Franchise VS Licensing

Introduction

Franchising and licensing have always been mixed up by business owners, as both models share similar elements. For instance, both franchising and licensing involve granting rights to use a brand name to another party in running a business. However, while they may seem alike at first glance, they are two very different agreements that carry distinct implications. In this article, we will delve into the differences between franchise and licensing.

What is a License?

Unlike a franchise, the term “license” is not defined in legislation. There is no specific law governing the licensor-licensee relationship, hence licensing agreements are based on the contract entered into between the parties.

In a licensing agreement, the licensor grants the licensee the right to sell its goods or services, use its trademarks or other intellectual property, and possibly receive training or support. In exchange, the licensee pays a licensing fee. However, unlike in a franchise, the licensor has much less control over how the licensee runs their day-to-day operations.

What is a Franchise?

A franchise generally involves a franchisor offering its brand name, know-how, and operational systems to a franchisee in exchange for payments, such as franchise fee and royalties. These payments are usually justified because the franchisor has developed a strong business identity and a system that is widely recognized. For instance, McDonald’s.

Under the Franchise Act, a “franchise” is defined as an agreement between a franchisor and a franchisee where:

1. The franchisor allows the franchisee to operate the business based on the franchisor's system.

2. The franchisor grants the franchisee the right to use its intellectual property.

3. The franchisor has the right to maintain control over the franchisee’s operations to ensure they follow the franchise system.

4. In return, the franchisee pays a fee or other forms of compensation to the franchisor.

What Makes Licensing and Franchise Different?

FRANCHISE

1. Governed by the Franchise Act 2022;

2. Registration is mandatory, where the Franchisor must register both the business and trademark before starting operations under a franchise agreement (Franchise Act 1998);

3. Continuous control over business by Franchisor;

4. Franchisee has the right to request renewal of the franchise agreement, even if previous terms were breached. The Franchisor must compensate the Franchisee if not renewed;

5. Franchisor cannot terminate the agreement before the agreed term (usually 5 years) unless there is good cause, mutual agreement, or court decision;

6. Franchise agreements must include specific terms set by the Franchise Act 1998. If not included, the agreement is void;

7. Franchisee, including directors, family, and employees are prohibited from engaging in similar business activities during the franchise term. Franchisee is prohibited from operating a similar business for up to 2 years after the franchise agreement ends; and 

8. To follow the franchise system – the Franchisee must operate strictly according to the franchisor’s system and guidelines.

LICENSE

1. Governed by the Contracts Act 1965;

2. Registration is not mandatory;

3. There is no control over business;

4. Licensor is not obligated to renew the license, and compensation is not required unless specified in the agreement;

5. Licensor can terminate the agreement if there’s a breach, as per the licensing terms;

6. Licensing agreements don’t have mandatory terms as the terms are negotiated between the parties;

7. Licensor cannot prevent the licensee from conducting a similar business during the terms of the agreement. Post-termination restraint clauses in a licensing agreement may be void under the Contracts Act 1950; and 

8. There is no franchise system.

Can You Draft a Licensing Agreement Like a Franchise?

No, simply drafting an agreement to mirror a franchise but using the title “licensing” to avoid being classified as a franchise will not work. Even if the agreement is labeled as “licensing agreement”, the court may still determine it to be a franchise if it contains the essential elements of a franchise.

The key thing to note is that whether or not a business is considered a franchise depends on the actual business operations, not just the words used in the agreement. Even if the term “franchise” isn’t used, courts will look at the business practices to determine if it meets the criteria of a franchise or if it’s a licensing arrangement.

Consequences for Non-Registration / Misclassifying Franchise 

Refund / Compensation

Failure to register a franchise with the Registrar of Franchises entitles the franchisee to request a refund or compensation under Section 66 of the Contracts Act 1950. 

Penalties

For a corporate body, the fine can be up to RM250,000 for the first offense, and RM500,000 for subsequent offenses. For non-corporate franchisors, the first offense can result in a fine of up to RM100,000, imprisonment of up to 1 year, or both. For second or subsequent offenses, the penalty can increase to a fine of up to RM250,000, imprisonment of up to 3 years, or both.

Prohibited from opening the ‘franchise’ outlet

Franchisors and franchisees are prohibited from opening or operating the franchise in Malaysia.

This also applies if a franchisor misclassifies a franchise as a  “licensing” agreement while still operating it as a franchise. In such cases, the franchisor would still be subject to the same penalties for failing to properly register the franchise.