Have you ever heard of the terms “franchise/franchising” or license/licensing” but don’t really know how they differ? It is common for business owners to mistakenly interchange them, thinking both franchising and licensing are similar as both arrangements share similar elements such as a party granting rights to use its brand name to another party for business purposes. However in reality, both arrangements have notable differences.
In this article, we will explore both franchise and license arrangements to demonstrate the distinction between both. If you are wondering whether your business model is either a franchise or license arrangement, we hope this article provides some clarity.
Franchise Arrangement
A franchise arrangement involves a franchisor (providing party) offering the franchisee (receiving party) the use of its brand, trade name, know-how, operation skills and business model in exchange for payments, which are usually the franchise fee and royalty payments.
Under section 4 of the Franchise Act 1998 (“FA 1998”), a franchise is defined as 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.
(Referred to as the “Four Elements”)
In simple words, a business arrangement consisting of the Four Elements above would be regarded as a franchise, irrespective of whether the business arrangement was intended to be otherwise.
Examples of franchise businesses in Malaysia are McDonalds, Family Mart, Secret Recipe, Boost Juice, OLDTOWN White Coffee, KFC and 7-Eleven. The Malaysian Franchise Association (MFA) reports that the food and beverage sector is the business sector with most franchises in Malaysia, followed by the services sector.
(Note: The trademarks displayed belong to their respective proprietary owners. We do not represent or claim to own any proprietary rights of these trademarks)
Franchise arrangements in Malaysia are governed by the Franchise Act 1998 (“FA 1998”) and regulated by the Registrar of Franchises (“Registrar”) under the purview of the Ministry of Domestic Trade and Cost of Living (“MDT”). The FA 1998 governs various areas of the franchise arrangement such as the registration of franchise, mandatory provisions of the franchise agreement and the operation of the franchise, which should be complied by both franchisors and franchisees.
License Arrangement
Licensing is a contractual arrangement between the licensor (providing party) and licensee (receiving party) whereby the licensor may grant the licensee the permission / right to use its business which includes trademarks, logos, business identifiers and goods or services in order for the licensee to generate revenue in exchange of fees by the licensee to licensor (usually known as licensing fee or royalty fees). There is no specific legislation that governs a licensor-licensee relationship and therefore, parties are free to negotiate terms they wish to incorporate in the license agreements. As license agreements are contractual in nature, they would fall under the purview of general contract laws in Malaysia.
Differences between the franchise and license arrangement
As mentioned above, the franchise model is heavy governed by the FA 1998 and as such, it is fair to say that the terms can be quite restricted compared to the license model, whereby parties are freer to decide their own terms without having to comply with certain legislations. Non-compliances of the FA 1998 are constituted as offences of which the offending party can be penalised with financial penalties and/or imprisonment. Below are some of the key differences between these both models:
A. Degree of control
Under the franchise arrangement, the franchisor has the right to administer continuous control over the franchisee’s business operations in accordance with the franchise systems and operations manuals to ensure conformity. This means that the franchisor has a significant control over the franchise business and is usually involved and monitors the operation of the franchise business. The franchisee would have limited flexibility in running the franchise business as they are bound to the franchise system. Any alterations or modifications of the franchise business would usually require the franchisor’s permission.
In a licensing arrangement on the other hand, the licensor would have a significantly less control over how the licensee operates its day-to-day business as licensors usually do not have continuous control over the licensee’s business. As such, the licensees usually have more flexibility to run the license business as desired.
B. Term
In the franchise arrangements, the FA 1998 expressly states that the franchise term shall not be less than 5 years. However, licensing arrangements have no such fixed term and parties are free to set their own term / duration of the license arrangement.
C. Registration of trademark of the franchisor
In franchise arrangements, Section 24 of the FA 1998 requires that a franchisor register his trade mark relevant to the franchise in accordance with Malaysia trademarks laws before applying for the registration of the franchise. However, there is no such mandatory requirement imposed on licensors in the licensing arrangement. Despite that saying, its is best practice for a licensor to register all relevant trademarks relating to the business prior to entering the licensing agreement with the licensee for protection of the licensor’s intellectual property rights.
D. Prohibition against similar business
A licensor is unable to prohibit its licensee from conducting a similar business after the expiration or termination of the license agreement as this run fouls under the Contracts Act 1950. Any prohibition against similar business clause or often known as non-competition clause in the license agreement can be void.
However, under the franchise arrangement, section 27 of the Franchise Act makes it mandatory for the franchisee, including its directors, spouses and immediately family of the directors, and his employees to be prohibited from carrying on any similar business during the franchise term and 2 years after the expiration or termination of the franchise agreement, failing which, the same shall be constituted as an offence under the FA 1998.
E. Renewal and Extension
The FA 1998 states that a franchisor commits an offence if he refuses to renew a franchise agreement or extend a franchise term without compensating the franchisee either by a repurchase or by other means at a price to be agreed between parties. Further, a franchisor must extend the franchise term to another period if the extension has been requested by the franchisee through a written notice to the franchisor not less than 6 months prior to the expiration of the franchise term. The franchisor is only allowed to refuse the franchisee’s request for extension of franchise term if the franchisee has breached the terms of the franchise agreement.
However, there are no such requirements imposed on the licensor in the licensing arrangement.
F. Termination
Under the franchise arrangement, the franchisor and franchisee are only allowed to terminate the franchise agreement before the expiration date provided that there is a “good cause” to do so. Section 31(2) has defined “good cause” as (non-exhaustive):
a) the failure of a franchisor or a franchisee to comply with any terms of the franchise agreement; and
b) 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 days, for the breach to be remedied. Do note that the requirement of such written notice is mandatory, failing which, the franchisor can run foul of section 31(2) of the FA 1998.
However, the FA 1998 recognises some events of “good cause” whereby a written notice would not be required nor an opportunity of remedy which are when the franchisor or franchisee:-
a) makes an assignment of the franchise rights for the benefit of creditors or a similar disposition of the assets of the franchise to any other person;
b) becomes bankrupt or insolvent;
c) voluntarily abandons the franchised business;
d) is convicted of a criminal offence which substantially impairs the goodwill associated with the franchisor’s mark or other intellectual property; or
e) repeatedly fails to comply with the terms of the franchise agreement.
Alternatively, a licensing arrangement does not have such requirement for termination. It gives an opportunity to parties to set their own terms for events which would lead to termination.
G. Mandatory terms
A franchise agreement would need to incorporate mandatory terms stipulated by section 18 (2) of the FA 1998, which are as below. Failure to incorporate such mandatory terms shall be an offence under the FA 1998:
the name and description of the product and business under the franchise;
the territorial rights granted to the franchisee;
the franchise fee, promotion fee, royalty or any related type of payment which may be imposed on the franchisee, if any;
the obligations of the franchisor and franchisee;
the franchisee’s rights to use the mark or any other intellectual property, pending the registration or after the registration of the franchise;
the conditions under which the franchisee may assign the rights under the franchise;
a statement on the cooling off period which shall not be less than 7 working days during which the franchisee has the option to terminate the agreement;
a description pertaining to the trademark or any other intellectual property owned or related to the franchisor which is used in the franchise;
if the agreement is related to a master franchisee, the franchisor’s identity and the rights obtained by the master franchisee from the franchisor;
the type and particulars of assistance provided by the franchisor;
the term of the franchise, and the terms of renewal and extension of the franchise agreement; and
the effect of termination or expiration of the franchise agreement.
As mentioned above that license agreements are flexible and reliant on parties’ own negotiation, there are no mandatory terms required to be incorporated into license agreements.
Conclusion
The above shows that franchise arrangements are stricter and more restricted compared to license arrangements as it heavily relies on the provisions of the FA 1998. License arrangements are more flexible and gives parties more room for negotiations. However, licensors have much lesser control of the licensed business compared to the franchise arrangements.
In order to analyse whether your business model falls under the franchise or license arrangement, the key importance is determining whether the Four Elements are present.
In Dr H K Fong Brainbuilder Pte Ltd v Sg-Maths Sdn Bhd & Ors [2018] MLJU 682, the Master License Agreement was not titled a “franchise” nor did it use the word “franchise”. However, the High Court held that it is not bound by the label or description given by the parties to the agreement. The Court ruled that the Master License Agreement clearly showed that the same fulfilled all four mandatory elements constituting a “franchise” and therefore deem a franchise instead of a license arrangement.
It is pivotal to remember that having the Four Elements present would mean that the business arrangement is a franchise and thus, the same has to be registered with the Registrar in order to prevent potential criminal penalties under the FA 1998.
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