting guidelines and standards of ethical practice among its members, it serves as a forum through which expertise and experiences of members may be exchanged. The MFA also conducts seminars, exhibitions and educational programmes on franchising.

Perbadanan Nasional Berhad (PNS) is an agency under the MDTCA, 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 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.

In what circumstances may a franchisor terminate a franchise relationship? What are the specific legal restrictions on a franchisor’s ability to terminate a franchise relationship?

A franchisor may only terminate a franchise relationship under certain circumstances prescribed by the FA. For instance, section 31 of the FA provides that no franchisor shall terminate a franchise agreement before the expiration date, except for good cause.

‘Good cause’ includes:

• the franchisee’s failure to comply with any terms of the franchise agreement; and
• the franchisee’s failure to remedy the breach committed within the period stated in a written notice given by the franchisor, which shall not be less than 14 days, for the breach to be remedied.

Good cause also includes - without the requirement of notice and an opportunity to remedy the breach - instances in which the franchisee:

• assigns the franchise rights for the benefit of creditors or a similar disposition of the assets of the franchise to any other person;
• voluntarily abandons the franchised business;
• is convicted of a criminal offence which substantially impairs the goodwill associated with the franchisor’s mark or other intellectual property; or
• repeatedly fails to comply with the terms of the franchise agreement.

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 by a 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:

• the franchisee is barred by the franchise agreement, or by the refusal of the franchisor at least six months before the expiration date of the franchise agreement, to waive any portion of the franchise agreement which prohibits the franchisee from continuing to conduct substantially the same business under another mark in the same area subsequent to the expiration of the franchise agreement; or
• the franchisee has not been given written notice of the franchisor’s intention not to renew the franchise agreement at least six months prior to the expiration date of the franchise agreement.

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:

• where both parties mutually agree to terminate the franchise agreement; or
• when a court has decided that there are certain conditions in the franchise agreement that merit the agreement being terminated earlier than the minimum term.

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.

In what circumstances may a franchisee terminate a franchise relationship?

Section 31 of the FA (as amended by the Franchise (Amendment) Act 2012) expressly provides for circumstances in which a franchisee may terminate a franchise relationship. It is now clear that the rights of the franchisee to terminate the relationship would be based on good causes as provided to the franchisor, as provided in question 32.

How are renewals of franchise agreements usually effected? Do formal or substantive requirements apply?

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.

May a franchisor refuse to renew the franchise agreement with a franchisee? If yes, in what circumstances may a franchisor refuse to renew?

The franchisor may refuse to renew the franchise agreement with a franchisee in the following circumstances:

• the franchisee has breached the terms of a previous franchise agreement; or
• the franchisee fails to give written notice to the franchisor to renew the term.

Unless the franchisor is able to establish either one of the above circumstances, it appears from section 34 of the FA that the franchisor must renew the franchise agreement to another period if the franchisee has applied for such renewal. It should also be noted that the franchise agreement for the renewed 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 renewed period for a franchise agreement based on similar or no less favourable terms is limited to one additional term from the initial term.

May a franchisor restrict a franchisee’s ability to transfer its franchise or restrict transfers of ownership interests in a franchisee entity?

Yes, provided that such restrictions are contained in the franchise agreement.

Are there laws or regulations affecting the nature, amount or payment of 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 the following conduct:

• substantial and unreasonable overvaluation of fees and prices;
• conduct that is unnecessary and unreasonable in relation to the risks to be incurred by one party; and
• conduct that is not reasonably necessary for the protection of the legitimate business interests of the franchisor, franchisee or franchise system.

In addition to the above general provision, if a franchisor requires the franchisee to make payment of the franchise fee before signing the franchise agreement, including a payment which 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 would commit a criminal offence if it fails to do so.

If the fees or other charges imposed by the franchisor are, in the Registrar’s opinion, unreasonably or unjustifiably high, the Registrar may seek further information or explanations from the franchisor before the application or registration is approved or granted.

Are there restrictions on the amount of interest that can be charged on overdue payments?

The amount of interest charged on overdue payments should not be excessively high or it may not be recoverable.

Are there laws or regulations restricting a franchisee’s ability to make payments to a foreign franchisor in the franchisor’s domestic currency?

There is no restriction on payments by a franchisee to a foreign franchisor in the franchisor’s domestic currency (foreign currency).

Are confidentiality covenants in franchise agreements enforceable?

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 the confidentiality obligations, the franchisor may commence civil proceedings or proceedings regarding breach of the franchise agreement.

Is there a general legal obligation on parties to deal with each other in good faith during the term of the franchise agreement? If so, how does it affect franchise relationships?

Under the provisions of the FA, it is provided that a franchisor and a franchisee shall act in an honest and lawful manner and shall endeavour to pursue the best franchise business practice of the time and place. Nevertheless, failure to comply with these provisions is not an offence.

Does any law treat franchisees as consumers for the purposes of consumer protection or other legislation?

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.

Must disclosure documents and franchise agreements be in the language of your country?

Disclosure documents and franchise agreements may be in English. The Franchise Development Division expects a translated copy of the franchise agreement in Bahasa Malaysia to be submitted for approval by the local franchisors or master franchisees.

Describe the types of restrictions placed on the franchisees in franchise contracts.

Pursuant to the FA, there are various restrictions in relation to these provisions in the franchise contracts. They include, without limitation, the following:

• the duration of the franchise agreement must be at least five years;
• the franchisee must give a written guarantee that it and its employees will not carry on any other business similar to the franchise business during the franchise term and for two years after the expiry or termination of the franchise agreement; and
• the franchisor must not unreasonably and materially discriminate between franchisees where charges are offered or made for franchise fees, royalties, goods, services, equipment, rentals or advertising services, if such discrimination will cause competitive harm to the franchisees.

While the FA does not impose any restrictions on the franchisees on 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.

Describe the aspects of competition law in your country that are relevant to the typical franchisor. How are they enforced?

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). Towards 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 combined market share of the parties to the agreement is less than 20 per cent of the relevant market; and
• the parties to the agreement are not competitors and their individual market share in any relevant market is not more than 25 per cent.

It should be noted that 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.

Describe the court system. What types of dispute resolution procedures are available relevant to franchising?

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 and repealed 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 has recently adopted a practice that would require franchise agreements to incorporate a mediation clause.

Describe the principal advantages and disadvantages of arbitration for foreign franchisors considering doing business in your jurisdiction.

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. As well as 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 a more discretionary and flexible decision-making power than a judge’s and the hearing is private, meaning the ramifications of choosing the 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 what respects, if at all, are foreign franchisors treated differently from domestic franchisors?

Although the requirements for registration under the Franchise Act 1998 differ between foreign and local franchisors, the recent trends seem to show that the MDTCA has adopted a more stringent approach where foreign franchisors are concerned. Under the section 54 approval application, a foreign franchisor is now required to provide as much information and data as a local franchisor before it is approved to appoint franchisees in Malaysia, in order to create a level playing field for these players. Such information and documents include, without limitation, its detailed profile, extent of experience and knowledge in the franchised business, the total number of franchise outlets globally, initial franchise investment costs and certified true copies of audited accounts for the past three years. A foreign franchisor does not have to submit a disclosure document as yet though it does appear that the information and documents submitted are similarly extensive.