The Problem
Malaysia’s franchise industry has developed significantly over the years, but one recurring legal problem remains difficult to resolve: when does a licensing arrangement cross the line and become a franchise?
This issue becomes particularly serious for young and growing businesses. Many SMEs are commercially viable, have established outlets, possess valuable intellectual property and are already attracting potential operators. Yet they may still not be ready to proceed with formal franchise registration because they have not accumulated the necessary business and financial track record. During this period, licensing often becomes the natural route for expansion.
The problem is that the law looks at the substance of the relationship, not merely the title of the agreement. A document called a “Licence Agreement” may nevertheless be treated as a franchise where the arrangement contains the essential characteristics of franchising. Once that happens, the question of non-registration under Section 6 of the Franchise Act 1998 may arise, and the consequences can be serious.
What may begin as an ordinary commercial disagreement between a licensor and licensee can suddenly become a much larger legal dispute concerning whether the entire relationship was, in substance, an unregistered franchise. It is this regulatory gap that I believe deserves closer attention.
The Licensing Trap
My recent discussions with several franchise consultants, including Dr David Tan, reinforced this concern. In his book The Licensing Trap, Dr David observed:
“Every year, thousands of Malaysian SMEs aspire to transform their business into franchise systems. Yet, many unknowingly fall into what appears to be a faster, easier path — only to discover later that it is filled with legal uncertainty, regulatory risk, and structural weaknesses.”
His observation reflects a practical problem which many in the industry are increasingly seeing. The issue is not simply that businesses are deliberately trying to avoid franchise registration. There are also genuine businesses which are still developing, still proving their systems and still building the track record necessary to become franchise-ready.
Yet those same businesses may already be exercising quality control, providing training, licensing their trademarks, supplying products, prescribing standards and receiving consideration from operators. In doing so, the licensing relationship may gradually acquire the characteristics of franchising. This creates an uncomfortable position: the business may still be too early to register as a franchise, but its commercial relationship may already be capable of being characterised as one.
When a Licence Starts Looking Like a Franchise
A business owner may start with a genuine licence arrangement and have no intention whatsoever of avoiding the Franchise Act. He simply wants to grow the business while building the necessary track record. However, as the business develops, the licensor naturally wants to protect the brand. He wants the licensee to use the trademark correctly, maintain the outlet according to certain standards, ensure that staff are properly trained, follow prescribed operating procedures, use approved products or suppliers and provide a consistent customer experience.
Commercially, all of these requirements are entirely understandable. In fact, many of them are exactly what a responsible business owner should be doing. A business cannot build a strong brand if every operator is allowed to use the trademark differently, change the product, alter the concept or ignore the standards which made the business successful in the first place.
The legal difficulty, however, is that the more systems, control, intellectual property rights, training and continuing obligations are introduced into the relationship, the greater the possibility that the arrangement begins to resemble a franchise. In other words, a genuine business may be attempting to protect its brand and develop a sustainable operating system, but in doing so, it may unknowingly move closer towards the statutory definition of a franchise.
Calling the document a “Licence Agreement” does not necessarily solve the problem. The Courts will look at the true substance of the arrangement, and if the relationship contains the essential characteristics of franchising, the arrangement may be treated accordingly.
When the Relationship Turns Sour
The danger becomes particularly serious when the relationship between the parties turns sour. When business is good, everybody is generally happy. The licensee operates the outlet, the licensor provides support, payments are made, products are sold and the trademark is used. Very often, nobody raises any question about whether the relationship should properly be classified as a licence or a franchise.
However, once the commercial relationship breaks down, the entire arrangement may suddenly be examined from a completely different perspective. The licensee may then argue that the arrangement was never truly a licence in the first place. The arguments may be that the licensor granted the right to operate the business, permitted the use of its trademark, imposed operational requirements, exercised continuing control and received consideration in return. From there, the argument may be made that the arrangement was actually a franchise and that the licensor should therefore have been registered under Section 6 of the Franchise Act 1998.
At that point, what began as an ordinary commercial dispute may become something far more serious. Instead of arguing simply about breach of contract, unpaid fees, supply, territory, renewal or termination, the parties may suddenly be litigating over whether the relationship itself was unlawful or unenforceable because of non-registration.
This is where the consequences can become especially damaging for a genuine business. A company that may have operated successfully for years may suddenly find itself facing claims for restitution, repayment and arguments that the entire contractual relationship was legally defective from the beginning.
A Gap in the Law?
I am not suggesting that the Courts should ignore the Franchise Act, nor am I suggesting that registration should be treated lightly. The Courts are required to apply the law as it stands. The more important policy question is whether the law itself should recognise that there may be a genuine developmental stage between ordinary licensing and full franchising.
That is why I believe Malaysia should consider introducing a new provision into the Franchise Act 1998. For discussion purposes, I propose calling it Section 58A — Transitional Developmental Licensing.
The purpose of Section 58A would be to create a controlled statutory pathway for genuine businesses during their formative years. The concept is simple: a business should be allowed to license, develop, prove, register and then franchise within a regulated framework.
A qualifying business could therefore be permitted to operate under a developmental licensing framework for a limited period while it builds its systems, establishes its financial and operational track record and prepares for eventual franchise registration. The intention would not be to create a permanent alternative to franchising, but rather to recognise that there is a legitimate period during which a business may be growing towards franchise readiness without yet being fully ready to enter the franchise system.
Business Does Not Wait
This approach would also recognise commercial reality. Business does not necessarily wait for three years. Opportunities can arise in the first or second year. An operator may approach the founder. A landlord may offer an attractive location. A business partner may want to take the concept into another State. An investor may see potential in the brand. A growing business should not necessarily be told that the only legally safe option is to stop expanding until the required track record has been accumulated.
At the same time, Section 58A must be carefully designed because it must never become a loophole for businesses to disguise franchises as licences. There must be safeguards, disclosure requirements, basic financial transparency, a clear transitional period and a proper pathway towards eventual franchise registration. There may also need to be limits on the number of developmental licensees, notification to the Registrar and restrictions against abuse.
Genuine Business or Fly-by-Night Operator?
Most importantly, the law must distinguish between two very different situations.
On one side is a genuine operating business. It has real outlets, real customers, real employees, real products or services, real investment and a founder who is genuinely trying to build and improve the business. The business may still be learning, improving its systems, strengthening its operational structure and building its financial track record. Its use of licensing is therefore part of that developmental journey.
On the other side is the fly-by-night operator. Such an operator may have little or no genuine operating history, and its real business may simply be the sale of “licences” to the public. It may collect substantial upfront payments, exercise complete control over operators and use the word “licence” only as a device to avoid the Franchise Act.
Section 58A must never protect such an operator. The law must therefore be capable of distinguishing between a genuine developmental business and someone deliberately using licensing as a mechanism to avoid regulation.
Regulation Without Killing Growth
That balance is important because the purpose of Section 58A should not be to weaken franchise regulation. It should be to resolve a genuine legal and commercial problem which presently sits between licensing and franchising.
If properly structured, Section 58A could provide greater certainty to licensors, better disclosure and protection to licensees, greater visibility to the Registrar and ultimately a stronger pipeline of future Malaysian franchisors. It could also help reduce one of the recurring problems increasingly seen in litigation, where parties enter into what they believe to be a commercial licensing relationship only for the entire arrangement to be challenged later on the basis that it was actually an unregistered franchise.
The objective must therefore be balance. We must protect the franchisee and the licensee. We must prevent businesses from deliberately circumventing the Franchise Act. At the same time, we must recognise that genuine businesses need time to grow, experiment, strengthen their systems and prepare themselves before becoming franchisors.
Franchise law should not merely regulate businesses after they become franchisors. Perhaps it should also provide a structured pathway to help promising businesses become franchisors in the first place.
The Ecosystem Argument
That, to me, is the wider ecosystem argument.
Every successful franchise system began somewhere. Before there were 100 outlets, there was one. Before there was a sophisticated operating system, there was experimentation. Before there was a franchise system, there was a founder building a business. Before the business became proven, it had to be developed.
The regulatory framework should therefore recognise that developmental journey. If Malaysia wants to create more strong home-grown franchise brands, then the legal framework should not only be concerned with regulating mature franchise systems. It should also consider how genuine businesses can progress safely from entrepreneurship to structured expansion and eventually into franchising.
Perhaps the time has therefore come for Malaysia to consider whether the Franchise Act 1998 requires a new provision to address this gap. Perhaps Section 58A can be that provision.
What Should Section 58A Look Like?
For now, this remains a proposal for discussion, but over the coming weeks and months, I intend to put on my thinking cap and work through what an appropriate Section 58A might actually look like. That will include examining its scope, safeguards, qualifying criteria, disclosure requirements, transitional period, notification mechanism, protection for developmental licensees and the circumstances in which the safe harbour should cease to apply.
The challenge will be to draft a provision that is sufficiently flexible to support genuine developing businesses, while at the same time sufficiently strict to prevent abuse. That balance will not be easy, but I believe it is worth attempting.
I also hope to engage with franchise consultants, lawyers, franchisors, franchisees, industry players and other stakeholders to hear their views and identify the practical difficulties they are seeing on the ground. This is also a conversation which, in due course, the Malaysian Franchise Association, the Malaysia Retail Chain Association, KPDN and other relevant stakeholders may wish to consider together.
The Conversation Starts Here
The intention is not to propose an amendment merely for the sake of amending the law. The intention is to see whether we can develop a practical legal solution to a recurring problem which affects genuine businesses, licensees and the wider franchise ecosystem.
Perhaps what begins today as an industry conversation can eventually develop into a meaningful proposal for reform of the Franchise Act 1998.
For now, the thinking starts here. Over the next few weeks and months, perhaps we can begin to shape what Section 58A should really look like.