Oh No! Further Registration Required for Foreign Franchisors?

Wong Jin Nee and Pua Siau Kee discuss the High Court’s recent decision which impacts the registration of foreign franchisors.

 

The High Court’s recent decision in Dr H K Fong BrainBuilder Pte Ltd v SG-Maths Sdn Bhd & Ors [2018] 11 MLJ 701 has certainly raised some concerns amongst those in the franchise industry. In the wake of this decision, foreign franchisors are left in a lurch, wondering if they will additionally be required to register their franchises under section 6 of the Franchise Act 1998 (‘FA’), on top of seeking the usual section 54 approval. This issue has particularly been weighing on the minds of foreign franchisors who have previously obtained franchise approval under section 54. Based on recent comments made by the Franchise Development Division of the Ministry of Domestic Trade and Consumer Affairs (‘FDD’), it does appear that foreign franchisors may be subject to additional registration requirements, in light of this decision.

 

Background

Dr Fong Ho Kheong (‘Dr Fong’) is the founder of BrainBuilder, a business which he established to teach mathematics to school students using a method developed by him. The Plaintiff, a Singaporean entity incorporated by Dr Fong, entered into a master license agreement (‘MLA’) with the First Defendant to open, operate and manage BrainBuilder centres in Malaysia.

Further to commencing the BrainBuilder business in Malaysia, the Plaintiff subsequently discovered that the First Defendant had committed various breaches of the MLA, prompting it to institute an action against the Defendants. In its defence, the First Defendant contended that the MLA was invalid. Aside from the other issues brought before the Court, emphasis in this article will be given to the issues relevant to the franchise industry.

 

Is the MLA subject to the FA?

Given that the MLA was neither entitled a “franchise” agreement nor was there any reference to the word “franchise” in its body, the Court had to decide whether the MLA is subject to the FA, based on the obligations therein. In this regard, it was held that the Court is not bound by any label or description given by the parties to the MLA. Rather, the Court delved into the factual matrix of the case, and decided that the BrainBuilder business bears the hallmarks of a franchise. The MLA is therefore subject to the FA. In arriving at its decision, the Court had particularly relied on the following facts:

  • the Plaintiff had granted the First Defendant the right to operate the BrainBuilder business according to a franchise system, for a term and consideration determined by the Plaintiff;
  • the First Defendant was granted the right to use the Plaintiff’s confidential information and intellectual property;
  • the First Defendant was required by the Plaintiff to comply with the latter’s “franchise operation manual” in its operation of the BrainBuilder business;
  • Dr Fong had referred to the First Defendant as a master franchisee in his email; and
  • the Plaintiff’s solicitor had advised Dr Fong to register the BrainBuilder business as a franchise, though this advice was not acted upon by him.

 

Is the MLA Valid and Enforceable?

The MLA’s validity hinged on whether the Plaintiff and the First Defendant had contravened the requirements under the FA, particularly sections 6(1) and 6A(1), which would render the MLA void and unenforceable against the First Defendant. Pursuant to section 6(1), a franchisor is required to register its franchise with the FDD before offering to sell its franchise to any party. Conversely, section 6A(1) requires a franchisee who has been granted a franchise from a foreign franchisor to register its franchise with the FDD, prior to commencing the franchise business.

In an attempt to prove the MLA’s validity, the Plaintiff had argued that it was not bound by section 6(1) since the said provision only applies to a local franchise (and local franchisor), whereas the BrainBuilder business is a foreign franchise. With regard to section 6A(1), since the onus was on the First Defendant to register with the FDD, the Plaintiff contended that it should not be penalised for the First Defendant’s omission to do so.

The Court rejected the Plaintiff’s arguments and held that both the Plaintiff and the First Defendant were obliged to register with the FDD under the respective provisions, which are deemed mandatory. By applying a purposive construction, the Court reasoned that section 6(1) applies to all franchisors, local and foreign alike, including a master franchisee. In its view, to hold otherwise would mean:

  • an absurdity whereby local franchisors would have to register with the FDD under section 6(1), but foreign franchisors would be exempted from such requirement. Under the FA, only the Minister of Domestic Trade and Consumer Affairs may exempt a franchisor, local or foreign, from this requirement under section 6(1); and
  • there would be an injustice caused to franchisees of foreign franchises, as a foreign franchisor would not have to comply with the mandatory provision under section 6(1).

In view of the Plaintiff’s and First Defendant’s failure to comply with the mandatory requirements of sections 6(1) and 6A(1) respectively, the MLA was held to be void in its entirety and therefore unenforceable.

 

Comments

 By adopting the ‘substance over form’ doctrine, the Courts are not bound by labels or descriptions given to agreements, but such determination is based on the legal consequences of such agreements, having regard to the true nature of the rights and obligations agreed by the parties. Accordingly, it is important for franchisors to note that an agreement will still be considered as a franchise agreement once the cumulative conditions in the FA are present, regardless of whether it is labeled as a license, consultancy, or management agreement, or otherwise.

It is interesting to note that the High Court did not consider section 54(1) in its decision, which governs the sale of foreign franchises in Malaysia. Would the outcome have been different had section 54(1) been raised and discussed? Would it have invoked the legal maxim, generalibus specialia derogant, meaning that a specific provision in a statute would exclude the operation of a general provision, thereby affirming the current practice of requiring foreign franchisors to seek approval under section 54(1) only?

Under the current practices of the FDD, local franchisors and local master franchisees are required to register under section 6, whereas foreign franchisors only have to seek approval under section 54. Unlike local franchisors and local master franchisees, foreign franchisors are thus not required to provide disclosure documents or file annual reports.

In the aftermath of this decision however, the FDD has plans to require all foreign franchisors to register under section 6, in addition to seeking approval under section 54. The FDD has now construed the section 54 application as a “visa” or “permit”, that is, a pre-condition to be complied with by foreign franchisors, prior to seeking registration under section 6. Notwithstanding there being additional requirements under section 6 (amongst others, the need for the franchise agreement to be translated into the national language, and the submission of training and operation manuals), the FDD is considering an automatic registration for foreign franchisors who have obtained prior approval under section 54. However, only time will tell whether the FDD will impose more stringent requirements on foreign franchisors, which may necessitate full compliance with all registration requirements under section 6.