In the highly publicised Chatime-Tealive dispute, it was alleged that the Chatime franchisee used raw materials that were not approved by the franchisor under the franchising agreement.  Franchising in Malaysia is heavily regulated by the Franchise Act 1998 (“Franchise Act”), which is subsequently amended by the Franchise (Amendment) Act 2012. The Franchise Act regulates various areas of franchising such as registration of the franchise, mandatory provisions in the franchise agreement, operation of the franchise and extension of franchise term.

In this article, we will explore the common questions of ‘Is my business a licence or a franchise?’ and ‘What’s the difference between franchising and licensing?‘. Whether a given business model is a franchise or a licence may often be ‘grey’, and it will be a matter of degree requiring an analysis of the specific features in each business model.

 

What is a “franchise”?

Broadly speaking, most people understand ‘franchise’ as involving a franchisor offering the use of its brand name, know-how and skills in operations to the franchisee in return for payments which may be imposed on the franchisee, such as a lump sum franchise fee and ongoing royalty payments. These payments are usually justified because the franchisor has developed a distinct business identity, and its products or services are usually provided via a well-established system and have enjoyed widespread recognition (think McDonalds, Secret Recipe, Kenny Rogers Roasters and the like).

Under the Franchise Act, “franchise” means a contract or an agreement, either expressed or implied, whether oral or written, between two or more persons by which—

(a)          the franchisor grants to the franchisee the right to operate a business according to the franchise system as determined by the franchisor during a term to be determined by the franchisor;

(b)          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 the franchisor or relating to the franchisor, and includes a situation where the franchisor, who is the registered user of, or is licensed by another person to use, any intellectual property, grants such right that he possesses to permit the franchisee to use the intellectual property;

(c)           the franchisor possesses the right to administer continuous control during the franchise term over the franchisee’s business operations in accordance with the franchise system; AND

(d)          in return for the grant of rights, the franchisee may be required to pay a fee or other form of consideration.

Given the phrase “either expressed or implied, whether oral or written” used in the definition, the interpretation of whether a business model falls within the ambit of “franchise” is a matter of substance over form. Meaning, just using the term “franchise” or avoiding the word “franchise” in the agreement is not determinative of the business model, and courts will look into the actual operations of the business to determine whether it is a franchise or a licence.

From pre-contract disclosure requirements, registration and submission of key contractual documents, express provisions on parties’ rights and obligations, renewal & termination, even upholding ‘restraint of trade’ clauses (during and post franchise term) which are disallowed under the Contracts Act, operation of a franchise is extensively regulated. As stated by the High Court in Noraimi bt Alias v Rangkaian Hotel Seri Malaysia [2009] 9 MLJ 475,the Franchise Agreement takes a dimension beyond the simple private business relationship between the contracting parties to one that includes the interests of the consumer and good business practices”.

In a franchise business, the franchisee has to operate the business in adherence to a franchise system, often documented in an “operations manual”. More importantly, the franchisor will have a high level of continuous control over the franchisee’s operation of its business, which is understandable to ensure that the customers enjoy the same quality of the goods and services offered so long as it is from the same franchised business. The Spicy Chicken McDeluxe should taste the same regardless of which store you go to!

 

What is a license?

In contrast to a ‘franchise’, the term ‘licence’ is not defined in legislation. As there is no one specific legislation which governs or prescribes how the licensor-licensee relationship should be, the licensing model is largely governed by the actual contract freely negotiated between licensor and licensee.

In a licensing agreement, the licensor may grant the licensee the right to sell its goods or services, use its trademarks, logos or colour scheme, obtain trainings and assistance, all in exchange of a licensing fee. The licensor may even impose royalty payments on the licensee for the use of its intellectual property or be entitled to a portion of the licensee’s revenue or profits. However, unlike a franchise model, a licensor has significantly less control over how the licensee operates its day to day business.

 

Key Differences between Licensing and Franchising
  • Registration of Franchise

Franchising: A franchisor must register the franchise with the Registrar of Franchises before he can operate the franchise business or make an offer to sell the franchise to any person. There is also an onerous list of disclosure documents to be submitted by the franchisor as part of the application for registration. The importance of the registration of franchise is explained in the case of Noraimi Alias (supra):

A quick perusal of the Act shows the regulation of franchise is through a system of registration of franchises. The importance of registration is reflected in the imposition of penalties. Unless the person, class of persons, business or industry is exempted from all or any of the provisions of the Act, including the requirement of registration, the failure to register before offering the franchise for sale is an offence. [Emphasis Added]”

Licensing: Generally speaking, there is no requirement for registration of the license with any particular authority.

  • Degree of control

Franchising: The right of the franchisor to administer continuous control over the franchisee’s business operations in accordance with the franchise system is a hallmark of a franchise business. However, whether a franchisor exercises “continuous control” is often a matter of fact and degree.

In Dr Premananthan Vasuthevan v Permai Polyclinics Sdn Bhd [2013] MLRHU 1026, the words “franchise fee” and “franchise” were used in the Management Agreement entered into between the parties. Pursuant to this Agreement, Permai Polyclinics provided management services to Dr Premananthan’s medical service, as well as procured contracts with third parties for Permai Polyclinics to be appointed onto their medical panels, whereby the panel patients could receive medical treatment in Dr Premananthan’s clinic. In consideration, Dr Premananthan paid Permai Polyclinics what was termed a “franchise fee” of 10% of all patient billing and a fixed service fee every month. It was also agreed that all fees received shall be paid weekly into Permai Polyclinics’s account and Permai Polyclinics will remit the monies to Dr Premananthan after deducting tax and payments due to Permai Polyclinics.

The fact that Permai Polyclinics had control of the billings and payments of the panel patients in Dr Premananthan’s clinic was only part of the whole business operations. The management and treatment of patients and other operational matters remained under the control of Dr Premananthan. The Court held that it fell short of the franchise requirement that the franchisor was administering continuous control over the franchisee’s business operations.

The Court also went on to examine whether the parties intended to enter into a franchise agreement. In this instance, the parties had mutually agreed on the termination clause by themselves and did not capture the words provided under the Franchise Act. More importantly, the nature of the business which provided professional medical services also made it impossible to achieve uniformity in the management or operation of the business as different doctors managed patients differently. As such, the Court held that the parties could not have intended to enter into a franchise agreement and concluded that the Management Agreement was not a franchise agreement under the Franchise Act.

In contrast, in Dr H K Fong Brainbuilder Pte Ltd v Sg-Maths Sdn Bhd & Ors [2018] MLJU 682, even though the Master License Agreement in question was not titled a “franchise” nor did it use the word “franchise”, the High Court held that it is not bound by the label or description given by the parties to the agreement. The Court went on to conclude that a perusal of the Master License Agreement clearly showed that it fulfilled all four mandatory elements constituting a “franchise” and thus, the Franchise Act applied to the “Master License Agreement”.

Licensing: While a licensor can still contractually oblige the licensee to observe certain standards, procedures and practices as essential conditions to the licence agreement, parties should be cautious that the licensor does not go so far as to administer continuous control over the licensee’s business operations, and in doing so risk having the agreement fall under the purview of Franchise Act.

  • Registration of Trade Mark or Service Mark

Franchising: Under the Franchise Act, a franchisor is required to register his trade mark or service mark relevant to the franchise in accordance with the Trade Marks Act 1976 before applying for the registration of the franchise.

Licensing: No such mandatory requirement. However, it is often recommended for the licensor to also register the trade mark of the business such as its logo and the brand name. The use of common trademarks, logos, colors to signify that a group of companies or businesses are within the same group does not, on its own, make the business a franchise business (see Dr Premananthan Vasuthevan v Permai Polyclinics Sdn Bhd (supra)).

  • Term

Franchising: The Franchise Act provides that a franchise term shall not be less than 5 years.

Licensing: Licensor is free to set out the term of the license granted to the licensee.

  • Restraint of Trade / Conducting a Similar Business

Franchising: Under the Franchise Act, a franchisee, including its directors, spouses and immediate family of the directors, and his employees, are restrained from carrying on any similar business during the franchise term and 2 years after the termination of the franchise agreement.

Licensing: Licensor is unable to restrain the licensee from conducting a similar business. A post-termination restraint of trade clause in the licensing agreement may be void under the Contracts Act 1950.

  • Renewal & Termination

Franchising: The Franchise Act protects a franchisee by providing that a franchisor commits an offence if he refuses to renew the franchise agreement without compensating the franchisee. Further, a franchise agreement shall not be terminated except for “good cause”. The Franchise Act provides for a non-exhaustive list of “good cause” for termination.

Licensing: A licensor has a greater contractual flexibility not to renew or extend the license without cause, unlike how a franchisor must.

Key Takeaways

The difference between franchising and licensing can be a fine one. Having certain key features of a franchise while passing off as merely a licensing agreement may lead to the arrangement being regarded as an unregistered and illegal franchise resulting in potential criminal penalties.

In contrast, improperly drafting a franchise agreement which does not strictly comply with the Franchise Act, when it is in substance merely a license (as in the Permai Polyclinics case) may result in a party not being able to rely on the protections afforded under the Franchise Act.

Business owners must take great care to deliberate on the desired business model before deciding on the model of expansion as the legal requirements and consequences can vary greatly from one another.

***

This article was written by Shawn Ho and Ee Lyne Chong from our corporate, property and tax practice group.  Our corporate team advises on legal compliance, corporate governance, shareholder and founder arrangements, joint venture and partnership structures and corporate tax matters.

 

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