The first part of this article explores the commercial law environment in Singapore in the context of franchises. The second part, which will be published in the next issue, is an environment scan of franchise-specific laws and practices adopted in some other countries, together with the rationale behind those laws. The author believes that this article would benefit both lawyers and local SMEs in their understanding of the fragmented world of franchise-specific legal requirements, procedures, pitfalls and more importantly, the business cost of franchising before bringing the home-grown brands to overseas markets, as encouraged by the Singapore government.1 Given that this article is not a policy paper, one may also consider it an academic musing to appreciate the issues that may arise if franchise-specific legislation were to be introduced in Singapore.
The Legal Environment
of Franchising in Singapore and a Comparative Overview
of Franchise Laws in Some Other Countries – Part 1: Existing
Singapore Laws
Essentially, the franchise agreement is a contract, therefore, contract law governs the relationship between the franchisor and the franchisee. In addition to contract law, tort of deceit or fraud, the Misrepresentation Act and the Competition Act can also be applied to regulate the relationship and conduct of the franchisor and franchisee.
Contract Law
If a franchisor breaches a condition of a contract (for example, failing to provide the requisite details necessary for the operation of its franchise outlet), the franchisee would be entitled to terminate the contract – that is, “get out” of the contract. In The Best Source Restaurant Pte Ltd v Wan Chai Capital Holdings Pte Ltd,2 the franchisee’s complaint was that the franchisor breached the franchise agreement when he, among other things, failed to provide the recipes for many of the food items on the menu. The Court found that there was common intention of both the franchisee and the franchisor to regard the franchisor’s obligation to provide full details of the system and the operation of the business as an important one. As such, it ruled that the termination of the contract was lawful and the franchisor was to pay damages to the franchisee.
In Tan Wee Fong and others v Denieru Tatsu F&B Holdings (s) Ptd Ltd,3 the franchisor terminated a master franchise arrangement that was effected through two contracts. The two contracts were inter-dependent in that a breach of one would give each party the right to terminate the other. Both contracts expressly provided that the franchisor was entitled to seek liquidated damages from the franchisee of up to five times the upfront fee upon breaching one of the two contracts. In breach of the non-complete clause, the franchisee solicited for the employment of two of the franchisor’s employees. The Courts upheld the non-compete clause and ruled that the termination by the franchisor was lawful.
The Courts ruled that the liquidated damages clause was a penalty and, therefore, unenforceable. Having such penalty clauses reflects the franchisee’s lack of bargaining power when the franchisor introduces such onerous unenforceable clauses. This explains why governments impose legislation that seeks to protect franchisees. To see how governments deal with excessive penalty clauses, you may refer to the example from Japan in the second part of the article titled: “Part II: Franchise-specific Laws in Some Other Countries” in the next issue of the Law Gazette.
In D’Oz International Pte Ltd v PSB Corporation Pte Ltd,4 the franchisee wanted to get out of the contract by complaining that there was a mistake. By the franchise contract, the franchisee was to use the franchisor’s system of establishing, operating, and managing a training centre in China. However, its application to the Ministry of Education in China for an education licence was unsuccessful and thus, business could not start. The Court ruled that the contract was not void as the franchisees’ problematic situation was a result of their own failure to conduct due diligence prior to the signing of the franchise agreement. The franchisee failed to obtain a refund of the $120,000 that they had paid.
Contracts (Rights of Third Parties) Act (Cap 53B)
This legislation entitles a third party to enforce contracts directly, where the conditions of the legislation are satisfied.
Although this legislation seeks to preserve existing statutory and common law exceptions to privity by expressly excluding certain kinds of contracts from its application, it also applies to commercial documents, for instance, a franchise agreement. Therefore, franchisors and franchisees must consider carefully whether they have, in their franchise agreement, inadvertently granted rights to third parties. For an example of how the Singapore Court of Appeal decides and affirms a third party’s right to enforce a contract, one can refer to a recent non-franchise related case of CLAAS Medical Centre Pte Ltdv Ng Boon Ching.5
Unfair Contract Terms Act (Cap 396)
The Unfair Contract Terms Act requires that a franchise contract must be fair and reasonable, having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made.6
Where there is an exclusion or restriction of any liability, the franchise contract must pass the test of reasonableness, regard shall be had in particular to the matters specified in the Second Schedule of the Unfair Contract Terms Act.7
Where liability is restricted to a specified sum of money, and the question arises whether the franchise contract passes the reasonableness test, matters to be considered include the following:
1. The resources which he could expect to be available to him for the purpose of meeting the liability should it arise; and
2. How far it was open to him to cover himself by insurance.8
Tort of Deceit Or Fraud
This area of law seeks to protect the franchisor and the franchisee by ensuring that statements made by either party are not false.
The following are the elements of the tort of deceit that were applied in the latest franchise dispute in Mentormophosis Pty Ltd and others v Phua Raymond and another 9 (famously known as the “Da Vinci case” since the defendants are the home-grown high-end furniture shop Da Vinci and its managing director):
1. There must be representation of fact, made by words or conduct;
2. The representation must be made with the intention that it should be acted upon by the complainant;
3. It must be proved that the complainant had acted upon the false statement;
4. It must be proved the complainant suffered damage by so doing; and
5. The representation must be made with knowledge that it is false; it must be wilfully false, or at least made in the absence of any genuine belief that it is true.
In the Da Vinci case, three franchisees from different countries banded together and won damages against the franchisor who eventually wounded up when the Court ruled that the franchisor deceived the franchisees into believing that it had the backing of the Da Vinci Group.
Misrepresentation Act (Cap 390)
Enshrined in this legislation is the principle that one is not to make false statements, or misrepresentation when entering into a contract.
Section 2(1) provides:
Where a person has entered into a contract after a misrepresentation has been made to him by another party thereto and as a result thereof he has suffered loss, then, if the person making the misrepresentation would be liable to damages in respect thereof had the misrepresentation been made fraudulently, that person shall be so liable notwithstanding that the misrepresentation was not made fraudulently, unless he proves that he had reasonable ground to believe and did believe up to the time the contract was made that the facts represented were true.
Duty of Good Faith
The legal position as to whether Singapore law recognises the existence of a duty of good faith in a franchise contract has not yet been established, although one franchisee attempted to rely on this in Telestop Pte Ltd v Telecom Equipment Pte Ltd and Another Suit.10 The franchisee failed because he did not plead that in a contract between a franchisor and a franchisee, there is a duty of good faith. They did not plead what such a duty would consist of and they did not plead how such duty was allegedly breached. As such, the Court ruled that the franchisees were not entitled to make submissions relating to a duty of good faith or a breach of such duty. If the pleadings had been done properly, there may be a case for the establishment of a duty of good faith.
Competition Act (Cap 50B)
Based on the premise that strong and vibrant economies have competitive markets at their core, with the aim to spur businesses to be more efficient, innovative, productive and responsive,11 the Competition Act acts strongly against anti-competitive activities that unduly prevent, restrict or distort competition. There are three main prohibited activities under this Act:
1. Anti-competitive agreements, decisions and practices (“the s 34 prohibition”);
2. Abuse of a dominant position (“the s 47 prohibition”); and
3. Mergers and acquisitions that substantially lessen competition (“the s 54 prohibition”).12
Agreements, decisions or concerted practices may, in particular, have the object or effect of preventing, restricting or distorting competition within Singapore if they:
1. directly or indirectly fix purchase or selling prices or any other trading conditions;
2. limit or control production, markets, technical development or investment;
3. share markets or sources of supply;
4. apply dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage; or
5. make the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts.
Conduct on the part of one or more undertakings which amounts to the abuse of a dominant position13 may, in particular, constitute such an abuse if it consists in:
1. predatory behaviour towards competitors;
2. limiting production, markets or technical development to the prejudice of consumers;
3. applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage; or
4. making the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of the contracts.
The s 34 prohibition and the s 47 prohibition, although having come into force only on 1st January 2006, have retrospective effect.
Having said that, the s 34 prohibition does not apply to a vertical agreement. 14 However, this is not a blanket exclusion. The Minister for Trade and Industry may order15 certain vertical agreements to be prohibited.
On the scope of the exclusion of vertical agreements provided under para 8 of the Third Schedule (“vertical exclusion”), the Competition Commission of Singapore (“CCS”) has clarified16 that the vertical exclusions cover Intellectual Property Rights (“IPR”) provisions, provided they do not form the primary object of the agreement, and are directly related to the use, sale or resale of goods and services. Vertical exclusions are meant to apply to purchase and distribution agreements only, and not to intellectual property (“IP”) licensing agreements.
Do franchise agreements fall within the scope of the vertical exclusion? The following is an extract from the CCS Guidelines on the Treatment of Intellectual Property Rights:
3.10 The section 34 prohibition does not apply to vertical agreements, other than such vertical agreements as the Minister for Trade and Industry may by order specify. This exclusion is provided for under paragraph 8 of the Third Schedule. Vertical agreements are agreements entered into between 2 or more undertakings each of which operates, for the purposes of the agreement, at a different level of the production or distribution chain, and relating to the conditions under which the parties may purchase, sell or resell certain products. This includes IPR provisions contained in such agreements, provided that they do not constitute the primary object of such agreements, and are directly related to the use, sale or resale of products.
3.11 The exclusion covers agreements which concern the purchase or redistribution of products, such as a franchise agreement where the franchisor sells to the franchisee products for resale. This includes IPR provisions contained in the franchise agreement, such as the trademark and know-how which the franchisor licenses the franchisee in order to market the products.
The CSS has explained that while IP licensing agreements,17 especially those made between non-competitors, are generally considered to be pro-competitive, it is not appropriate for a blanket vertical exclusion to be extended to IP licensing agreements, which are likely to be inbuilt in a franchise agreement because of potential effects on the technology and innovation markets that may also need to be taken into account. IP licensing agreements will be assessed, where necessary, using the assessment framework in clause 3.2 of the Guideline.
Also, the CSS has clarified18 that vertical restraint within a franchise agreement is generally covered by the vertical exclusion. This includes IPR provisions, such as trademarks, provided that the IPR provisions do not constitute the main object of the agreement and are directly related to the use, sale or resale of goods and services.
However, it can be difficult in individual cases to determine whether or not a particular franchise agreement falls foul of the competition law rules. This is something that the parties have to determine for themselves.19 For this reason, and because of this practical difficulty, the CCS has elaborated on the following framework published in the abovementioned paper CCS Guidelines on the treatment of Intellectual Property Rights to which practitioners usually turn:
Step 1: The CCS will first distinguish if the agreement is made between competing or non-competing undertakings. In general, agreements between non-competitors pose significantly smaller risks to competition than agreements between competitors. In order to determine the competitive relationship between the undertakings, it is necessary to examine whether the undertakings would have been actual or potential competitors in the absence of the agreement. The CCS will review the competitive relationship between the undertakings at the time the agreement is made.
Step 2: The CCS will then consider if the agreement and the licensing restraints restrict actual or potential competition that would have existed in their absence. The CCS will consider the impact on both inter-technology competition (i.e. competition between undertakings using different technologies) and intra-technology competition (i.e. competition between undertakings using the same technology).
Step 3: The CCS will consider if an agreement that falls within the scope of the section 34 prohibition may, on balance, have a net economic benefit.20 An agreement may have a net economic benefit, where it contributes to improving production or distribution or promoting technical or economic progress and it does not impose on the undertakings concerned the possibility of eliminating competition in respect of a substantial part of the goods or services in question. Such an agreement will be excluded by virtue of section 35 of the Act, no prior decision by the CCS to that effect being required.
Securities and Futures Act (Cap 289)
Previously, the protection for members of the public from being misled into participating in any interest, defined by the old Companies Act as any right to participate in any profits, assets or realisation of any financial or business undertaking or scheme, whether in Singapore or elsewhere, used to be found in the Companies Act.21 The then Companies Act22 mandated that if an investment scheme falls within the definition of interest under the Act and an offer is made to the public for subscription or purchase of that interest, the company making such an offer must issue a prospectus. A 1998 amendment to the Companies Act has clarified that franchises are excluded from the ambit of the then s107 of the Companies Act.
In 2001, these provisions were exported to the Securities and Futures Act (“SFA”), amongst other things, to create a new regulatory regime for collective investment schemes. Division 6 of Part IV of the Companies Act containing s 107 were then repealed.23 SFA specifically states that a franchise is excluded from the definition of a collective investment scheme24 and, therefore, the Code on Collective Investment Schemes issued by the Monetary Authority of Singapore does not apply to franchises. It is, therefore, clear that it was intended for franchises to be unregulated by the new SFA.
Prime Minister Lee Hsien Loong (then Deputy Prime Minister) clarified this in Parliament:
The public will be reminded time and again that the primary responsibility for making investment decisions lies with themselves and, over time, they will be able to learn to be able to look out for their own interest. There is no alternative. We have to shift. We cannot go on the basis that the regulator, or MAS, or the Exchange will make sure that every investment is safe and sure to make money. If you want to invest, you have to make your own judgement, find out your own information and make your own decisions.25
Constance Leong*
Goh Phai Cheng LLC
E-mail: [email protected]
*LLM (London); Advocate & Solicitor (Singapore); Barrister-at-law (Middle Temple), Solicitor (England & Wales).
Disclaimer: The opinions expressed in this article are the sole responsibility of the author and do not necessarily reflect any position or policy of Goh Phai Cheng LLC (‘the firm’). While every effort has been made to ensure that the information contained in this article is correct, neither the author nor the firm can accept any responsibility for any errors or omissions or for any consequences resulting therefrom. Nothing in this article is intended to amount to legal advice and professional opinion should be sought on a case by case basis.
Acknowledgment: The author thanks Mr Albert Kong, Executive Committee member of the Franchising and Licensing Association (Singapore), and Chairman/CEO of Asiawide Franchise Consultants Pte Ltd26 and Senior Counsel Mr Goh Phai Cheng for their comments. All references with hyperlinks were last accessed 14 January 2011.
Notes
1 International Enterprise Singapore Annual Report 2009/2010, p 38.
http://www.iesingapore.gov.sg/wps/wcm/connect/8fd6940043e39e578983cd7a20a3f877/2010_ARV2.pdf?MOD=AJPERES
2 [2009] SGHC 266.
3 [2009] SGHC 290.
4 [2009] SGDC 221.
5 [2010] 2 Singapore Law Review(SLR) 386; [2010] SGCA 3.
6 Section 11(1) of the Unfair Contract Terms Act (Cap 396).
7 Section 11(2) of the Unfair Contract Terms Act (Cap 396).
8 Section 11(4) of the Unfair Contract Terms Act (Cap 396).
9 [2010] SGHC 188.
10 [2004] SGHC 267.
11 The Competition Commission of Singapore (“CCS”) Competition Philosophy published in the CCS website
http://app.ccs.gov.sg/AboutUs_CEPhilosophy.aspx.
12 http://app.ccs.gov.sg/CompetitionAct.aspx.
13 Section 47(3) of the Competition Act, “dominant position” means a dominant position within Singapore or elsewhere.
14 Paragraph 8(2) of the Third Schedule of Competition Act, and paragraph 3.10 of the CCS Guidelines on the Treatment of IPRs. The CCS Guidelines on the Treatment of IPRswas published in June 2007, post-public consultation of the CCS Draft Guideline on the Treatment of IPRs. It is found at http://app.ccs.gov.sg/cms/user_documents/main/pdf/IPR_Jul07FINAL.pdf.
15 Paragraph 8(1) of the Third Schedule of Competition Act and para 3.10 of the CCS Guidelines on the Treatment of Intellectual Property Rights.
16 Paragraph 4 of the CCS Guidelines on the Treatment of IPRs.
17 Paragraph 5 of the CCS Guidelines on the treatment of IPRs.
18 Paragraph 6 of the CCS Guidelines on the treatment of IPRs.
19 Paragraph 21 of the Competition Regulations 2007.
20 Annex C of the CCS Guidelines on the Section 34 Prohibitionsets out how the CCS will determine if an agreement meets the criteria for the exclusion of individual agreements under the Third Schedule.
21 Division 6 and s 107 of the Companies (Amendment) Act 1998, as it then was. It is now repealed.
22 Section 113 of the Companies Act, as it then was in 1998.
23 Securities and Futures Bill No 33/2001, Explanatory Statement.
24 Section 2(1) of the Securities and Futures Act 2001.
25 Hansard Report, sitting date 5 October 2001, title: “Securities and Futures Bill”.
26 www.asiawidefranchise.com. Asiawide Franchise Consultants Pte Ltd has strategic partner and franchisee offices in Australia, Brazil, Cambodia, Canada, China, England, Germany, Greece, Hong Kong, India, Indonesia, Italy, Japan, Korea, Lithuania, Malaysia, Mexico, Middle East, Mongolia, New Zealand, Philippines, Russia, South Africa, Thailand, UK, USA, and Vietnam.