Malaysia: Malaysia Case Provides Guidance On Franchise Law

Last Updated: 22 March 2018
Article by Robyn Chatwood

Overview

A recent interlocutory case in Malaysia, (the "La Kaffa decision") has provided some helpful guidance on when an interlocutory injunction will be granted to restrain a franchisee from operating a competing business after termination of the franchise agreement. The case will be of interest to any franchise which is operating in Malaysia or considering establishing in Malaysia as it clarifies, in particular, aspects of the Malaysian Franchise Act 1998 dealing with the franchisee's use of franchisor confidential information and non-compete restraints.   

Background facts of the La Kaffa case

The La Kaffa decision concerned the competing Chatime and Tealive bubble tea outlets in Malaysia.  

La Kaffa was the Taiwanese-based Master Franchisee pursuant to Regional Exclusive Distribution Cooperation Agreement dated 1 June 2011 (REDCA). Loob was La Kaffa's Malaysian-based sub-franchisee who signed a Regional Exclusive Representation Agreement dated 15 October 2013 with La Kaffa (RERA). The Chatime franchise had 165 outlets in Malaysia.

La Kaffa claimed Loob breached RERA by:

  • not purchasing all raw materials from La Kaffa as required by the RERA; 
  • failing to allow La Kaffa to inspect or audit Loob's accounts, books and records; and 
  • failing to pay for raw materials purchased from La Kaffa.

The RERA had provided that the law governing the agreement was Singaporean but that disputes would be settled by arbitration. La Kaffa commenced Singapore Arbitral Proceedings. Loob counterclaimed that La Kaffa itself had breached the RERA. 

In the meantime, La Kaffa terminated the RERA. After termination, Loob started a competing bubble tea franchise business under the Tealive brand and converted 161 Chatime outlets to Tealive outlets.

La Kaffa initiated proceedings in the Malaysian High Court to obtain an injunction restraining Loob, its directors and employees from providing operations consultancy services to Chatime franchisees and disclosing or using La Kaffa's confidential information. La Kaffa also sought orders prohibiting the Loob parties from passing off La Kaffa's goodwill and requiring them to return Chatime materials and proprietary information.

Loob counterclaimed - seeking orders to restrain La Kaffa, its directors, employees and agents from taking any action which had "the effect of interfering with" the Tealive franchise business.

The interlocutory proceedings were issued pending the disposal of the Singapore Arbitral Proceedings under provisions relating to applications for interim injunctions under section 11(1) of the Malaysian Arbitration Act 2005 (AA). Both applications were heard together.

Will an interim injunction be obtained during arbitration proceedings in Malaysia?

The Court considered whether it had the power to intervene in light of the circumstances that:

  • there was a dispute resolution mechanism agreed by the parties under the sub-franchise agreement that arbitration would be used to resolve disputes; and
  • La Kaffa had commenced arbitration proceedings.  

Specifically, the Court reviewed its power under sections 8 and 11(1) of the Malaysian Arbitration Act 2005 (AA).

Section 8 of the AA seeks to limit the Court's inherent jurisdiction. It states that "No court shall intervene in matters governed by the [AA] except where so provided in [AA]."

Section 11(1) of the AA deals with the Malaysian High Court's power to review arbitration agreements and grant interim relief and provides as follows:

A party may, before or during arbitral proceedings, apply to a High Court for any interim measure and the High Court may make the following orders for:

  1. security for costs;
  2. discovery of documents and interrogatories;
  3. giving of evidence by affidavit;
  4. appointment of a receiver;
  5. securing the amount in dispute;
  6. the preservation, interim custody or sale of any property which is the subject-matter of the dispute;
  7. ensuring that any award which may be made in the arbitral proceedings is not rendered ineffectual by the dissipation of assets by a party; and
  8. an interim injunction or any other interim measure.

La Kaffa applied to the Court to exercise its inherent jurisdiction however the Court did not agree that this jurisdiction applied and, in light of section 8, the Court concluded that it can only exercise powers conferred by section 11(1) of the AA.  

The Court determined that, depending on the particular evidence adduced in court, it did have discretion to grant any interim measure because of the clear wording of "may" in section 11(1) of the AA. In the La Kaffa case, the Court considered that a clauses in contracts stipulating that injunctive relief "may" or "shall" be an appropriate remedy where damages may not be or where there is irreparable harm would not mean that such relief will be granted as of right as the party seeking equitable relief must still satisfy the court that the pre-requisites for granting injunctive relief are prevalent. The Court concluded that, in such cases, it could grant interim measures before or during an international arbitration only but not permanent relief.  

The Court held that any interim measures must support, assist, aid or facilitate the arbitration and the court, in granting the interim measures, should not decide the merits of the dispute which are only to be decided by the arbitral tribunal agreed by the parties. However, the Court did note that despite such limits to the Court deciding the merits of the dispute, the Court could still nevertheless can assess whether a party has met the necessary thresholds for an interim remedy (as laid down by case law). The parties will however not be bound or estopped in any arbitral proceedings by the court's interlocutory decisions.  

This meant that, if subsequently the arbitral tribunal rules against the party who is subject to the interim measure, the 

other party would be entitled to apply to enforce any undertakings to pay damages for all losses suffered by the innocent restrained party which had been incurred as a result of the interim measure. 

Was the sub-franchisee ordered to destroy the Master Franchisee's proprietary materials?

In applying the above principles, the Court then decided whether it could order the sub-franchisee to destroy the Master Franchisee's proprietary materials. The Court decided that it could not grant an order enforcing article 13(IV) of the RERA (which provided that upon the termination of the RERA, La Kaffa may request in writing for Loob to destroy Chatime materials at Loob's own cost) as this type of order would be "final in effect and is therefore beyond the scope of s 11(1) AA".

Was the sub-franchisee ordered to stop passing off La Kaffa's goodwill?

Similarly, the Court refused to grant orders restraining the sub-franchisee, Loob, from passing off La Kaffa's goodwill on the basis that the Court was of the opinion that:

  • any interim measure would not "support, assist, aid or facilitate" the Singapore Arbitral Proceedings and, even if it did, La Kaffa could "easily" file a suit against Loob and seek final relief rather than interim measures; and 
  • there was no prejudice to La Kaffa by the court's refusal.

In summary, the implications of this decision is that it will be harder to obtain interlocutory relief where it may have a final effect (such as orders to destroy confidential information) or might impact the final determination of the merits of the case subject to arbitral proceedings. This is especially so where the court considers that its refusal to grant interim relief would not have a prejudicial effect on the party seeking the injunction. These are high thresholds to overcome.

Malaysian Franchise Act non-compete restraints on the franchisee

The Court also interpreted some important provisions of the Malaysian Franchise Act 1998 – specifically sections 26, 27, 28(1) and 39(1) of the FA which respectively deal with obligations of the franchisee from using the franchisor's confidential information and non-competes and penalties which relate to breaches of these provisions.  

In deciding whether the Court should exercise its discretion to grant any interim injunction, there are threshold considerations (which are similar to the considerations in Australia) e.g.:

  1. there must be a bona fide and serious question to be tried; and
  2. damages would be an inadequate remedy if the injunction were not granted; and
  3. the balance of convenience must favour the grant of an interim injunction.       

Sections 26, 27, 28(1) and 39(1) of the FA provided:

26 Confidential information

(1)A franchisee shall give a written guarantee to a franchisor that the franchisee, including its directors, the spouses and immediate family of the directors, and his employees shall not disclose to any person any information contained in the operation manual or obtained while undergoing training organized by the franchisor during the franchise term and for two years after the expiration or earlier termination of the franchise agreement. 

(1) The franchisee, including its directors, the spouses and immediate family of the directors, and his employees shall comply with the terms of the written guarantee given under subsection (1). 

(2) A person who fails to comply with subsection (1) or (2) commits an offence. 

27 Prohibition against similar business 

(1) A franchisee shall give a written guarantee to a franchisor that the franchisee, including its directors, the spouses and immediate family of the directors, and his employees shall not carry on any other business similar to the franchised business operated by the franchisee during the franchise term and for two years after the expiration or earlier termination of the franchise agreement. 

(2) The franchisee, including its directors, the spouses and immediate family of the directors, and his employees shall comply with the terms of the written guarantee given under subsection (1). 

(3) A person who fails to comply with subsection (1) or (2) commits an offence. Waivers void 28(1) Any condition, stipulation or provision in a franchise agreement purporting to bind a franchisor or a franchisee to waive compliance with any provision of this Act is void.

39 General penalty 

(1) A person who commits an offence under this Act for which no penalty is expressly provided shall, on conviction, be liable – 

(a) if such person is a body corporate, to a fine of not less than ten thousand ringgit and not more than fifty thousand ringgit, and for a second or subsequent offence, to a fine of not less than twenty thousand ringgit and not more than one hundred thousand ringgit; or

(b) if such person is not a body corporate, to a fine of not less than five thousand ringgit and not more than twenty-five thousand ringgit or to imprisonment for a term not exceeding six months, and for a second or subsequent offence, to a fine of not less than ten thousand ringgit and not more than fifty thousand ringgit or to imprisonment for a term not exceeding one year.

The Court noted that there are no similar provisions in any franchise legislation in the United Kingdom, Singapore, Australia, New Zealand, Canada or the US. 

The Court held that sections 26(1) and 27(1) provide that a franchisee "shall" give written guarantees as provided in the statutes, but that these laws do not imply any such guarantees into the franchise agreement. The Court was of the opinion that, if Parliament intended for the incorporation of the guarantees into the franchise agreements, then they would have expressly provided for that. Under the rules of statutory interpretation in Malaysia, the Court interpreted the effect of sections 26(3) and 27(3) strictly in favour of the party who might be liable to penal consequences for breach of the statute (that is, the sub-franchisee in this case). 

So reading sections 26(2) and 27(2) with penal consequences under sections 26(3) and 27(3) and section 39(1)(a) and (b), the Court held that no guarantees were incorporated into the RERA solely by reason of sections 26(1) and 27(1) of the FA. Thus, these provisions did not bind La Kaffa or Loob and so Loob was not considered to be in breach of the FA or to have provided any such guarantees to La Kaffa. The consequence was that there was no serious question to be tried in respect of whether Loob breached sections 26(1) or 27(1) of the FA and so the High Court dismissed the La Kaffa's interim injunction applications and Loob was not restrained from operating its competing Tealive business.

In summary, the implications of this decision is that it will be necessary to incorporate expressly clauses into the franchise agreement providing for franchisee guarantees to not disclose franchisor confidential information and not compete both during and after the term. Relying on implying any such obligations as a result of the FA will not be effective.  

Interpretation of governing law clause in the franchise agreement

Another preliminary matter of interest dealt with by the case was which law would be applied to the sub-franchise agreement in Malaysia. The sub-franchise agreement (the RERA), provided that the law governing the agreement was Singapore. The parties did not give evidence regarding Singaporean law and so the Malaysian High Court, noting that the circumstances related to the application and interpretation of Malaysian statutes including the FA, applied a rule of Private International Law and past precedents to presume that Singaporean law was the same as Malaysian law. 

Implications of the La Kaffa decision for franchisors and franchisees

Many franchise agreements include an agreement by the franchisor and franchisee that they will resolve disputes by arbitration rather than litigation, as this method will help the parties to keep matters confidential. Some, but not all agreements, deal expressly with the rights of parties to seek interim interlocutory relief from a court in certain circumstances.

The La Kaffa decision has clarified when interlocutory relief in Malaysia is likely to be granted in circumstances of the parties having agreed arbitration as their dispute resolution process.  In short, injunctions will not be easy to obtain. Malaysian courts will not grant relief if would have a final effect or fetter the arbitral proceedings – especially if the refusal to grant interim relief would not have a prejudicial effect on the party seeking the injunction. These thresholds are high.  The decision means that a difficult assessment will need to be made as to whether any interim orders sought will in fact support, assist, aid or facilitate the final arbitration. Interlocutory injunctions which will have the side effect of deciding the merits of the dispute will not be granted. There is a risk that, even if an interim remedy is granted, the party obtaining the order may be liable for the damages to the other party caused by the interim measure being in place, once the case is finally determined by the arbitral tribunal. This is expected to be a disincentive to seeking interim orders before arbitration.  

The La Kaffa decision also provides a wakeup call for any franchisors in Malaysia who may be relying solely on provisions in the Malaysian Franchise Act to imply obligations on the franchisee to not misuse the franchisor's confidential information and to not compete with the franchise while the franchise agreement is on foot and for two years after its termination.These provisions will not be implied – rather the agreement needs to expressly set out exactly what obligations will bind the franchisee in Malaysia.

Parties to franchise agreements in Malaysia should consider the implications of the La Kaffa decision. In particular, if franchising in Malaysia (or considering doing so), franchisors should review their non-compete, confidentiality and governing law clauses to ensure they are effective. 

Dentons is the world's first polycentric global law firm. A top 20 firm on the Acritas 2015 Global Elite Brand Index, the Firm is committed to challenging the status quo in delivering consistent and uncompromising quality and value in new and inventive ways. Driven to provide clients a competitive edge, and connected to the communities where its clients want to do business, Dentons knows that understanding local cultures is crucial to successfully completing a deal, resolving a dispute or solving a business challenge. Now the world's largest law firm, Dentons' global team builds agile, tailored solutions to meet the local, national and global needs of private and public clients of any size in more than 125 locations serving 50-plus countries. www.dentons.com.

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