Franchising is commonly described as a contractual relationship. A franchisor grants a franchisee the right to operate a business under an established brand and business system, while the franchisee pays fees or other consideration in return.
That description is legally correct, but philosophically incomplete.
In my view, franchising in its truest meaning is not merely an exchange of contractual promises.
It is a continuing relationship founded upon mutual entrustment, loyalty, confidence, stewardship and responsibility.
A franchise may begin with a contract, but the relationship created by that contract goes beyond the ordinary boundaries of contract law. It carries characteristics that are fiduciary in nature. The contract is the doorway into the relationship. It is not the entire relationship itself.
Contractual in Origin
It must first be acknowledged that a franchise is contractual in its legal origin.
Section 4[1] of the Franchise Act 1998[2] defines a “franchise” as a contract or an agreement, either express or implied, whether oral or written, between two or more persons, possessing the characteristics prescribed by the Act.
Accordingly, a franchise relationship cannot arise in a vacuum. There must be an agreement through which the franchisor grants the franchisee the right to operate according to the franchisor’s system, use the franchisor’s intellectual property and remain subject to the franchisor’s continuous control for a determined period.
The contractual foundation of franchising should therefore not be denied.
However, the fact that a franchise originates from a contract does not mean that the relationship is merely contractual in nature.
Section 4 explains how the franchise relationship is created. It does not exhaustively define the duties, standards of conduct and obligations of loyalty that arise after that relationship has been established.
Those responsibilities are found elsewhere in the Franchise Act, particularly in sections 26[3], 27[4], 29[5] and 30[6].
The better distinction is this:
The franchise agreement is the source of the grant, but the Franchise Act determines the character of the relationship created by that grant.
The franchise is therefore contractual in formation, statutory in governance and, in my view, fiduciary in character.
A Franchisee Does Not Truly “Buy” a Franchise
The expression “buying a franchise” is commercially convenient, but legally and philosophically misleading.
A franchisee does not purchase ownership of the franchisor’s trademark, business system, operations manual, confidential information, training materials, goodwill or intellectual property.
What the franchisee receives is a limited and conditional right to use those assets for a prescribed purpose and duration.
The franchisee may own the franchisee company. The franchisee may own the equipment, furniture, stock and physical outlet. But the franchisee does not own the franchise identity itself.
The franchisee is temporarily admitted into a business system belonging to another.
Within that relationship, the franchisee receives the right to operate according to the franchisor’s system, use the franchisor’s trademark and intellectual property, receive training and assistance, represent the franchise brand before the public, and benefit from the franchisor’s accumulated reputation and goodwill.
These rights exist only within the limits of the franchise relationship.
Upon expiry or lawful termination, the franchisee must ordinarily stop using the franchise identity, return or destroy proprietary materials, cease using the operations manual and continue protecting confidential information.
The franchisee cannot simply remove the franchisor’s name from the outlet and continue operating the same system as though it had become the franchisee’s own creation.
The franchisee owns the outlet, but does not own the franchise.
What the franchisee receives is not ownership, but entrustment.
The Temporary Entrustment of a Business Identity
The franchisor may have spent many years developing the brand, refining its methods, correcting mistakes, building customer confidence, creating operating procedures and producing a system capable of replication.
When a franchise is granted, the franchisor opens that system to the franchisee.
The franchisor entrusts the franchisee with the trademark and brand identity, the operations and training systems, confidential information and commercial know-how, recipes, processes and methods, supplier and purchasing knowledge, customer experience standards, goodwill, reputation and the public representation of the franchise network.
The franchisee is permitted to use these assets, but only for the authorised purpose of operating the franchised business.
The franchisee is therefore not merely a purchaser of contractual services. The franchisee is a temporary custodian and steward of another person’s business identity.
Franchising, in its truest meaning, is:
The temporary entrustment of a proven business identity to an independent entrepreneur.
Mutual Entrustment
The entrustment does not flow in one direction only.
The franchisee also places significant interests in the hands of the franchisor.
The franchisee entrusts substantial capital, livelihood, the future of the franchised business, local goodwill created through personal effort, reliance upon the franchisor’s system and reputation, confidence in the franchisor’s training and assistance, dependence upon continued innovation, and the expectation that the franchise system will be managed responsibly.
This produces mutual vulnerability.
A dishonest or careless franchisee can damage the franchisor’s brand, misuse confidential information and weaken the reputation of every franchisee in the network.
At the same time, an irresponsible or opportunistic franchisor can destroy a franchisee’s investment through poor management, excessive charges, unreasonable control, lack of support or abuse of contractual power.
Each party holds important interests of the other in its hands.
That is the essence of mutual entrustment.
It is also the foundation of my view that franchising is fiduciary in character.
The Orthodox Judicial Position AND Why the Debate is NOT OVER!
It must be acknowledged that the orthodox judicial position in many common-law jurisdictions does not treat the existence of a franchise agreement, by itself, as automatically creating a fiduciary relationship.
Courts have generally distinguished between a contractual obligation to act honestly or in good faith and the more demanding fiduciary obligation of single-minded loyalty. A fiduciary may be prohibited from placing personal interests in conflict with the interests entrusted to that fiduciary, making unauthorised profits or pursuing opportunities belonging to the principal. By contrast, ordinary commercial parties are generally permitted to pursue their respective interests, subject to their contracts, applicable legislation and the duty not to act dishonestly.
The American decisions of Arnott v American Oil Co and Bain v Champlin Petroleum Co.[7] illustrate the tension particularly well.
In Arnott, the United States Court of Appeals for the Eighth Circuit used broad language suggesting that a fiduciary duty was inherent in the franchise relationship. The decision arose from particularly serious circumstances involving the termination of a service-station relationship and was influenced by the statutory policy of South Dakota franchise law.
However, only a few years later, the same appellate court in Bain v. Champlin Petroleum Co.[8] carefully confined Arnott. The Court explained that trust and confidence may exist in many business relationships, but their mere presence does not automatically make the parties fiduciaries in every aspect of their dealings.
The Court further explained that Arnott essentially concerned an arbitrary termination in breach of the implied obligation of good faith and fair dealing. It was unnecessary, according to the Court in Bain, to describe that obligation as fiduciary. Most importantly, Bain held that the grant of a franchise does not, in itself and in every case, impose all the duties traditionally associated with a true fiduciary.
The distinction is important. Bain does not establish that a franchise relationship can never become fiduciary. It establishes that fiduciary status cannot be presumed merely from the label “franchise”. There must be something in the statute, agreement, conduct, powers assumed or particular circumstances of the relationship that justifies the imposition of duties of loyalty.
There is no franchise case on point in Malaysia except that in the case of Solid Investments Ltd v. On-Line Credit Sdn Bhd (Federal Court)[9], while not explicitly a franchise case, the Apex Court in an obiter dictum, observe that a fiduciary relationship could be found on the facts of a particular case rather than a contract, and the court ought to apply a flexible approach in ascertaining whether a fiduciary relationship exists in a given circumstance. However, in that case, the Appeal was dismissed. The court noted that traditional fiduciary categories (like director-company or trustee-beneficiary) do not apply to arm’s-length business deals. This was a case of a Consultancy Agreement.
Section 29: Conduct Beyond the Contract
The clearest statutory expression of this relationship is found in section 29 of the Franchise Act.
Section 29 appears under the heading concerning the conduct of parties, rather than merely within the provisions prescribing the contents of a franchise agreement.
This distinction is significant.
The Act first recognises the franchise agreement and then separately regulates how the franchisor and franchisee must behave within the relationship created by that agreement.
Section 29(1) provides that:
“A franchisor and a franchisee shall act in an honest and lawful manner and shall endeavour to pursue the best franchise business practice of the time and place.”
This provision does not merely require the parties to comply with the written terms of the franchise agreement.
It imposes a continuing standard of behaviour.
The parties must act honestly and lawfully, and they must pursue the best franchise business practices applicable at the relevant time and place.
The reference to the best franchise business practice of the time and place is especially important. It means that the parties’ responsibilities are not frozen within the words of a document signed several years earlier.
Their conduct must also be measured against an external and evolving standard of proper franchise behaviour.
A party may therefore comply literally with a contractual clause but still act contrary to the relationship required by section 29.
Section 29(2) further requires the parties to avoid unreasonable overvaluation of fees and prices, unnecessary and unreasonable conduct concerning risks borne by the other party, and conduct exceeding what is reasonably necessary to protect legitimate interests.
The provision recognises three interdependent interests: the legitimate interests of the franchisor, the legitimate interests of the franchisee and the legitimate interests of the franchise system.
This is not the language of a simple buyer-and-seller relationship. It is the language of proportionality, responsibility and stewardship.
The Franchise System as a Shared Commercial Ecosystem
Section 29 is also important because it recognises the franchise system itself as an interest worthy of protection.
The franchise system is more than the private property of the franchisor and more than the individual business of one franchisee.
It is a shared commercial ecosystem.
The conduct of one franchisee may affect every other franchisee operating under the same brand. Similarly, the decisions of the franchisor may affect the investments, employees and livelihoods of the entire franchise network.
Both parties therefore have responsibilities extending beyond their immediate personal interests.
The franchisor must not exercise control merely because the agreement gives it power to do so. Control must be exercised for legitimate franchise purposes.
The franchisee must not exercise independence in a manner that undermines the consistency, goodwill or integrity of the franchise network.
The franchise relationship therefore requires both sides to consider not only:
“What am I contractually entitled to do?”
but also:
“Is the manner in which I am acting honest, reasonable and consistent with the legitimate interests of the franchise relationship and system?”
That is a fundamentally relational obligation.
Sections 26 and 27: A Statutory Code of Loyalty
Sections 26 and 27 provide an even more compelling illustration of the fiduciary nature of franchising.
Section 26 requires the franchisee to provide a written guarantee that the franchisee, its directors, the directors’ spouses and immediate family members, and employees will not disclose information contained in the operations manual or obtained during training organised by the franchisor.
The obligation applies during the franchise term and continues for two years after the expiry or earlier termination of the franchise agreement.
Section 27 similarly requires a written guarantee that the franchisee and the same extended group of persons will not carry on another business similar to the franchised business during the franchise term and for two years after expiry or earlier termination.
Non-compliance with these statutory obligations may constitute an offence.
These provisions are extraordinary because they extend beyond the person or company that signed the franchise agreement. They reach into the human network surrounding the franchisee by including directors, employees, spouses and immediate family members.
That is not normally seen in an ordinary commercial contract.
Beyond Contractual Privity[10]
In an ordinary contract, obligations generally bind the parties who entered into the agreement.
Sections 26 and 27 recognise that the protection of a franchise system cannot be confined to the name appearing on the signature page.
Without these provisions, a franchisee could attempt to circumvent its responsibilities by claiming that the competing business belongs to a spouse, that the operations manual was disclosed by an employee, that a family member owns the new company, or that the competing business is being operated through a separate corporate vehicle.
The Act therefore looks beyond contractual form and addresses the substance of loyalty.
It recognises that confidential knowledge, business opportunities and competing activities may be channelled through persons closely connected to the franchisee.
Sections 26 and 27 consequently create what I describe as a:
Statutory fiduciary perimeter around the franchise system
The franchise agreement may be signed by two parties, but the relationship creates a wider circle of responsibility and loyalty.
Section 26: Entrusted Information
Section 26 is not merely about keeping a document secret.
An operations manual may contain the franchisor’s accumulated experience, operating procedures, product standards, supplier arrangements, quality controls, recipes, pricing structures, customer service systems and methods of managing the business.
The franchisee receives this information for one authorised purpose: to operate the franchised business.
The franchisee must not treat that information as personally owned knowledge, disclose it to competitors, transfer it to a family-controlled company, reproduce it for another business, use it to build a competing system or continue exploiting it after the right to operate has ended.
The underlying obligation is not simply:
“Do not breach the confidentiality clause.”
It is:
Do not betray the confidence by which you were admitted into the franchise system.
The franchisee must not appropriate information received for a limited purpose and convert it into a personal commercial advantage.
This resembles a fundamental fiduciary principle: property, knowledge or opportunity entrusted for a particular purpose must not be used for an nauthorized purpose.
Section 27: Loyalty and Non-Appropriation
Section 27 is often understood merely as a statutory non-compete provision.
In my view, it is more fundamentally an obligation of fidelity.
A franchisee should not be permitted to enter the franchise system, receive the franchisor’s training, learn its operating methods, understand its suppliers, benefit from its brand and then use all of that knowledge to establish a competing business.
The wrongdoing is not simply that the franchisee competes.
The wrongdoing is that the competition is built upon knowledge, opportunities and advantages obtained through the franchise relationship.
Section 27 reflects two important fiduciary principles.
The first is the principle against conflict. A person admitted into the franchise system should not place personal commercial interests in direct conflict with the purpose of the relationship.
The second is the principle against appropriation. A person should not appropriate for personal benefit an opportunity or advantage acquired through a position of trust and confidence.
Section 27 therefore operates as a statutory prohibition against the disloyal appropriation of the franchise system.
Duties That Survive the Contract
The continuing nature of sections 26 and 27 is especially revealing.
The obligations do not immediately end when the franchise agreement expires or is terminated. They continue for a further statutory period.
This means the duty is not limited to:
“I will perform my promises while the agreement remains alive.”
It extends to:
“Because I was entrusted with the system and its confidential knowledge, I remain obliged not to betray or exploit that entrustment even after my authority to operate has ended.”
The contract may expire, but the consequences of the previous entrustment continue.
That is much closer to a duty of loyalty and fidelity than to an ordinary exchange of contractual promises.
Do Spouses and Family Members Become Fiduciaries?[11]
The extension of sections 26 and 27 to spouses and immediate family members strongly supports the fiduciary philosophy of franchising.
However, a proper distinction should be made.
A spouse does not necessarily become a full fiduciary merely by reason of marriage. A family member who never participated in the franchise, never received confidential information, never attended training and had no involvement in the business may not have assumed the same responsibilities as the franchisee.
Nevertheless, where the spouse or family member signs the statutory guarantee, works in the franchise business, receives the operations manual, attends training, controls the franchisee company, receives franchise assets, establishes a competing business or acts as a nominee for the franchisee, the argument becomes considerably stronger.
That person has entered the sphere of entrustment created by the franchise relationship.
The person may then owe a limited or subject-specific duty of loyalty concerning confidential information, intellectual property, franchise opportunities, goodwill, business methods and competing interests.
The existence of the statutory guarantee shows that Parliament intended loyalty to follow the entrusted information and commercial opportunity, rather than stop at the formal boundaries of contractual privity.
Section 30: The Franchisor’s Stewardship
The fiduciary character of franchising cannot operate only against the franchisee.
The franchisor also occupies a position of considerable responsibility.
The franchisor commonly controls the brand and intellectual property, the operations system, training and support, marketing direction, approved products and suppliers, technological development, quality standards, territorial policies and the strategic direction of the franchise network.
Section 30 requires the franchisor to provide assistance such as materials and services, training, marketing, and business or technical assistance.
It also requires both franchisor and franchisee to protect the interests of consumers.
The franchisor must therefore not treat the franchise agreement merely as an instrument for collecting initial fees and royalties.
The franchisor is the steward of the franchise system. The franchisor’s responsibility is not to guarantee that every franchisee will make a profit. Business always carries risk.
However, the franchisor should be expected to maintain and improve the system, provide meaningful assistance, exercise control honestly, avoid unreasonable exploitation, protect the brand, administer the network consistently, disclose material information honestly and treat the franchisee’s investment as something placed under the franchisor’s stewardship.
The franchisor owns the system, but the franchisor’s decisions may determine the future of the franchisee’s business.
That power carries responsibility.
Mutual but Not Identical Duties
The fiduciary duties within franchising are mutual, but they are not necessarily identical.
The franchisee’s responsibilities principally involve fidelity to the system. The franchisee must protect confidential information, comply with legitimate standards, preserve the reputation of the brand, avoid competing interests, refrain from appropriating business methods or opportunities and return or cease using proprietary materials when the relationship ends.
The franchisor’s responsibilities principally involve stewardship. The franchisor must manage the system responsibly, provide promised assistance, exercise control for legitimate purposes, avoid unreasonable or oppressive conduct, protect the collective interests of the network and treat the franchisee’s investment with honesty and responsibility.
The franchisee owes fidelity because the franchisee is admitted into the system.
The franchisor owes stewardship because the franchisor controls the system.
A Qualified Fiduciary Relationship?
I do not suggest that franchising is necessarily identical to the conventional trustee-beneficiary relationship.
A traditional fiduciary may be required to place the beneficiary’s interests ahead of the fiduciary’s own interests and observe strict rules against conflict and unauthorised profit.
A franchisor and franchisee remain independent commercial parties. Each is entitled to pursue legitimate business interests and earn commercial returns.
The Franchise Act itself recognises that the franchisee operates separately from the franchisor and that the relationship is not to be regarded as a partnership, service contract or agency.
But commercial independence does not necessarily exclude fiduciary responsibility.
A person can remain an independent business owner while owing specific duties concerning property, information, opportunities and powers entrusted to that person.
The franchise relationship is therefore better understood as a qualified and mutual fiduciary relationship.
Each party may pursue its own legitimate interests, but neither should be permitted to do so through dishonesty, concealed self-dealing, abuse of control, appropriation of confidential information, diversion of entrusted opportunities, unreasonable conduct or betrayal of the interests entrusted to it.
The fiduciary responsibility is connected to the particular property, knowledge, control and vulnerability created by the franchise relationship.
A Statutory Fiduciary Compact
The combined effect of sections 26, 27, 29 and 30 is significant.
Section 26 imposes confidentiality and protection of entrusted knowledge. Section 27 imposes loyalty and restraint against competing appropriation. Section 29 requires honesty, lawful conduct, proportionality and the pursuit of best franchise business practices. Section 30 imposes continuing obligations of assistance and protection of consumers.
Read together, these provisions create a statutory framework founded upon confidence, loyalty, fidelity, responsible exercise of power, protection against appropriation, protection of legitimate interests, stewardship of the franchise system and mutual responsibility.
These are not merely contractual values. They are fiduciary values.
The franchise relationship may therefore be described as a:
Statutory fiduciary compact between independent commercial parties.
The Legal Caution
It must nevertheless be acknowledged that courts are generally cautious before declaring an ordinary commercial relationship to be fiduciary.
The mere existence of trust, confidence, a confidentiality clause or a non-compete obligation may not, standing alone, convert every commercial contract into a fiduciary relationship.
There may also be no definitive Malaysian judicial pronouncement declaring that every franchise relationship is automatically fiduciary in the traditional equitable sense.
For strict legal pleading, the safer formulation may therefore be that the Franchise Act creates:
Independent, non-waivable statutory relational duties bearing the essential characteristics of fiduciary responsibility, loyalty, good faith and mutual stewardship.
But philosophy often develops before legal terminology catches up.
The statutory architecture of Malaysian franchising points clearly towards a relationship that is deeper than an ordinary commercial exchange.
My Philosophy of Franchising
My philosophy of franchising can therefore be expressed in these terms:
Franchising is a fiduciary relationship of mutual entrustment between independent parties.
The franchisor entrusts its brand, intellectual property, confidential information, goodwill and proven business system to the franchisee.
The franchisee entrusts its capital, livelihood, effort and commercial future to the franchisor’s stewardship of that system.
The franchise agreement records the rights and obligations of the parties. But the relationship created by that agreement is governed by a wider statutory framework of honesty, loyalty, confidentiality, restraint, support, stewardship and responsible conduct.
A franchise is therefore not merely a licence to use a trademark, an investment opportunity, a method of expanding with another person’s capital, a collection of contractual clauses or a commercial transaction lasting for a fixed period.
It is a relationship in which each party is entrusted with something valuable belonging to, or affecting, the other.
In its truest meaning:
A franchise is contractual in origin and fiduciary in relationship.
The franchisee owns the business, but is entrusted with the franchise.
The franchisor owns the system, but is entrusted with the franchisee’s future.
That mutual entrustment is the soul of franchising.
[1] Section 4 is a definition section
[2] The Franchise Act 1998 was officially enacted by the Malaysian Parliament in 1998, gazetted on 31 December 1998, and came into full legal force on 8 October 1999
[3] Section heading for Confidential Information
[4] Section heading for Prohibition Against Similar Business
[5] Section heading for Conduct of Parties
[6] Section heading for Obligations of Franchisor and Franchisee
[7] 609 F.2d 873 (8th Cir. 1979)
[8] 681 F.2d 1057 (8th Cir. 1982)
[9] (2014) 3 MLJ 785
[10] Generally it means Privity of Contract. It is the legal principle that a contract generally creates rights and obligations only between the parties who entered into it. A person who is not a party to the contract ordinarily cannot sue under it and cannot be sued for breaching it.
[11] This question was posed because section 26 and 27 include spouse and family member liable for the conduct of the franchisee who signs the franchise agreement. The significance of these provisions lies in the fact that the law extends duties connected with the franchise relationship to persons who may not themselves be parties to the franchise agreement.
Under the ordinary doctrine of Privity, contractual obligations generally bind only the parties who entered into the contract. Yet sections 26 and 27 look beyond the identity of the contracting franchisee and recognise that confidential information, operating knowledge and competing opportunities may be passed to or exploited through directors, employees, spouses and family members.