Are you taking the most proactive measures to stay compliant and avoid legal loopholes?
This issue we are launching a new department, Legal Briefs. In each issue, Direct Selling News will ask a leading attorney to share their perspective on the channel’s most pressing issues and opportunities.
Direct selling companies face constantly evolving legal and regulatory challenges. Business practices and methods once viewed as compliant may now invite legal or regulatory risk. Here are some areas where companies may be creating unnecessary and avoidable risk.
Is Your Distributor Agreement Enforceable?
The consultant agreement plays a critical part in protecting a company from legal and regulatory exposure. No company wants to discover during a pending lawsuit that it cannot legally enforce provisions in its consultant agreement. Yet this is a recurring problem for many companies.
Most enforceability problems stem from flaws in the electronic enrollment process. A company should not process a consultant enrollment without creating a valid electronic record of the new consultant’s agreement to be bound by the terms of all documents comprising the consultant agreement. Even if a company captures the applicant’s assent to the agreement terms (or any amendments), it must still be able to demonstrate that the electronic signature can be attributed to the individual who electronically enrolled.
Sufficient evidence of attribution can include requiring the applicant to provide personal identifying information such as a social security number or address; assigning a unique identifier to a user; or maintaining a single, secure system for tracking user activities that prevents unauthorized access. If not done properly, a judge or arbitrator may find that a company’s consultant agreement is not enforceable because the company cannot prove that the new consultant agreed to the agreement terms. This can lead to a harsh result, such as a company’s inability to enforce an arbitration provision or class action waiver.
Another enforceability issue can arise if there are similar or identical provisions of the consultant agreement in different parts of the distributor agreement. For example, a provision in the online terms and conditions and a similar provision in a policies and procedures (P&P) document. If a company amends one of these provisions but neglects to amend the other, the two provisions may conflict—nullifying the enforceability of either provision. This very occurrence forced one multi-level marketing (MLM) company to defend a costly class action lawsuit that could have been avoided if not for conflicting provisions in the consultant agreement and P&P.
Are All Material Terms Disclosed During the Enrollment Process?
Legal enforceability is not the only problem that can arise from a flawed online enrollment process. The Federal Trade Commission (FTC) views any failure to “clearly and conspicuously disclose all material terms of the transaction before obtaining the consumer’s billing information” to be a violation of Section 5 of the FTC Act.
Material terms include a full description of auto-renewal and cancellation provisions. If a company utilizes a separate policy and procedures document, it is not sufficient to incorporate it by reference but not provide the complete document for review or to require the consultant to agree to the P&Ps within 30 days of enrollment. Similarly, if a company uses hyperlinks to reference other documents during the enrollment process, the applicant should be required to open the link, review and expressly agree to the terms of all contract documents before the enrollment is processed.
Do Restrictions on Consultant Mobility Create Misclassification Exposure?
At one time or another, MLM companies experience the disruption of a top leader leaving to join another company. The disruption is magnified if the leader solicits other consultants to join the other company.
MLM companies have historically tried to prevent this disruption by including non-compete or non-solicitation restrictions in the consultant agreement. With the evolution of the gig economy and influencer/social media-generated advertising, there is a clear trend that company and brand loyalty are less important to today’s workers. Moreover, the ability to work for more than one company is a key factor in numerous state independent contractor classification tests.
A non-solicitation policy is a less risky alternative to a non-compete provision. It simply prohibits a consultant from recruiting or soliciting other consultants to join another company. Still, companies should proceed with caution in utilizing a non-solicitation provision.
The non-solicitation restriction must be “reasonable.” Reasonableness focuses on two things: the scope and length of the restriction. MLM companies often “compete” with one another regardless of whether they market similar products or services. This fact may not be obvious to a judge or arbitrator not familiar with this industry. For this reason, a non-solicitation provision should define other MLM or network marketing companies as “competitors.” As for the length of the restriction, non-solicitation restrictions that extend past the termination of the agreement are much more scrutinized than non-solicitation restrictions limited to the term of the agreement.
Is Your Company’s Compensation Plan in Need of a Makeover?
It’s no secret that the FTC has prioritized scrutiny of MLM compensation plans. It is imperative that companies undertake regular, periodic reviews of their compensation plans to avoid getting caught in the FTC’s crosshairs. Companies must be able to demonstrate that commissions are derived primarily from the retail sale of products to non-participant purchasers. The failure to monitor or collect this data, or the non-existence of such data, is viewed by the FTC as indicative of an illegal pyramid scheme.
Additionally, the words and terms used in a compensation plan matter. One of the first things a regulator looks at is how “volume” is defined in the compensation plan. Volume should be defined to reflect an emphasis on retail sales to non-consultants. Many comp plans define volume as inclusive of both volume from participant personal purchases and volume generated from sales to non-consultant customers. If volume is defined this way, this means that the compensation plan—at least theoretically—allows for rewards to be earned exclusively from participant personal purchases.
Even if this does not accurately reflect how commissions are generated in reality, a loose definition of volume allows a regulator to conclude that a company is an illegal pyramid because rewards attainable in the compensation plan can be achieved based on volume with no retail sales activity. A company can spend years—and millions of dollars—seeking to correct a regulator’s misperception created by imprecise language in the company’s compensation plan.
Brent Kugler is a prominent attorney in the direct selling industry with over 23 years of experience. Formerly the General Counsel for a large MLM company, Brent provides comprehensive legal representation to direct sales companies including advice on regulatory issues, distributor policies and procedures, compensation plans, independent contractor classification, governmental affairs and risk management.
From the January/February 2025 issue of Direct Selling News magazine.
