In Malaysia, franchising is governed by the Franchise Act 1998 (Act 590, or “the Act”). Section 4 of the Act defines “franchise” as a contract or an agreement, either expressed or implied, whether oral or written, between two or more persons by which:

1. 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;
2. 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;
3. 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
4. in return for the grant of rights, the franchisee may be required to pay a fee or other form of consideration.

The High Court in the case of Cheah Yee Chen & Ors v. Safeway Solutions Sdn Bhd & Ors [2023] 6 CLJ 841 held that an agreement is a franchising agreement for as long as the four cumulative conditions as set out in limbs (a)-(d) above are fulfilled.

The Act applies throughout Malaysia to the sale and operation of any franchise in Malaysia.  For purpose of the Act, the sale and operation of a franchise is deemed to be in Malaysia where (a) an offer to sell or buy a franchise – (i) is made in Malaysia and accepted within or outside Malaysia; or (ii) is made outside Malaysia and accepted within or outside Malaysia; and (b) the franchised business is operated and will be operating in Malaysia.

A franchisor must first register his franchise with the Registrar of Franchises (“the Registrar”) before he can operate a franchise business or make an offer to sell the franchise to any person. In addition, a foreign person must also obtain an approval to sell a franchise in Malaysia or to any Malaysian citizen under section 54 of the Act. Failure to seek approval from the Registrar and/or register a franchise are deemed as offences punishable by fine and/or imprisonment under the Act.  Upon conviction, a body corporate may be imposed a fine not exceeding RM250,000, and for second or subsequent offence, to a fine not exceeding RM500,000. If such person is not a body corporate, such person may be liable to a fine not exceeding RM100,000 or to imprisonment for a term not exceeding one year or to both, and for a second or subsequent offence, to a fine not exceeding RM250,000 or to imprisonment for a term not exceeding three years or to both.

Yes, subject to section 58 of the Act where the Minister may grant exemption from registration, both franchisor and franchisee are required to submit application for approval in such form as determined by the Registrar together with the prescribed fees as well as the following pursuant to section 7 of the Act: (a) the complete disclosure documents with all the necessary particulars filled in; (b) sample of the franchise agreement; (c) the operation manual of the franchise; (d) the training manual of the franchise; (e) a copy of the latest audited accounts, financial statements, and the reports, if any, of the auditors and directors of the applicant and (f) such other additional information or documents as may be required by the Registrar for the purpose of determining the application. Submissions by any franchisor for the requisite approval must be made prior to operating a franchise business or making an offer to sell the franchise to any person.  Franchisees on the other hand are required to apply to register the franchise with the Registrar prior to commencing the franchise business.  At the moment, franchisors are obliged to register for and on behalf of their franchisees.  Currently, all submissions can only be made online through https://myfexv2.kuskop.gov.my.

Franchisors

Local Franchisor

A local franchisor is required to register his franchise with the Registrar before the operation of his franchise business or offering for sale of franchise to any person under section 6 of the Act.

Foreign Franchisor

In addition to the above requirement for local franchisor, a foreign franchisor must first obtain an approval to sell his franchise in Malaysia or to any Malaysia citizen under section 54 of the Act.  However, in practice, one single application is required to be submitted by a foreign franchisor, for the purpose of obtaining the approval under both Sections 54 and 6.

Effect of Non-Registration

The non-registration of a franchise renders any agreements relating to it being tainted with illegality and consequently void, pursuant to sections 2(g) and 24 of the Contracts Act 1950.  Section 2(g) of the Contracts Act 1950 provides that “an agreement not enforceable by law is said to be void”, whereas section 24(a) and (b) provide: “The consideration or object of an agreement is lawful unless (a) it is forbidden by a law; (b) it is of a nature, if permitted, if would defeat any law.”

In Dr H K Fong Brainbuilder Pte Ltd v SG-Maths Sdn Bhd & Ors [2021] 1 CLJ 155, the Court of Appeal affirmed the High Court decision that an unregistered franchise agreement is void and unenforceable for illegality. At the High Court level, the High Court did not invoke section 66 of the Contracts Act 1950 for restitution and took the position that the defendant (franchisee) had not received any advantage to be restored to the plaintiff.  The Court held that, for section 66 of the Contracts Act 1950 to apply, (a) there must be evidence that a contracting party has received an “advantage” in an agreement “discovered to be void” or when the agreement “becomes void”; and any contracting party who received an advantage can be ordered by the court to restore any advantage or pay compensation to the other contracting party.

Contrast from Janet Ooi Hui Ming v STC Management Sdn Bhd & Anor [2021] 8 CLJ 852 where the High Court held that an unregistered franchise agreement which fulfils the 4 limbs of franchise under the Act is void and unenforceable. As the agreement was found to be void as it was tainted with illegality, the ‘franchisee’ was entitled to restitution under section 66 of the Contracts Act 1950. It followed that the plaintiff (franchisee) was entitled to be restored to the position she would have been had the tort not been committed. This essentially meant that the plaintiff (franchisee) was entitled to all payments made by her to the defendants under the agreement.

Penalties

Franchisors who fail to comply with the registration requirement in section 6 of the Act will be subject to the following penalties on conviction: For body corporates, a fine of up to RM250,000 for a first offence, and a fine of up to RM500,000 for subsequent offence(s). Non-body corporates found in violation will face a fine not exceeding RM100,000 and/or imprisonment for up to one year for a first offence. For repeat offences, the penalties increase to a fine of up to RM250,000 and/or imprisonment for up to three years.

Franchisees

Local Franchisees

Pursuant to section 6B of the Act, a franchisee who has been granted the right to operate a franchise of a local franchisor or a local master franchisee must register the said franchise with the Registrar within fourteen (14) days from the date of signing the relevant franchise agreement between the franchisor and the franchisee, non-compliance of which constitutes an offence under the Act.

Franchisees of Foreign Franchisor

Pursuant to section 6A of the Act, franchisees of a foreign franchisor shall apply to register the franchise with the Registrar by before commencing the franchise business.

In practice currently, the franchisor is obliged to register for and on behalf of the franchisees.

Penalties

Failure of franchisees to comply with the requirements set forth in Sections 6A and 6B of the Act are offences under the Act.

Obligation to update existing registrations

There is a statutory obligation for franchisors to update existing registrations. Under section 16 of the Act, franchisors must submit an annual report with the Registrar within six (6) months of the end of the financial year of the franchise business. Failure to do so constitutes an offence. The report must contain updated disclosure documents. The Registrar may review the report and disclosure documents and notify the franchisor:

1. if any additional information or modification of the disclosure documents is to be included or deleted; or
2. issue an order to suspend, terminate, or cancel the approval of the registration of the franchise in the public interest or for the purpose of protecting prospective franchisees until any deficiencies specified by the Registrar have been corrected.

If there is any material change in the supporting documents for registration of franchise, namely, the disclosure document, franchise agreement, operation manual, training manual or any other documents, the applicant or his director or manager may only amend the documents with the approval of the Registrar. The amendment made to any of the supporting documents shall be filed with the Registrar together with the prescribed fees.

Pursuant to section 15 of the Act, a franchisor must submit to his franchisee a copy of the franchise agreement and documents including amendments to the documents duly approved by the Registrar of Franchises at least 10 days before the franchisee signs the franchise agreement with the franchisor or after the document is approved by the Registrar, whichever is applicable.  These documents include the ones mentioned in section 7 of the Act, namely,  (a) the complete disclosure documents with all the necessary particulars filled in; (b) sample of the franchise agreement; (c) the operation manual of the franchise; (d) the training manual of the franchise; (e) a copy of the latest audited accounts, financial statements, and the reports, if any, of the auditors and directors of the applicant and (f) such other additional information or documents as may be required by the Registrar for the purpose of determining the application.

A franchisor’s failure to disclosure is an offence under section 15(3) of the Act. Upon conviction, a body corporate may be imposed a fine not less than RM10,000 and not more than RM50,000, and for a second or subsequent offence, to a fine of not less than RM20,000 and not more than RM100,000. If such person is not a body corporate, the penalty shall be a fine of not less than RM5,000 and not more than RM25,000 or to imprisonment for a term not exceeding 6 months, and for a second or subsequent offence, to a fine of not less than RM10,000 and not more than RM50,000 or to imprisonment for a term not exceeding 1 year.

The above requirements extend to include subfranchisee which is defined by the Act to mean a subfranchise holder.  Subfranchise in turn is defined to mean a franchise granted by a master franchisee to a subfranchisee for business purposes under the Act.

Pursuant to section 15 of the Act, submission of a copy of the franchise agreement and documents including amendments to the documents must be made to the franchisee who will be signing the agreement with the franchisor, for example. As the purpose and intent of the Act is to ensure that franchisee is duly informed, it is prudent to ensure disclosure is duly made to all affected parties, so as to avoid challenges under section 15 of the Act.

Under section 37 of the Act, a person who in relation to an offer to sell a franchise or during the sale of a franchise, whether directly or indirectly (a) employs any device or scheme in order to defraud; (b) makes any untrue statement of a material fact or omits to state a material fact which renders his statement to be misleading; (c) engages in any act, practice or course of business, which operates or would operate as a fraud or deceit upon any person, commits an offence. Any mis-selling described above can be an offence.

Further, where false representations have been made by the franchisor knowing them to be false and without any belief to its truth and with an intention to induce the franchisee to enter into the franchise agreement and subsequently, causes the franchisee to enter into the agreement, the franchisor may be liable for negligent, reckless and/or fraudulent misrepresentation.

In the case of Janet Ooi Hui Ming v. STC Management Sdn Bhd & Anor [2021] 8 CLJ 952, the Court held that the franchisor must be inferred, from the act of executing an agreement, that it has represented to the franchisee that the franchisor had a valid and registrable franchise brand in Malaysia. The Court accordingly found injury to have been caused when it transpired that the franchise business was not validly registered, rendering the agreement void.  In this case, the Court held that the franchisee was entitled to restitution under section 66 of the Contracts Act 1950 as the agreement was void for illegality. It followed that the franchisee was entitled to be restored to the position she would have been in had the tort not been committed.

In the case of Khor Yiap Seng v Soo Geok Ki & Ors [2023] 1 LNS 571, the Court ruled that the defendants’ fraudulent misrepresentation had induced the plaintiff to enter into an unregistered franchise business with an agreement falsely labelled as a “License Agreement” rendered the agreement illegal. The court declared the agreement void and hence unenforceable, ordering the return of RM350,000 paid as a franchise fee to the defendants by the plaintiff.

Disclaimer

Disclaimer of liability and non-reliance clauses in agreement have been stringently construed and applied by the courts. See the case of Top Glove Corp Bhd & Anor v Low Chin Guan & Ors [2018] MLJU 1179.

Whilst there are no express provisions in the Act specifically prohibiting the issuance of a franchise agreement on a non-negotiable, “take it or leave it” basis, section 37 of the Act prohibits a person who offers to sell a franchise or during the sale of franchise to undertake, whether directly or indirectly, the following: (a) the employment of any device or scheme in order to defraud, (b) making any untrue statement of a material fact or omitting to state a material fact which renders his statement misleading or engaging in any act, (c) practice or course of business which operates or would operate as a fraud or deceit upon any person.   Further, it should be noted that the general principles of contract law apply equally to franchise agreements. Thus, the contract must still adhere to principles of fairness and mutual consent, and should be free of any element of duress, coercion, or undue influence.

Trademarks

Trademarks may be protected via a registration process with the Malaysian Intellectual Property Office (MyIPO).  Upon registration, a trademark shall be registered for a period of ten years from the date of filing.  A trademark proprietor in that sense, has exclusivity over the trademark in relation to the scope of goods or services registered during this period of time.  A trademark may be renewed every 10 years.  In addition, unregistered trademarks or service marks may also be protected under common law through the tort of passing-off, since Malaysia practises the ‘first to use’ principle, provided that these marks have attained goodwill and reputation in the country.

However, before submitting an application for franchise registration, section 24 of the Act stipulates that a franchisor must first register the trademark relevant to the franchise.

Know-how and Trade Secrets

Whilst obligations to safeguard confidentiality may arise from agreements, the obligation or duty of confidence may also be said to arise in equity, from a relationship of trust between a confider and his confidant. According to the Federal Court’s case of Dynacast (Melaka) Sdn Bhd & Ors v. Vision Cast Sdn Bhd & Anor [2016] 6 CLJ 176, the tort of breach of confidence has the following three ingredients:

1. the information must have the necessary quality of confidence,
2. the information must have been imparted under circumstances that imports an obligation of confidence, and
3. there must be unauthorised use of that information to the detriment of the party communicating it.

In addition, section 26 of the Act extends the obligations of confidence beyond that of the franchisee, so as to cover the franchisee’s directors, the spouses and immediate family of the directors.  Pursuant to section 26(1) of the Act, a franchisee shall give a written guarantee to a franchisor that the franchisee, including its directors, the spouses and immediate family of the directors, and his employees shall not disclose to any person any information contained in the operation manual or obtained while undergoing training organized by the franchisor during the franchise term and for two years after the expiration or earlier termination of the franchise agreement. Failure to comply is an offence.

Copyright

Copyright is the exclusive right to control creative works created by the author, copyright owner and performer for a specific period governed under the Copyright Act 1987. Copyright protects literary, musical, and artistic works, including films, sound recordings, broadcasts, and derivative works. Copyright protection can cover marketing materials, training manuals and operational guidelines, the software system used for the franchise business as well as any trademark logos, etc.  There is no registration scheme for copyright in Malaysia.  Owners may however choose to submit a notification of his copyrighted work to the Malaysian Intellectual Property Office (MyIPO) under the Copyright (Voluntary Notification) Regulations 2012 or execute a statutory declaration made pursuant to section 42 of the Copyright Act 1987. Either the declaration or notification shall be prima facie evidence of particulars entered therein namely, copyright subsistence and ownership and is admissible as evidence in the courts.

The duration of copyright protection varies by type of work.  For literary, musical, and artistic works, protection lasts for 50 years after the author’s death.

The Act outlines and provides for the ongoing relationship between franchisor and franchisee. In fact, pursuant to Section 18 of the Act, a franchise agreement must include provisions regarding the obligations of both parties. Section 30 of the Act further states these obligations as follows:

1. A franchisor shall give a written notice about a breach of contract by a franchisee and allow the franchisee time to remedy the breach.
2. A franchisee shall pay the franchise fees, royalty, promotion fees or any other payment as provided in the franchise agreement.
3. A franchisor shall provide assistance to a franchisee to operate his business, such as the provision or supply of materials and services, training, marketing, and business or technical assistance.
4. A franchisor and a franchisee shall protect the consumer’s interests at all times.

Competition Act 2010 (“CA”), which is the primary legislation on competition law in Malaysia, applies to any commercial activity within Malaysia except for those specified in the First Schedule of the CA. Franchising is not one of the exempted commercial activities, hence provisions of the CA are applicable to franchise transactions.

CA contains two main prohibitions namely: (i) anti-competitive agreements under section 4(1) of the CA and (ii) abuse of dominant position under section 10(1) of the CA. The former prohibition would be the most relevant one in the context of franchise agreements.

Section 4(1) of the CA prohibits any horizontal or vertical agreement between enterprises to the extent it has “the object or effect of significantly preventing, restricting or distorting competition in any market for goods or services”. Section 2 of the CA defines a vertical agreement as “an agreement between enterprises each of which operates at a different level in the production or distribution chain”. This would include a franchise agreement between a franchisor and a franchisee. The MyCC has previously indicated that separate guidelines will be issued for franchise, but no such document has been published by the MyCC to date.

It is however noted that the MyCC in its A Guide for Business (https://www.mycc.gov.my/sites/default/files/pdf/newsroom/Competition-Act-2010-A-Guide-For-Business.pdf) recognises that provisions in franchise agreements  that may prevent, restrict, or distort competition are incorporated therein to safeguard the franchisor’s brand reputation. Accordingly, the MyCC states that such provisions can be justified if they are proportionate to the aim of protecting the franchisor’s brand reputation.  However, as this document has no legal effect, parties will need to fall back on the general provisions under the CA when assessing franchise transactions from the perspectives of competition law.

According to the Guidelines on Chapter 1 Prohibition (“Chapter 1 Guidelines”) issued by the Malaysian Competition Commission (MyCC), anti-competitive agreements will not be considered as significantly preventing, restricting or distorting competition if:

• The parties to the agreements are competitors who are in the same market and their combined market share of the relevant market does not exceed 20%.
• The parties to the agreement are not competitors and all of the parties individually has less than 25% in any relevant market.

Thus, the question of whether a franchise agreement is anti-competitive would depend on how one defines the relevant market of the franchisor and franchisee.

Further, section 13 of the CA read together with the Second Schedule excludes the applicability of section 4 in respect of an agreement which is engaged to comply with a legislative requirement. Thus, a clause inserted into the franchise agreement to comply with the Act is arguably not infringing the CA. One example of such instances is the requirement for the franchisee to provide written guarantee on prohibition against similar business under section 13 of the Act, even if it does significantly prevent, restrict, or distort competition.

Bearing the above in mind, the common restrictions under a franchise agreement which may be impacted by competition law are discussed below.

Fixing retail prices

Price fixing or resale price maintenance refers to instances where the price at which the goods are to be sold is fixed. According to the Chapter 1 Guidelines, the MyCC will take a strong stance against minimum resale price maintenance and find it anti-competitive. Any other forms of resale price maintenance including maximum pricing or recommended retail pricing could also be deemed anti-competitive if it serves as a focal point to determine the price. However, if the recommended price is a genuine recommendation only, it will be permitted by the MyCC. In view of this, caution should be taken when incorporating price fixing clauses in franchise agreements, as such clauses may be deemed anti-competitive under the CA depending on the “relevant market” and the parties’ market share.

Exclusive supply

According to the Chapter 1 Guidelines, a vertical agreement mandating the buyer to buy all or most supplies from the seller or the seller’s designated supplier may be anti-competitive, if the seller has a significant part of the downstream market. The main anti-competitive concern here lies in whether the exclusive supply obligation will foreclose the downstream market to other suppliers. Thus, depending on the market share of the franchisor in the downstream market, franchise agreements with clauses insisting on exclusive supply may be treated as anti-competitive under the CA.

Prohibition on online sales

To date, there is no express provision in the CA and its Guidelines nor any judicial decision which addresses whether prohibition on online sales would be anti-competitive under the CA. While CJEU’s decisions on competition law have persuasive value in Malaysia, it remains to be seen whether Malaysia will adopt the same position. Thus, reliance will need to be made to the general principle namely whether the said prohibition on online sales has the object or effect of significantly preventing, restricting or distorting competition in the relevant market of the goods or services in the franchise transaction.

Non-compete clauses

Non-compete clauses are generally void and unenforceable in Malaysia as they are a form of restraint of trade, falling under section 28 of the Contracts Act 1950.  As a general rule, any agreement to restrain anyone from exercising a lawful profession, trade, or business void.

Section 27 of the Act however allows for non-compete situation for during the franchise term and for two years after the expiration or earlier termination of the franchise agreement.  This prohibition extends to include not only the franchisee but also his directors, the spouses and immediate family of the directors, and his employees.

Non-solicitation clauses

There is no specific clause against non-solicitation.  That said, the allowability for non-compete clause post-expiry or early termination of the franchise agreement, albeit for a limited duration of time, keeps solicitation at bay.

Yes. Under section 29(1) of the Act, it is provided that a franchisor and a franchisee must act in an honest and lawful manner and endeavour to pursue the best franchise business practice of the time and place. Section 29(2) of the Act further provides that a franchisor and a franchisee in their dealings with one another shall avoid the following conduct:

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

In a franchise relationship, the franchisee is generally responsible for hiring and managing its own employees, and there is no direct employment contract between the franchisee’s staff and the franchisor. The legal agreement exists solely between the franchisee and the franchisor, without involving the franchisee’s staff directly. As such, the staff of the franchisee should not typically be considered employees of the franchisor. However, it is important to note that courts have the power to infer an employment relationship based on the specifics of each case.

To mitigate this risk, the franchise agreement should include clear provisions stating that the franchisee’s staff are not employees of the franchisor. The franchisor should also avoid managing or overseeing the franchisee’s staff to maintain a clear separation between the two parties’ employment structures. Importantly, section 29(3) of the Act mandates that the franchisee operate his business separately from the franchisor and that the relationship of the franchisee with the franchisor shall not at anytime be regarded as a partnership, service contract or agency.

Section 135 of the Contracts Act 1950 defines an ‘agent’ as a person employed to do any act for another or to represent another in dealings with third persons. The person for whom such act is done, or who is so represented, is called the “principal”.

In order to prevent the relationship between the franchisor and franchisee to be regarded as an agency, it is crucial to clearly delineate in the franchise agreement the obligations of both the franchisor and the franchisee. Additionally, the franchise agreement should explicitly disclaim any agency relationship to ensure that the franchisee is not deemed a commercial agent of the franchisor.

Generally, payments made by a resident to a non-resident is subject to the relevant rules/requirements under the foreign exchange policy (“FEP”) administered by the Central Bank of Malaysia/Bank Negara Malaysia (“BNM”). Briefly, pursuant to Notice 4 (Payment and Receipt) of the Foreign Exchange Policy Notices issued by BNM on 1 June 2022 (“FEP Notices”):

• paragraph 2 provides that a Non-Resident is allowed to make or receive payment in Ringgit, in Malaysia, to or from another Resident or Non-Resident for, inter alia, “income earned or expense incurred in Malaysia” or “settlement of… a trade in goods or services, excluding payment between Non-Residents for settlement of a trade in goods or services outside Malaysia”;
• paragraph 5 provides that a Resident is allowed to make or receive payment in Foreign Currency, to or from a Non-Resident for any purpose other than in relation to certain derivative transactions, subject to compliance with the other relevant FEP rules/requirements.

There is no specific prohibition on payments to be expressed in currency other than the local currency.  That said, as a matter of practice, the equivalent sum in local currency must be expressed in the Disclosure Document.

The innocent party’s entitlement to contractual penalties or liquidated damages (LAD) are provided in section 75 of the Contracts Act 1950:

“When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach … the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named … ”

The Federal Court in Cubic Electronics Sdn Bhd v Mars Telecommunications Sdn Bhd [2018] MLJU 1935 held that the effect of section 75 is that the party seeking to enforce the damages clause will be entitled to reasonable compensation to be awarded by the court regardless of whether actual loss or damage is proven. Reasonable compensation is not confined to actual loss, although evidence of that may be a useful starting point. The party seeking to enforce the penalty or LAD clause must show that there was a breach of contract and that the contract contains a clause stipulating a sum to be compensated upon breach. Once these elements are established, the innocent party is entitled to receive a sum capped to the amount specified in the contract regardless of whether actual damage or loss is proven. The defaulting party is entitled to dispute the reasonable compensation by discharging the burden of proving the unreasonableness of the damages clause including the sum stipulated therein.

What tax considerations are relevant to franchisors and franchisees?

Payment towards the initial cost of acquiring the right to operate or commence the franchise business is generally regarded as a capital expenditure and thus not likely to be allowed tax deduction.

Having said that, however, under the Income Tax (Deduction for Expenditure on Franchise Fee) Rules 2012, tax deduction is allowed on franchise fee paid by a resident taxpayer in Malaysia prior to the commencement of the franchise business provided the following criteria are met:

it is a “local franchise brand”, i.e. a trademark or service mark that is registered under the Trademarks Act by a franchisor whose franchise business is registered under Section 6 of the Franchise Act 1998 (“FA”);

• “franchise fee” means a fee paid to the franchisor for the right to use a mark, trade secret, confidential information, intellectual property (“IP”) or system of franchise owned by that franchisor in accordance with the terms of a franchise agreement but shall not include royalty payment or other periodical payments;
• the franchise fee shall not be refundable; and
• the franchisor, as defined under the FA, wholly owns the local franchise brand and if the franchisor is a company, then at least 70% of the share capital must be Malaysian-owned.

On the other hand, unlike the initial payment, it is arguable that subsequent recurrent / periodical payments for the use of IP should be allowed tax deduction as the franchisee would not be able to generate income without the use of the IP.

Franchise fees (both initial and periodical) received by the franchisor would constitute revenue receipt which is taxable if the same is receivable in the ordinary course of his business where it remains as the owner of the IP.

Previously, income received in Malaysia from sources outside Malaysia was tax-exempt under the Malaysian Income Tax Act 1967 (“ITA”). However, with effect from 1 January 2022, such exemption is only available to income arising from sources outside Malaysia and received in Malaysia by a non-resident.

Are franchise royalties subject to withholding tax?

It should not be assumed that all payments made to a non-resident franchisor would be subject to withholding tax. In the context of a franchise agreement / arrangement, withholding tax would normally be applicable to the royalty component if it falls within the ambit of the definition of “royalty” in the ITA.

Under Section 2 of the ITA, “royalty” is given an extensive meaning whereby it is deemed to include, amongst others, any sums paid as consideration for, or derived from:

“(a)    the use of, or the right to use in respect of, any copyrights, software, artistic or scientific works, patents, designs or models, plans, secret processes or formulae, trademarks or other like property or rights;

                    (b)    …

                    (c)    the use of, or the right to use, know-how or information concerning technical industrial, commercial or scientific knowledge, experience or skill;

                    (d)    …

                    (e)    …

                    (f)     …

                    (g)    …

                    (h)    the alienation of any property, know-how or information mentioned in paragraph (a), (b) or (c) of this definition”

Currently, there are no guidelines issued that govern the use of e-commerce in the franchise businesses. The territoriality of the franchise business would appear to depend on contractual agreement between parties.  Any restriction or otherwise could be subject to competition law.  See response to question 10 above.

What are the applicable data protection laws and do they have any specific implications for the franchisor/franchisee relationship?

In Malaysia, the primary legislation governing data protection is the Personal Data Protection Act 2010 (PDPA). It seeks to apply to any person who processes or has control over or authorises the processing of personal data (referred to as ‘data user’). Data processing is defined widely under the PDPA to cover a wide range of activities, including using, collecting, recording, and/or storing personal data. The PDPA establishes a framework for the processing of personal data in commercial transactions and imposes certain rights and obligations to data users.

Under the PDPA, both franchisors and franchisees may be considered data users if they use data belonging to individuals such as customers and employees. The PDPA outlines key principles that data users must adhere to, including the need for consent, data security, and the rights of data subjects to access and correct their personal information.

In the context of a franchisor-franchisee relationship, the franchise agreement should clearly set out parties’ respective data protection responsibilities, especially if the customer data is shared or centralized through a franchisor-managed system or there are cross-border data transfers between parties.  The terms should ensure compliance with the PDPA’s requirements by both parties, including ensuring adoption and implementation of adequate security measures in the event of data breaches.  Failure to comply can result in penalties that can potentially extend to the director, chief executive officer, chief operating officer, manager, secretary or other similar officer of body corporates of the data user.

Is the franchisor permitted to restrict the transfer of (a) the franchisee’s rights and obligations under the franchise agreement or (b) the ownership interests in the franchisee?

Yes, the franchisor is permitted to restrict both (a) the franchisee’s rights and obligations under the franchise agreement and (b) the ownership interests in the franchisee, provided that such restrictions are clearly outlined within the terms of the franchise agreement. There are no statutory constraints that limit a franchisor’s ability to impose these restrictions.

Does a franchisee have a right to request renewal

Yes, a franchisee’s right to request renewal on expiration of the initial term is governed by the Act. Under section 34(1), a franchisee may, at his option, apply for an extension of the franchise term by giving a written notice to the franchisor not less than six (6) months prior to the expiration of the franchise term.

Can a franchisor refuse to renew a franchise agreement?

The franchisor may be able refuse to renew the franchise agreement with a franchisee if the franchisee has breached the terms of a previous franchise agreement, pursuant to section 34(2) of the Act.

Compensation for franchisee?

A franchisee is entitled to compensation in the event of non-renewal of franchise upon the occurrence of either of the following situations;

1. 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 that prohibits the franchisee from continuing to conduct similar business under another mark in the same area subsequent to the expiration of the franchise agreement; or
   1. 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.

There is no strict guideline on compensation, though factors such as diminution in the value of the franchised business has been mentioned as one of the factors under the Act.

Except for agreement by both parties to mutually terminate prior to the expiry of the term of the agreement or via Court order under section 33 of the Act, the Act provides that no franchisor or franchisee shall terminate the agreement before the expiration date except there arises ‘good cause’.  ‘Good cause’ includes but is not limited to:

1. the failure of a franchisor or a franchisee to comply with any terms of the franchise agreement or any other relevant agreement entered into between the franchisor and franchisee;
2. the failure of a franchisor or the franchisee to remedy the breach committed by him or any of his employees within the period stated in a written notice given by the franchisor, which shall not be less than fourteen (14) days, for the breach to be remedied;
3. without the requirement of notice and an opportunity to remedy the breach, circumstances in which the franchisor or franchisee:

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

The Court of Appeal in the case of Gerbang Alaf Restaurants Sdn Bhd v. Chai Su Lin & Anor [2023] 8 CLJ 337 involving the brand McDonald’s, held that vis-à-vis termination of a franchise agreement by the franchisor (master franchisee) for repeated failure to comply with the terms of the franchise agreement under section 31(3)(d) of the Act, the Court held that the fact that such failure or breach of the terms of the franchise agreement had been remedied did not extinguish the fact that there was a failure to comply or a breach in the first place.  In other words, whether the failure or the breach had been remedied or not, was irrelevant to the termination of the franchise agreement under section 31(3)(d) of the Act.  The Court opined that to hold otherwise would defeat the objective of this provision.

As the franchisor is usually the proprietor of most of the elements that were used in the course of the franchise business, it is logical to assume that franchisor will also own any local goodwill that arise through the use of the said elements (IP inclusive).  For the avoidance of doubt however, it is good practice for franchise agreements to stipulate that the franchisor owns any intellectual property and goodwill associated with, arising out of or developed by the franchise business.  For instance, there might well be improvements made onto certain training or operation manual during the course of business, for which the franchisor would wish to remain as the copyright owner, for instance.  Vis-à-vis customer data, the issue of consent by data subject is of more relevance, and hence, knowing the parameters and extent of consented use would help drive the franchise business, in-term and post agreement with a particular franchisee.

The Malaysian Franchise Association (MFA) was formed in 1994 to support the implementation of government programmes to promote entrepreneurship through franchising. However, membership with the MFA is not mandatory. The MFA serves as a resource hub for the public, as well as for current and prospective franchisors and franchisees. It hosts seminars and educational programmes on franchising, including franchise development courses for those interested in starting a franchise business, learning the structuring of franchise models and recruiting the right franchisees. The MFA also collaborates with PERNAS (a Malaysian government agency established to promote and develop local businesses, particularly in the small and medium-sized enterprise (SME) sectors) to support the growth and development of local franchises by providing financial assistance.

Are foreign franchisors treated differently to domestic franchisors?

Under section 54 of the Act, foreign franchisors are required to first seek franchise approval under section 54 of the Act in addition to the requirement of registering as franchisors under section 6 of the Act; whereas local franchisors and local master franchisees are only required to register as franchisors under section 6 of the Act. However, as mentioned in above, only one single application is to be submitted for obtaining both approval and registration under Sections 54 and 6.

Does national law/regulation impose any debt/equity restrictions?

National law and regulations do impose debt/equity restrictions. These are usually sector specific depending on the type of business carried out by a company in Malaysia and the laws, regulations, licences, approvals, authorisations that apply to the company. Some of these may prescribe conditions relating to equity (for example, maximum permitted foreign shareholding in the company or the minimum local shareholding in the company) or there may be debt restrictions (for example, the proportion of total borrowings over total asset value).

Are there any restrictions on the capital structure of a company incorporated in your country with a foreign parent (thin capitalisation rules)?

Thin capitalisation was replaced by the earning stripping rules implemented with effect from January 1, 2019. Under the Income Tax (Restriction on Deductibility of Interest) Rules 2019, the amount of interest expense which is deductible on any “financial assistance” (as defined) granted in a controlled transaction, is restricted to a maximum limit (“Limit”) so that any interest expense in excess of the Limit would not be tax-deductible, in ascertaining a person’s adjusted income from a business source.

The maximum amount of deductible interest expense is an amount equal to 20% of the amount of tax-EBITDA of a person from each of his sources consisting of a business for the basis period for a year of assessment. Any interest expense in excess of the limit may be carried forward to subsequent years of assessment to be deducted against the subsequent year’s adjusted income (subject to the limit for the relevant year) until it is fully utilised.

The Act does not strictly mandate the adoption of local laws.  While parties appear to have the right to choose the governing law, it would appear that the Act continues to apply and that both franchisor and franchisee alike must still comply with the Act.  In the case of Dr HK Fong BrainBuilder Pte Ltd v SG-Maths Sdn Bhd & Ors [2018] 11 MLJ 701, the High Court held that parties could not circumvent the mandatory application of ss 6(1) and 6A(1) of the Act in relation to the registration of a franchise by local and foreign franchisors.

Commercial disputes, including those between franchisors and franchisees 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, repealing 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 Malaysian Franchise Association (MFA) also offers valuable conciliation and counseling services to franchisors and franchisees who encounter disagreements or differing viewpoints. These services provide a platform for resolving disputes outside of formal legal proceedings.

When electing the dispute resolution procedures, each party—whether a franchisor or a franchisee—should carefully assess their respective positions. Any insistence on a particular mode of dispute resolution should be made with clear knowledge of the relevant facts, legal implications, and potential outcomes.

The franchise agreement and disclosure documents can either be in the Malay or English language.

Yes, electronic signatures are generally accepted. The key requirement is that the e-signature must adequately identify the person and indicate their approval of the information to which the signature relates. It must also be reliable, as per Section 9 of the Electronic Commerce Act 2006. To be considered reliable, the means of creating the e-signature must be linked to and under the control of that person only, any alterations to the electronic signature after signing must be detectable, and any alterations to the document after signing must also be detectable.

Recently, the Franchise (Amendment) Act 2020 and its subsidiary legislation which came into effect on 28 April 2022 have introduced changes to the Act, notably the inclusion of the provision which prescribes a specific period of five (5) years as the period of effectiveness for franchise registrations. Thereafter, the franchise registrations must be renewed with the Registrar in a prescribed format with payment of the requisite renewal fee. Additionally, there is a new procedural requirement for all franchisors and master franchisees who were previously registered under MyFEX 1.0 system to re-register their franchises through the new MyFEX 2.0 system. This practice must be completed within a three-year window, by 31 July 2025 and failure to do so may attract actions from the Registrar including the issuance of notices for the suspension, termination or cancellation of franchise registrations.

The above amendments notwithstanding, it is advisable for both franchisors and franchisees to stay informed about new developments including any procedural rules that might be introduced.