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Franchise vs Licence: Who is in Control of What?

Licensing and franchising have been on the up and up in the last few decades. With the country in MCO recovery mode, there appears to be an uptake in this trend. You should understand some basic features and differences between the two, before entering into either one.



There are opportunities in times of crisis. The Covid-19 pandemic is no different. On this score, an interesting trend I noticed is that SMEs are turning to franchising and licensing as opportunities for expansion during this Covid-19 / MCO recovery phase. The apparent upside with these systems is that companies and businesses can have a go at increasing revenue and market share, with relatively low-risk upfront investment on their end. And there appears to be takers - individuals and new businesses looking to capitalize or take advantage of the sudden void left by businesses unable to weather the Malaysian Covid-19 commercial hiatus.


Although they have significant overlap in terms of features, a franchise and a licence are quite different constructs, and they each attract significantly different legal treatment. Before getting involved in either one, it is important that you know what it is you are selling or buying.


Franchising vs Licensing


The term 'franchise' is defined in a 4-limb test found in Section 4 of our Malaysian Franchise Act 1998. In short, when one purchases a franchise, they (a) pay fees (b) for the right to operate a business according to a standardized operating system and (c) to use the brand name / proprietary information / know-how of the franchisor, (d) with the fundamental feature that the franchisor (franchise seller / brand owner) retains a continuous control over the franchised business. This may extend from determining the territorial operations of a franchise, the price of products / services offered to requiring strict compliance with a standard business or operation model. Think McDonald's.


'Licence' however is not statutorily defined, and is largely governed by the contractual terms negotiated by parties. In short, typically when one licenses a business, they sell the rights to use / sell the company's products and trademarks in exchange for some version of royalties. Ownership of the products or intellectual property typically remains with the licensor. For this, think Disney giving a licence to McDonald's to include Disney toys/characters in the latter's Happy Meals.


The above are archetypes of each system. However, there will be instances where the business model sold lies in a space in between, apparently neither here nor there. There are also instances where in order to escape the more stringent (and therefore, more tedious and expensive) requirements of the Franchise Act (more on this below), a franchise seller disguises a franchise as a licence. In such situations, whether the business model is a franchise or a licence is a question of fact, determinable by evaluating whether the terms of the agreement satisfy the 4-limb test in Section 4. In this, the Courts are not bound by the label or description of the agreement, and regard can be had to the relevant factual matrix and manner in which the agreement was carried out. As a general rule of thumb, when it can be shown that the seller of the business model has a control over the management, administration and operations of the business of the buyer (as opposed to control over the sale of a product or mark), a strong argument can be made for it being a franchise, despite any contrary labeling.


Importance of Distinction


The distinction is an important one because in Malaysia, a franchise is governed by the Franchise Act 1998. Franchisors and franchisees must comply with their specific duties and obligations set out in the Act, lest they be subject to investigations by the authorities and may also be exposed to penal sanctions. Given the nature of a franchise where one party exerts significant control over the other, it is not surprising that as a matter of public policy that it be subject to regulations.


Crucially, a key feature of the franchise legal regime in Malaysia (and most other countries with any semblance of a franchise regulatory regime) is the requirement for franchises to be registered before it can be operated or sold in Malaysia. This is a mandatory requirement, failure of which renders the franchise agreement (whether it is named expressly as such or not) void and unlawful (1).

Advantages vs Disadvantages


One of the main upside of buying a recognized franchise is that the risk of a new business (especially in present climate) is mitigated by being part of a proven business with a recognized brand that typically has an existing customer base to tap into. Such a business will also obtain valuable assistance from the franchisor (supplies, skills and sometimes, funding or payment plans - it is not good for the general brand if one of their franchisee fails at the outset) and will typically also gain a monopoly within a particular territory. The trade-off? The lower profits due to the franchise fees. The loss of control as a business owner (the franchisor makes quite a number of decisions for you) may also be off-putting to some, but welcomed by others.


A licence on the other hand would be the inverse of the above. I can however imagine the appeal for a licensor, with licences being great opportunities to expand their reach with little to no investment and effort. They can rely on the licensee's efforts to do so for them, tapping cheaply into new locations and distribution networks.


Which is the Right One for You?


The decision is often decided by the business or product being sold. Otherwise, your choice as a seller and a buyer rests ultimately on your goals, objectives and vision for your business. Franchises may appear the more complex and the upfront fees may not be palatable, but it may be appealing for first time business owners as you can rely on the experience, expertise and support system of the franchisor. However, if you are confident enough in your prowess as a business owner/operator, and do not want to be shackled by an overlord yet still want the an easier entry into a business through a recognized brand or product, a licence may be the right fit for you.


 

(1) I recall a case where parties entered into a franchise agreement. In order to circumvent the additional obligations required by the Franchise Act (which requires time and money), the seller couched the agreement as a licence. The High Court eventually found that the agreement was a franchise, and was void for non-registration. My client, the innocent buyer, was awarded restitution, and was entitled to the payments she made to the seller under the void agreement. This is why it is important to understand what exactly it is you are selling or buying.

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