By Gan Jer Nynn & Dickson Loo
Introduction
How is McDonald’s (“McD”) so successful? While due credit should be given to their iconic crispy fries, their franchising programme also played a vital role in the expansion and development of the McD brand worldwide. In fact, according to McD’s website, its franchising programme is so successful that at least 93% of the McD stores worldwide are franchises.[1] That said, what exactly is a franchise and how is it different from licensing? These will be the questions this article seeks to answer.
What is franchising?
The concept of franchising itself is not new and has been practiced since the Middle Ages where feudal lords or the monarchy (as the franchisor), would grant special privileges to merchants or high officials (who will be the franchisees), to hold markets or perform business-related activities. In turn, the franchisees will pay to the franchisor a sum of payment in the form of royalty in exchange for, amongst other, exclusive rights and/or protection. Over time, the franchising concept was further developed, and its usage increased tremendously from the mid-late 19th century onwards; (alongside the boom of businesses and major corporations such as Coca-Cola, Ford, KFC, McDonald’s and Burger King).
Generally, the standard franchising practice is seen as a possible shortcut to the up and running of an established business by an unrelated third-party. In consideration of a lump-sum payment or a recurring payment (or both) by the franchisee, the franchisor will provide to the franchisee various proprietary business knowledge, processes and/or trademarks owned by the franchisor. This will allow the franchisee to offer services or products under the franchisor’s business name and to commence business almost immediately. The practice of franchising is governed by way of statute in Malaysia and the sequence of events of a franchising exercise is also briefly described under section 4 of the Franchise Act 1998.[2]
Franchise Act 1998 (“Act”)
In Malaysia, the act of franchising is governed under the Franchise Act 1998. The Act provides for the registration, administration, and enforcement of franchise business in Malaysia and is designed to protect both the franchisor and franchisee.
What is licensing?
Unlike franchising agreement, which is strictly governed under the Act, licensing agreement is not governed under any specific statute and is simply a contractual agreement between two parties. As a contractual agreement, parties are free to negotiate the terms of contract and as such it is often less stringent when compared with a franchising agreement. In the event of any breach of the licensing agreement, the parties will have to refer to the Contracts Act 1950.[3]
How is the franchise regime regulated under the Act?
Under section 3 of the Act, it is expressly stated that the Act will be applied to the sale and operation of any franchise in Malaysia. This includes circumstance where an offer to sell or buy a franchise is made outside of Malaysia or even if the offer is accepted outside of Malaysia, so long as the franchised business concerned is operated or will be operated in Malaysia.
In addition, pursuant to section 4 of the Act, the term “franchise” is defined as a contract or an agreement, either expressed or implied, whether oral or written, between two or more persons in which —
- 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;
- 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;
- 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
- in return for the grant of rights, the franchisee may be required to pay a fee or other form of consideration.
From the above, the scope of application of the Act is clear. However, it should be noted that notwithstanding section 4(a) above, section 25 of the Act mandated that a franchise term shall not be less than five years.
What benefits does a franchising exercise has over licensing?
(i) Licensing
On one hand, licensing has the absolute benefit in terms of flexibility and adaptability. However, due to the definition of ‘franchise’ as noted above, precautions must be taken when drafting a licensing agreement to prevent the occurrence of a ‘disguised franchising agreement’. This means that a licensing agreement may not be suited for individuals with the intention of conducting a franchising exercise.
In determining whether a business falls within the ambit of franchise or license, the Court had, in Dr Premanathan a/l Vasuthevan v Permai Polyclinics Sdn Bhd [4] looked into the following elements:
- the nature of the agreement entered between parties;
- the degree of control administered over the business operation; and
- parties’ intention when entering into the agreement.
In addition to the above, the Court also noted the relevance of section 4 of the Act. As seen in the case of Dr H K Fong Brainbuilder Pte Ltd v SG-Maths Sdn Bhd & Ors[5], the Court gave its verdict that the Master License Agreement entered between parties fell within the definition of a franchise under section 4 of the Act, based on the fact that the agreement had fulfilled the mandatory elements which constitutes a “franchise”.
(ii) Franchising Exercise
On the other hand, whilst additional requirements are imposed upon the parties in the Act in a franchising exercise which includes:
- registration requirements (section 6 of the Act);
- prescribed format requirements (section 18 of the Act);
the Act also included various sections designed to offer protection to both parties. This includes:
- Prohibition against discrimination (section 20 of the Act);
- Usage of promotion fund (section 22 of the Act);
- Protection of confidential information (section 26 of the Act);
- Prohibition against similar business (section 27 of the Act);
- Stipulated conduct and obligations of parties (section 29 & 30 of the Act);
- Terms on termination of franchise agreement (section 31 of the Act); and
- Imposition of criminal liabilities for failure of compliance (part VI of the Act).
This means that the parties in a franchising exercise are automatically afforded protection under the statute and there is an element of certainty as opposed to a licensing agreement.
Conclusion
Whilst licensing allows the parties to freely contract to each other on such terms as they think fit, the protections afforded are often minimal and highly dependent on the exact terms of the licensing contract. In a situation of uneven bargaining power, a weaker party may not be able to negotiate sufficiently to fully safeguard its rights and interest. On the other hand, franchising agreement is highly regulated in Malaysia and the rights of the parties are enshrined in the Act itself.
[1] https://corporate.mcdonalds.com/corpmcd/franchising-overview.html
[2] Act 590
[3] Act 136
[4] [2015] 5 MLJ con 127
[5] [2021] 1 MLJ 549