Advising a Franchisee on a Franchise Agreement and Franchise Regulatory Requirements in Malaysia

Franchising is a popular business model for Malaysian entrepreneurs due to its ease of entry and the benefits it offers. Despite the challenges of the COVID-19 pandemic, Malaysia's franchise industry witnessed an 8% growth in 2020, and the number of franchise outlets increased by 47% in 2021, creating numerous job opportunities[1]. At the end of September 2022, then Prime Minister Datuk Seri Ismail Sabri Yaakob stated that the country’s franchise industry is expected to see further growth, with sales value projected to reach RM22.66 billon by 2025[2].
 
Why is franchising such a popular choice in Malaysia? Franchising provides several advantages over starting a business from scratch. Firstly, franchisees benefit from an established brand and reputation, saving time and resources required to build brand awareness. Secondly, the franchise model comes with a proven business strategy, including product offerings, marketing, and operations, reducing the need for costly trial and error.
 
Franchisees also receive comprehensive training and ongoing support from the franchisor, enhancing their chances of success. Moreover, franchise businesses often enjoy access to resources, negotiated pricing, and marketing expertise which may not be as readily available to independent businesses. With lower risk, easier access to financing, and flexibility in location and hours of operation, franchisees have greater opportunities for growth, making franchising an attractive and viable option for Malaysian entrepreneurs seeking business success.
 
That said, franchisors and franchisees alike must be aware of franchising laws and its requirements before embarking on the franchise business in Malaysia. Franchising is governed under the Franchise Act 1998 (“Act”), and it applies to the sale and operation of any franchise in Malaysia. The Act provides for the registration of franchises and it regulates franchises, including setting out mandatory terms and conditions that must be contained within a franchise agreement in Malaysia. Contravention of the Act may render a franchise agreement null and void or expose a franchisor or franchisee to criminal penalties[3].
 
The Franchise Development Division, or better known as the Registry of Franchise (“ROF”) under the Ministry of Domestic Trade and Costs of Living is responsible for enforcing franchising laws and regulations, including administering the registration of all franchises in Malaysia. 
 
The process of establishing a franchise business involves several key stages. It begins with the franchisee initiating contact with the franchisor, expressing interest in joining the franchise network. The franchisor then conducts a thorough evaluation of the franchisee to ensure their suitability for the franchise. Simultaneously, the franchisee undertakes due diligence, verifying critical aspects of the franchise, such as the background of the franchisor and the franchise business including whether the franchisor has a valid registration with the ROF. Upon successful vetting and confirming the franchisor has a valid registration with the ROF, the franchise agreement undergoes careful review, aligning both parties' expectations and commitments. Once the franchise agreement is signed, the franchisee must also be registered with the ROF, and should all formalities and statutory requirements be fulfilled, the franchisor and franchisee assume ongoing responsibilities as part of their engagement with the franchise, solidifying their roles.
 
Key Considerations Before Sealing the Franchise Deal
 
Before signing the franchise agreement, it is important for franchisees to be aware of the laws and regulations that would apply to the franchise as well as the franchise agreement. Unlike other contracts, franchise agreements are heavily regulated under the Act and the franchisee should ensure that the franchise agreement complies with the Act and all registration requirements are complied with prior to commencing the franchise business or risk breaching the Act. Although the Act places most of the obligations on the franchisor, the franchisee should also be made aware of their obligations. 
 
A “franchise” is defined under Section 4 of the Act as a contract or an agreement, either expressed or implied and whether oral or written, between two or more persons, by which:
 

 
An arrangement which encompasses all the aforementioned elements will be construed as a “franchise” and will fall within the purview of the Act[4]. It is essential that the franchisee operates the business independently from the franchisor[5]. Additionally, throughout the entire duration of the relationship, it should not be considered a partnership, service contract, or agency. If all these criteria are met, the arrangement qualifies as a franchise, irrespective of whether it is explicitly termed as such. 
 
What to Consider in a Comprehensive Franchise Agreement: From Essentials to Post-Registration Obligations
 
The franchisor or master franchisee will usually provide the franchisee with a template of the franchise agreement. It is essential for franchisees to carefully review and understand the terms and conditions laid out in the agreement and ensure that it complies with the Act. 
 
The Act sets out a number of provisions which regulate a franchise agreement. Failure to comply with these requirements is an offence, with penalties ranging from RM 10,000 to RM 50,000 for a first offence, and RM 20,000 to RM 100,000 for subsequent offences[6]. Non-corporate offenders face fines of RM 5,000 to RM 25,000 for a first offence and RM 10,000 to RM 50,000 for subsequent offence[7].
 

 
Requirements in a franchise agreement
A franchise agreement is a written document that outlines various crucial terms of the agreement. Section 18 of the Act sets out the requirements in a franchise agreement, which should include, but is not limited to the following: 

 
It is important to note that failure to adhere to the requirements outlined under Section 18 of the Act constitutes an offence[8].
 
In addition, the following matters are also regulated under the Act. 
 
Cooling-off period
Section 18(4) of the Act states that the franchise agreement must provide for a cooling-off period of not less than seven (7) working days during which the franchisee has the option to terminate the franchise agreement. If the franchisee opts to terminate the agreement, the franchisee must be refunded all monies paid to the franchisor, save for an amount to cover the reasonable expenses incurred by the franchisor to prepare the agreement (Section 18(5) of the Act). 
 
Prohibition against discrimination
Section 20 of the Act provides that franchisors must not unreasonable 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. 
 
Fees
Under Section 19 of the Act, if a franchisor requires that a franchisee makes a payment before signing a franchise agreement, including a payment which is part of a franchise fee, the franchisor shall state in writing in the disclosure document the purpose for the payment and the conditions for the use and refund of the moneys. Further, under Section 21 of the Act, if a franchisee is required to pay any franchise fees or royalty to a franchisor, the rate of the franchise fees or royalty shall also be the rate as provided in the disclosure document. 
 
Promotion Fund 
Section 22 and 23 of the Act provides that if a franchisor requires franchisees to make payments for promoting the franchise's product, the payment shall be at the rate as provided in the disclosure document and they must create a separate promotion fund. This fund must have its own bank account and can only be used for product promotion. If franchisees make such payments, the franchisor must provide a financial statement for the fund, verified by a registered accountant, to the ROF within thirty (30) days after the financial term ends, along with the annual report required under Section 16 of the Act. Failure to comply is an offence.
 
Prior to the Franchise (Amendment) Act 2020, the High Court in the case of Ridpest Sdn Bhd v. Bug Buster Specialists Sdn Bhd & Ors[9] held that Section 22 of the Act merely provided that the marketing fund shall be managed under a separate account and to be used for promotional purpose of the product under the franchise. The High Court was of the view that a 'separate account' did not mean separate bank account and as long as the money for the marketing fund was used for promotional purpose, the provision of Section 22 of the Act was deemed complied with, irrespective that the fund was collected and paid to the agent. However, the Act now explicitly states ‘separate bank account’, and therefore it is pertinent for franchisors to adhere to this requirement. 
 
Trademark 
As stipulated in Section 24 of the Act, it is important to ensure that the trademark used in the franchise agreement is registered, valid, and that the franchisor possesses valid rights over the trademark. That said, the ROF may also accept documents showing that the trademark application has been filed with the Intellectual Property Corporation of Malaysia. 
 
Term 
Franchisees must note that the minimum franchise term under Section 25 of the Act is five (5) years.
 
Non-compete and confidentiality obligations 
Under Section 26 of the Act, franchisees must also provide written guarantees regarding the disclosure and handling of confidential information whereby the franchisee, along with its directors, their spouses, immediate family, and employees, is required to provide a written guarantee to the franchisor, promising not to disclose any information from the operation manual or obtained during training organized by the franchisor. This obligation extends throughout the franchise term and for two (2) years after the agreement's expiration or termination. 
 
Section 27 of the Act further stipulates that franchisees must provide written guarantees that they will not engage in any similar business activities. The franchisee, along with its directors, their spouses, immediate family, and employees, is required to provide a written guarantee to the franchisor, promising not to engage in any other business similar to the franchised business during the franchise term and for two (2) years after the agreement's expiration or termination. The franchisee and their employees must adhere to the terms of this guarantee.
 
Termination 
A franchisor may terminate the agreement only under specific circumstances outlined in the Act. Section 31 of the Act states that a franchisor cannot terminate a franchise agreement before its expiration date, except for "good cause." "Good cause" includes situations where the franchisee fails to comply with any terms of the franchise agreement or fails to remedy a breach within a specific period mentioned in a written notice from the franchisor, which must be at least fourteen (14) days.
 
In the recent case of Gerbang Alaf Restaurants Sdn Bhd v Chai Su Lin & Anor[10], the Court of Appeal held that the fact that a failure to comply or a breach of the terms of the Act has been remedied does not extinguish the fact that there was a failure to comply or a breach in the first place. If the failure to comply or the breach is repeated, even though the earlier breach has been remedied, the repetitive nature constitutes a repeated breach of the Act, and Section 31(3)(d) of the Act caters to such circumstances. As such, it is pertinent that the franchisee should always comply with the terms of the franchise agreement, and that even if a breach is remedied, repeated instances of non-compliance may still be a cause for termination.  
 
Renewals and Extension
It is also important to note that Section 32 of the Act imposes restrictions on the franchisor's ability to terminate a franchise relationship. It is an offence if the franchisor refuses to renew or extend a franchise agreement without compensating the franchisee, either through repurchase or other means, at an agreed-upon price. This compensation considers the reduction in the value of the franchised business due to the expiration of the franchise under the following circumstances:
 

 
It is crucial to keep the above in mind as the Act protects the franchisee’s rights to renew. This is evident in the case of Noraimi bt Alias v Rangkaian Hotel Seri Malaysia[11], where the defendant (franchisor) initially entered into franchise and premises management agreements with the plaintiff (franchisee) for the management of 'Seri Malaysia' hotel chain. The franchise agreement was initially for eight (8) years, but it was extended for another three (3) years. However, the defendant decided not to renew both agreements after they expired in January 2006. The plaintiff sued for breach of contract and claimed that this non-renewal violated the franchise agreement and the Act. The High Court held that the expiration of the franchise agreement was a reason for termination as provided under the franchise agreement, but not for the refusal to renew. Therefore, the defendant's refusal to renew on the ground that the franchise agreement had expired was invalid as it violated the terms of the franchise agreement. The Court of Appeal affirmed this decision.
 
Reviewing these crucial requirements in the franchise agreement will empower franchisees with a comprehensive understanding of their rights and responsibilities within the franchise partnership, which is why seeking legal advice and clarifying any uncertainties with the franchisor before signing the agreement is highly advisable to ensure a successful and transparent business relationship.
 

 
It is also important for a franchisee to know that Section 15 of the Act enforces a compulsory practice requiring the disclosure document approved by the ROF, along with the franchise agreement, to be given to potential franchisees, including the master franchisee in relation to his franchisor, and a sub-franchisee with regard to his relationship with a master franchisee, at least ten (10) days before signing the franchise agreement. This allows the franchisee time to review and understand the terms and conditions prior to signing the agreement. Another important note is that the approved disclosure document ought to be the franchise disclosure document that was submitted by the franchisor to the ROF during the franchise registration application. During the franchise application, the franchisor is also required to submit a template franchise agreement. Therefore, the franchisor should ensure that the disclosure document provided to the franchisee is the same document submitted to the ROF and that the franchise agreement entered with the franchisee is based on the template franchise agreement that they had previously submitted to the ROF. 
 
The new disclosure document template is available on the MyFEX 2.0 system, and failure to comply with the compulsory practice is an offence, with penalties ranging from RM 10,000 to RM 50,000 for a first offence, and RM 20,000 to RM 100,000 for subsequent offences[12]. Non-corporate offenders face fines of RM 5,000 to RM 25,000 for a first offence and RM 10,000 to RM 50,000 for subsequent offences[13].
 

 
Franchisor 
Generally, franchises must be registered before the franchise can be offered to franchisees or before the franchise business can operate in Malaysia. 
 
Section 6 of the Act mandates that any local franchisor or foreign franchisor must register their franchise with the ROF before conducting franchise business or offering the franchise for sale. In the case of a foreign franchisor, they must first be approved to sell a franchise in Malaysia to a Malaysian citizen under Section 54 of the Act before registering the franchise under Section 6 of the Act. This registration of a franchisor has been emphasised time and time again by the Malaysians courts, such as in the case of Hasjay Group Sdn Bhd & Anor v Eco Passions Sdn Bhd & Ors[14] where the High Court highlighted that Section 6(1) of the Act requires a franchise to be registered with the ROF by the franchisor before operating the franchise business or making an offer to sell the franchise to any person in Malaysia. In the case, there was no evidence to suggest that the 1st defendant had registered the franchise in Malaysia and regardless of the 1st defendant's position vis-à-vis whether is a franchisor (by name) or a master franchisee (in fact), the franchise still has to be registered first with the ROF before it could be allowed to offer to sell the franchise business within Malaysia.
 
As mentioned, a 'franchisor,' as defined in Section 4 of the Act, is someone who grants a franchise to a franchisee, including a master franchisee in relation to their sub-franchisee. Based on this definition and combined with Section 6 of the Act, local franchisors and master franchisees of foreign franchisors must register the franchise before offering or selling it to franchisees. Foreign franchisors must first obtain approval to sell a franchise in Malaysia or to any Malaysian citizen under Section 54 of the Act before applying for registration under Section 6 of the Act. Foreign franchisors face higher approval fees (RM 5,000) compared to local franchisors and master franchisees (RM 1,000), while the processing fee is the same for all at RM 50. With the recent amendments[15] to the Act, the effectiveness of a franchise registration is now five (5) years, and renewals require payment of RM 1,000 for local franchisors and RM 5,000 for foreign franchisors.
 
Failure to comply with the registration requirement under Section 6 of the Act can lead to fines of up to RM 250,000 for body corporates and up to RM 150,000 and/or imprisonment of up to one (1) year for non-body corporates upon conviction[16]. Subsequent offences may result in higher fines for corporations and fines of up to RM 250,000 and/or imprisonment of up to three (3) years for non-body corporates[17]. 
 
Applicants must use the MyFEX 2.0 system, which covers both local and foreign franchisors, to register the franchise. At present, there are no separate applications for local and foreign franchisors, and all applications go through the same process on the MyFEX 2.0 system. Franchises registered before the implementation of the Franchise (Amendment) Act 2020 have a grace period of three (3) years from 1 August 2022 to re-register on the MyFEX 2.0 system, with no additional fees imposed for this process.
 
Franchisee
The Act also makes it compulsory for franchisees to be registered with the ROF. According to Section 6A of the Act, a franchisee who has been granted a franchise from a foreign franchisor must apply to register the franchise with the ROF before the commencement of their business, and Section 6B of the Act stipulates that a franchisee who has been granted a franchise from a local franchisor or local master franchisee must register the franchise with the ROF within fourteen (14) days from the date of signing of the agreement between the franchisor and franchisee. 
 
Although Sections 6A and 6B of the Act require the franchisee to register themselves, at present, the obligation has fallen on the franchisor or master franchisee to register for the franchisee under their MyFEX 2.0 system account. Failure to register the franchisee is an offence under the Act, with penalties ranging from RM 10,000 to RM 50,000 for a first offence, and RM 20,000 to RM 100,000 for subsequent offences[18]. Non-corporate offenders face fines of RM 5,000 to RM 25,000 for a first offence and RM 10,000 to RM 50,000 for subsequent offences[19]. Since the franchisee is reliant on the franchisor to ensure that they are properly registered and in view of the repercussions for failure to register, franchisees should ensure that the franchise agreement requires the franchisor to undertake to register the franchisee within the required timelines.
 
It should also be noted that there are some information and documents that must be submitted to the ROF together with the franchisee registration application, such as the franchisee’s Certificate of Incorporation issued by the Companies Commission of Malaysia (“CCM”), CCM Certified Company Profile, and the franchisee details (address, email, etc). Should the franchisor request these documents and information, franchisees should cooperate with the franchisor to ensure a smooth registration process. 
 

 
Annual Report
It should be noted that under Section 16 of the Act, the franchisor is required to, within six (6) months from the end of each financial year of the franchise business, submit an annual report to the ROF, and failure to do so in an offence. Failure to submit the annual report for the duration of five (5) years continuously may result the cancellation of the registration of the franchise from the Franchise Register.[20] As such, the franchise agreement should include obligations for the franchisor to ensure that this is complied with in a timely manner.
 
Amendments to documents for registration of franchise
If there are any material changes to the documents for the registration of a franchise such as the disclosure document, franchise agreement, operation and training manuals and such other information or documents as may be required by the ROF for the purpose of determining the application, Section 11 of the Act provides that the franchisor must notify the ROF of the amendments and obtain the ROF’s approval. Upon the ROF’s approval, the franchisor should also provide a copy of the amended documents to the franchisee[21]. Failure by the franchisor to file amendments to the said documents is an offence[22], with penalties ranging from RM 10,000 to RM 50,000 for a first offence, and RM 20,000 to RM 100,000 for subsequent offences[23]. Non-corporate offenders face fines of RM 5,000 to RM 25,000 for a first offence and RM 10,000 to RM 50,000 for subsequent offence[24].
 
Display of registration of franchise
Section 10B of the Act has made it compulsory for a franchisor or franchisee to at all times display the registration of franchise in a conspicuous position at the place where the franchisor or franchisee carries on his business, and failure to comply with this constitutes a general offence under the Act.

Conclusion
 
The franchising landscape in Malaysia operates within a robust regulatory framework, demanding significant responsibilities from both franchisors and franchisees. It is paramount for both parties to maintain continuous compliance with the Act, given the substantial consequences associated with non-compliance. Apart from the specific penalties imposed for the failure to register a franchisor, Section 39(1) of the Act sets out the general penalty which applies to provisions where no penalty is expressly provided.
 
In addition, the Court may when sentencing a franchisor for an offence under Section 39 of the Act[25]:

 
Further, as the Act already imposes a set of mandatory obligations upon the franchisor and franchisee, these obligations should be adopted in the franchise agreement, as it also affords the franchisee recourse for breach of contract in the event of any non-compliances by the franchisor. 
 
 

---