Direct Seller misclassification litigation is on the rise. Here’s what you need to know.
Direct selling companies rely on an expansive field of independent distributors to sell their goods and services. That field is the lifeblood of direct selling companies. But recent legal and legislative developments are placing the independent contractor status of these distributors at risk and exposing direct sellers to litigation that threatens to upend the way they do business. Here, we address the best ways to protect your company from a misclassification lawsuit.
First, we discuss your company’s primary means of reducing exposure to distributor misclassification claims—an enforceable arbitration agreement and class action waiver. Second, we discuss the rising trend of various states enacting legislation authorizing representative actions that are immune from arbitration agreements and class action waivers. And third, we identify ways your company can make sure it is prepared to fight representative actions in those states where arbitration and class action waivers alone will not defeat misclassification lawsuits.
Arbitration Agreements with Class Action Waivers Are a Must
First, every direct selling company must have an enforceable arbitration agreement and class action waiver in its distributor agreements. In addition to being effective tools to defeat class action claims in general, these provisions are very effective at both discouraging and defeating misclassification lawsuits brought by a purported class of distributors (excepting representative actions, which we will discuss later in the article).
An enforceable arbitration agreement allows your company to quickly dismiss class litigation brought in court and force the distributor bringing the claim to litigate in private arbitration, where you can utilize your class action waiver to prevent all class claims. In most cases, when plaintiffs’ attorneys cannot bring misclassification claims on a class basis, the claims are not economically feasible to prosecute and the cases promptly settle for a very low sum.
Ask your general counsel if you have an arbitration agreement and class action waiver. If the answer is “no”, immediate consideration should be taken to adding one. Typically, however, direct sellers do have these provisions.
The next step is to ensure your provisions are enforceable under the law applying to your distributor agreement. There are many ways to attack an arbitration agreement, so we recommend retaining sophisticated counsel to ensure your provisions are enforceable.
Some of the issues we see frequently that could render your arbitration agreement unenforceable are:
- Unencumbered, unilateral modification rights.
- Arbitration provisions that could be considered unconscionable under the laws of certain states.
- Conflicts between different provisions of the various agreements that govern distributors (e.g., the policies, the terms and conditions, the application, etc.).
These issues can all be cured relatively easily with a thorough review of your agreements by experienced counsel.
Representative Actions Are on the Rise in California and Could Be Coming to Other States Soon
Unfortunately, an enforceable arbitration agreement and class action waiver only get you so far. That’s because states like California have enacted legislation allowing representative actions on behalf of the state, in which distributors argue they have been improperly classified. Importantly, these actions are not subject to arbitration or class action waivers—that is, companies cannot quickly and efficiently dismiss these representative actions in court and force individual arbitration.
At present, California’s Private Attorney General Act (“PAGA”) is the only statute that has been enacted allowing representative misclassification actions. And in the past two years, we have seen multiple direct selling companies sued under PAGA.
In these cases, the plaintiffs generally allege they have been misclassified as independent contractors instead of employees. The plaintiffs contend they are entitled to employee status, and as such, they demand minimum and overtime wages, meal periods, rest breaks, itemized wage statements, reimbursement for necessary expenditures, workers’ compensation insurance, among other benefits typically provided to W-2 employees.
Importantly, the plaintiffs are not seeking recovery solely on their own behalf; rather, they generally seek recovery for all current and former allegedly misclassified California distributors.
Although California is the only state to have enacted such legislation at present, at least the following states are attempting to enact similar legislation: New York, Massachusetts, Vermont, Washington, Maine, Connecticut, Oregon and New Jersey. In all these states, if the legislation is pushed through, distributor misclassification actions under the law will be exempt from arbitration and class action waiver agreements.
For direct sellers, these broad representative claims loop in thousands of distributors, depending on the state in which they are brought, thus exposing direct selling companies to expensive, bet-the-business litigation. Given this threat, the question then arises: What can companies do to protect themselves?
Eliminate Unnecessary Control from Your Distributor Agreements to Limit Your Exposure
Although states and various regulatory bodies have different rules and requirements controlling whether a distributor is misclassified, one basic issue always remains the same: Control. Does the company exercise so much control over the way its distributors operate that the relationship is more akin to an employer/employee than an independent contractor? If the answer is no, you’ve won a significant portion of the battle, if not the whole battle.
For companies facing representative actions alleging distributor misclassification, the company must prove, among other things, that it does not exert so much control over the affairs of its distributors that they should be classified as employees. To be sure, eliminating areas of control is a careful balancing act. Distributor agreements should be revised to eliminate control where possible, while at the same time ensuring the company is protecting itself from regulatory and other legal threats. Here are some things to consider:
1 / Control Should Protect Only Legitimate Company Interests
The authority you retain to exercise control over your distributors should be for the purpose of protecting a legitimate company interest. For example, companies can impose obligations to protect their brand and reputation from tarnishment; to prevent the disclosure of their confidential information; to comply with regulatory requirements, including those barring misleading product, income and lifestyle claims and to reduce other potential legal exposure. But broad reservations of rights that exert control over distributors’ work practices and daily activities could signal to an adjudicator that the distributors are not in reality independent contractors.
2 / Remove Indicia of a Traditional Employment Relationship
Indicia of an employment relationship can appear in unexpected contract provisions that may seem to have nothing to do with whether a worker is an independent contractor or an employee. For example, many direct sellers use robust restrictive covenants that seek to restrict distributors from working with competitors. Such restrictions may be seen as an exercise of employer-like control and, in states like California, may run against the assumption that an independent contractor is customarily engaged in similar work for multiple hiring entities. For more information on restrictive covenants in distributor agreements, please see our article, Protect Your Company from Downline Raiding at directsellingnews.com or in the October 2021 issue of Direct Selling News.
The balance for eliminating control, while still protecting your company, is a difficult one to find, but counsel experienced in these issues can help you.
The direct selling industry will almost certainly see more independent contractor misclassification litigation in the coming years. Make sure your company is prepared by:
- Ensuring you have an enforceable arbitration agreement and class action waiver.
- Eliminating all unnecessary control from your distributor agreements, while still maintaining those controls that are necessary for regulatory compliance and the operation of the business.
To those looking for help with these issues, we would be happy to assist you.
Winston & Strawn LLP represents dozens of direct selling companies in a wide range of disputes and consulting matters. The firm has successfully defeated class actions alleging pyramid schemes and securities claims, enforced non-compete and non-solicitation agreements against departing distributors, prosecuted individuals violating intellectual property rights, and counseled clients on regulatory compliance issues and publicity crises. The firm also regularly advises direct selling clients undergoing government investigations, including those brought by the FTC.
From the January 2022 issue of Direct Selling News magazine.