One of the most challenging issues often encountered in the MLM industry is the problem of poaching distributors. The basis for this is the article "Get Your Hands Off My Downline!!" by one of the most renowned American legal experts in MLM-related legal matters, Spencer M. Reese, who, along with his colleague Kevin D. Grimes, heads the legal services of the U.S. Direct Selling Association (DSA) and the World Federation of Direct Selling Associations (WFDSA), and serves as a consultant to many major MLM companies and distributor professional organizations. CONFLICT OF INTEREST If God were to govern MLM as He did the exodus of the Jews from Egypt, the first of the Ten Commandments given to the People of Israel through Moses would sound like this: "Thou shalt not steal downlines." Quite in the spirit of the Ten Commandments would be such as: "Thou shalt not covet thy neighbor's downlines" and "Thou shalt not raid downlines." The problem that any MLM company has to deal with from time to time is the poaching of distributor networks to another MLM company by someone among the still working or former distributors. In essence, a company may consider itself lucky if this happens no more than once a year. My practical experience allows me to say that such unethical poaching of distributors is the main cause of conflicts between distributors and the company. Looking at this issue emotionally, the surest way to turn old trusted friends into mortal enemies is to try to poach their downlines all at once. Your former friends will curse you at the mention of your name, if they agree to mention it at all. It is much more likely that in the future they will refer to you as nothing but "that dirty son of a b****" or add unprintable epithets to your name. Yes, passions are running high, and everyone has reasons to take their respective positions. A distributor who engages in recruiting for another company is convinced that competition laws give him the right to recruit whoever he wants, whenever he wants, and into whichever company he wants. He intends to exercise this right because the company already gets too much of the pie, and it also imposes unjustified restrictions on him. On the other hand, the higher-level distributors, who have worked hard and long to create their distributor lines, will not let others leave without a fierce fight. They cry out to the company to protect the fruits of their labor. Finally, on the third side, there is the company itself, from which distributors are being lured away. It is not easy for companies to believe that a distributor to whom they have paid so well and for whom they have done so much has the audacity to "throw" them. Add to this mix a number of slanderous and malicious statements from all parties involved, a large number of rumors, sometimes threats of physical violence, and you get a recipe for making a foolish lawsuit. For both MLM companies and distributors, the problem of raiding relates to the provisions of the distributor agreement, policies, and procedures that restrict distributors' ability to recruit for other MLM companies. Restrictions range from prohibiting the use of distributor lists as a recruitment tool to an absolute prohibition on participating in other MLM systems. In addition, the company has legal grounds to file a lawsuit to protect its trade resources from unfair competition. Distributors against whom legal actions are taken respond with lawsuits challenging the validity of rules that restrict trade freedom. As an argument, they argue that they are independent contractors and that the company has no right to burden them with agreements that violate competition laws. However, raiding is not only carried out by distributors. At times, the industry faces cases where executives of one company incite their distributors to recruit distributors from another company. MLM companies that are members of the Direct Selling Association (DSA) have attempted to address this issue through a DSA directive regarding "cross-recruiting." NON-ADVERTISED APPROACHES TO SOLVING THE "RAIDING" PROBLEM IN MLM. Order in your own house No matter how much the Company strives for perfection, it is simply unrealistic for this MLM system to satisfy everyone all the time. An unhappy distributor will always be a fact of MLM life, and inevitably a situation of poaching will arise. In these situations, it is necessary to act, keeping in mind the approaches described below. However, if a company chronically suffers from poaching problems, it should look at itself, deciding whether it has created this problem itself. The company must honestly answer several key, self-critical questions: 1. Are my products or services of poor quality? 2. Are my prices too high? 3. Are orders quickly processed and deliveries made? 4. Are the customer service department employees polite and courteous enough, and how diligently do they perform their duties? 5. Is the compensation plan competitive compared to others in the industry? 6. Are the qualification requirements too burdensome? 7. Will legal issues lead to a deterioration of the company's reputation? There are many similar questions that management must address. However, fundamental is whether the company can make distributors and consumers happy. The MLM industry is characterized by fierce competition, and there is no shortage of good companies selling high-quality products and offering generous compensation plans. If a company is not competitive in these positions, its distributors and consumers will scatter. Therefore, if a company has high turnover and an increased poaching problem, the first step should be to identify and correct its own shortcomings, rather than trying to blame everything on fraudulent distributors. Management must also analyze its relationship with distributors. I have seen companies expressing their arrogance towards distributors like "We are the Company, so damn it, we can do whatever we want - and if someone doesn't like it, they can leave!". A company that treats distributors this way simply opens the door for them to leave. Management must remember that in relation to all new MLM formations that have emerged in the last 10 years, distributors have a wide choice. Successful companies understand that they need distributors more than distributors need them. Accordingly, they prioritize the satisfaction of distributors and consumers. Distributors must conduct a similar self-assessment. The key question a distributor must ask themselves is, "why do I want to change companies?" If a distributor jumps between companies with the intention of quickly making money and moving on (similar to an "MLM addict"), they must evaluate the consequences of treating their downline as private property. It should not be forgotten that the downline consists of real people, each with their own feelings, goals, aspirations, and dreams. It is not a part of an industrial mechanism that can be used, moved, and replaced when worn out. Playing with manipulating the downline leads to the moral depletion of many people and elicits emotional reactions ranging from resentment to sharply hostile actions. In addition, those who believe the distributor and follow them into a new program with new promises may become confused and feel deceived when the distributor reneges on these promises and moves on to the next program. Finally, if the distributor is ruled by self-interest alone and acts without regard to the wakes in their wake, they must realize that they will be stamped with the label "I am selfish and arrogant - bring a case against me." Contractual Restrictions It is hopeless to seek an MLM system that lacks any contractual provisions limiting the ability of its distributors to recruit downline distributors into other companies. There are two fundamentally different policies: - prohibition of using downline lists or "genealogical" reports as a means of recruiting into another company; - prohibition of recruiting into another MLM. When implementing the second type of policy, there are several approaches. Some approaches allow a distributor to recruit directly sponsored distributors into other programs, while other policies prohibit recruiting any distributors. Some companies take an even stricter stance and prohibit distributors who have reached a certain rank from participating in other programs. Despite some approaches being more common than others, it should be remembered that companies develop policies based on their specific programs and corporate philosophy, and that there is no industry standard on this issue. Regardless of the format of contractual restrictions adopted by the company, legal approaches and analyses related to the legality of provisions are similar. These approaches are as follows: 1. Can the company protect downline lists as its trade secrets? 2. Do contractual provisions violate antitrust laws? 3. Are the restrictions overly broad?Is the list of downstream distributors a trade secret? For MLM, it is common to declare lists of downstream distributors as confidential commercial information and thus prohibit their use for purposes other than conducting business within the company. If the information does indeed constitute a trade secret, the court will impose a ban on its use by a third party. However, simply declaring that the information constitutes a trade secret is not sufficient for the list of downstream distributors to fall under the provisions of trade secret protection. For this, the list must meet certain requirements. Despite the existing differences among the legal requirements of state laws related to defining the status of protecting trade secrets, most states adhere to the Uniform Trade Secrets Act, in which a trade secret is defined as: Information, ... (i) derives independent economic value, actual or potential, from not being generally known and not being readily ascertainable by proper means by other persons who can obtain economic value from its disclosure or use, and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy. Uniform Trade Secrets Act. The list of downstream distributors obviously presents economic value to MLM competitors because it can be used as a list of potential customers and experienced sellers. But this fact alone is not sufficient to classify the information as confidential. Two other key questions arise: 1. Can the information be easily obtained through lawful alternative means? 2. What steps has the company taken to ensure the confidentiality of the information? Allowable means of obtaining informationThe Supreme Court of the United States has defined one of the policies satisfying the requirements of trade secret law as "compliance with commercial ethics standards". However, even with this approach, the boundaries of what constitutes "proper means" are so broad that the Model Law does not define this term. Rather, the Law sets parameters for what is impermissible, defining the concept of "improper means": "Improper means" include theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means. Uniform Trade Secrets Act, 1(1). Therefore, if a list of lower-level distributors can be obtained independently of the entire list of distributors and without using improper means, that list itself cannot constitute a trade secret. In this case, distributors regarding a minor network fragment can easily reproduce their downstream list from memory. However, it is implausible for a distributor with a branched downstream network to independently reproduce all information related to it. Thus, if a significant downstream fragment is involved in poaching, the company will view with skepticism any claim that the information was obtained properly. As a result, a biased investigation will follow into how the distributor acquired the information. Protection of Trade Secret Information The second key issue regarding the classification of a downstream list as a trade secret is: "What has the company done to protect the information?". Classifying a downstream list as a trade secret is just the first step. To protect the information, the company must take specific steps appropriate to the circumstances to prevent its dissemination among third parties. This will also entail a fact-based investigation. However, at a minimum, companies should investigate each suspicious case of unlawful use of downstream lists and vigorously pursue all individuals whose unlawful use of the list is proven. If a company uses security services selectively or sporadically, the information will lose its status as confidential. The company should also print a warning on all downstream lists that it considers this information to be trade secret and that it may only be used in the course of conducting business within the company. Do Antitrust Laws Violate? Clayton Act One type of restriction policy prohibits distributors from selling competing products of another company. For example, Company X sells dietary supplements and prohibits its distributors from selling any dietary supplements of competing brands. Such contractual restrictions are called "exclusive dealership contracts." This means that the distributor is obligated to deal exclusively with the dietary supplement brands of Company X. Under certain circumstances, an exclusive dealership contract is considered an illegal trade practice under the provisions of Section 3 of the Clayton Act. In essence, the Act deems it unlawful to prohibit a distributor from selling competitors' products if such restriction significantly reduces competitiveness or leads to the creation of a monopoly. To determine whether there is anti-competitive force, the Act requires the plaintiff to: 1. identify the substantial market segment covered by the contract; 2. prove that the contract creates actual - not speculative - decreased competitiveness in the substantial market segment. Thus, the first critical step becomes defining the "substantial market segment." Courts define a "substantial market segment" as a function of the products sold by the parties and the geographic area in which the parties operate. Therefore, if there are few competitors selling a specific product in a particular geographic area, a company may have the opportunity to dominate that segment, which could significantly impact competitiveness. In the context of the MLM industry, proving that an exclusive dealership contract will significantly reduce competition or lead to the creation of a monopoly is extremely difficult. In general, the products of most MLM companies are not unique. Although a specific product may have certain features, these qualities are usually insufficient to differentiate the product in terms of creating a substantial market share under the Clayton Act. The court determines whether consumers can purchase substitute products despite the unique features of a specific product. An exclusive dealership contract does not have the required significant negative impact on competitiveness if buyers can easily substitute the specific product for products of another brand. For example, many MLM companies sell cosmetics. Despite the unique distinguishing properties of each brand, most cosmetic products belong to a specific common category. If there are several competitors in this category and they are widely scattered across the United States, it will be very difficult for a particular MLM company to dominate a local territory in such a way that their activities have a significant impact on the local market. There are too many cosmetics retailers in each region for one company to establish dominance there. This approach is applicable to other goods often sold through MLM schemes - dietary supplements, cleaning products, or, for example, telephone services. Therefore, since one MLM company is unlikely to dominate its products or services in a specific geographic location, an exclusive dealership contract will not violate Section 3 of the Clayton Act. Sherman Act Any person who monopolizes or attempts to monopolize, or conspires or combines with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony, ... 15 U.S.C. 2. The Supreme Court of the United States has defined two types of violations of the Sherman Act.The first is a per se violation (letter of the law) because "the destructive impact of the absence of competition and the absence of feedback are decidedly impermissible and, thus, unlawful without any clarifying assessment of the harm they cause or business efficiency considerations." Fixed prices are such a clear example of a substantive violation of antitrust legislation. The second type of violation is established by applying the rule of reason. This is the result of a factual inquiry in which the court or jury "weighs all the circumstances of the case, deciding whether the practice in question, requiring prohibition, violates competition principles." Cases of distributor "termination" resulting from a distributor's violation of restrictive contractual provisions should be analyzed based on the application of the rule of reason, as restrictive provisions do not relate to price-fixing conspiracies. Princess House v. Lindsey Process This process illustrates how the rule of reason is applied to cases of MLM distributor "termination." In the case at hand, distributors (the Lindsey family) were "terminated" as distributors of Princess House because they were inclined to move to another MLM company (Park Lane) recruiting Princess House distributors. The distributors claimed that Princess House violated the provisions of Sections 1 and 2 of the Sherman Act: - by terminating the distributorship contract and refusing to pay commissions; - by entering agreements with Park Lane, whereby Park Lane agreed to refrain from recruiting Princess House distributors. The court ruled that the termination of contractual relations by Princess House and its refusal to pay commissions does not fall under the provisions of the Sherman Act, as these actions are considered "unilateral". In other words, Princess House took these steps on its own - there was no third party with whom they had an agreement or a secret conspiracy. Since a violation of the Sherman Act involves an agreement, understanding, or conspiracy to limit competition, the distributors' lawsuit reference to the Sherman Act is not valid. However, the court found that the agreement between Princess House and Park Lane, whereby Park Lane agreed not to recruit Princess House distributors, falls within the definition of an agreement between parties. As this agreement was established by the court, it analyzed these restrictions in terms of the letter of the law. The court determined that the restrictions did not violate the letter of the law. Then the court applied the rule of reason, using the following test: According to the rule of reason, a claim of an impermissible restraint of trade must be based on evidence that the defendant's actions in the market or the actual impact of the alleged contractual restrictions led to a restraint of trade. Initially, the court found that the distributors did not provide any evidence of an actual anticompetitive effect. Since the actual anticompetitive effect was not proven, the court ruled that the distributors must prove that "Princess House acquired market power, dividing the relevant market segment between the products of Princess House and Park Lane, and their conspiracy had an impact on the market". The court then decided that the distributors failed to identify a substantial market segment and thus concluded that the agreement between Princess House and Park Lane did not violate the provisions of Sections 1 or 2 of the Sherman Act. If you feel like we've come full circle, you're right. Despite the analysis based on the provisions of the Sherman Act starting from its own premises, it leads to the same analysis as if the Clayton Act were applied. In other words, the legal process with Princess House required distributors to identify a substantial market segment in geographic terms and in terms of products and demonstrate that Princess House held a dominant position in this substantial market segment. As shown in the analysis using the provisions of the Clayton Act, this task is very complex due to the specifics of MLM sales. Therefore, despite the fact that the agreement entered into by the respondent contains signs of violating the letter of the law, the analysis conducted based on the Sherman Act leads to the same results as the analysis based on the provisions of the Clayton Act. In other words, no MLM company, by imposing restrictive provisions, will achieve significant dominance in a substantial market segment, thereby violating the Sherman Act. Are the restrictions overly broad? Without a doubt, provisions related to solicitation restrictions contain a partial limitation of the right to trade. However, a partial restriction must be upheld if: - it is based on fair compensation; - arises from a reasonable need to protect the company's interests; - does not violate societal interests. Being aware that competition interests are directly related to this, the court will assess the mutual interests of the parties, drawing conclusions about the appropriateness of the restrictions. In a broad sense, the court will weigh on one hand the citizen's right to work and earn a living, and on the other hand the company's interests in protecting its significance and investments in the field of creating a network of distributors and consumers. The determination of how reasonable the restrictions are, depending on the circumstances, will be determined by the type of contractual provisions related to the problem. Provisions related to solicitation prohibition fall into two categories: - prohibitions that apply during the contract's duration; - post-contractual prohibitions. Prohibitions that apply during the contract's duration Courts generally apply a prohibition to employees or agents from acting on behalf of third parties during their employment or the term of the agency agreement. In this regard, the Restatement of Agency, Second requires a general loyalty assumed by the agent towards the principal: If not otherwise specified in the contract, the agent is obligated not to compete with the principal in matters related to the agency agreement. Restatement of Agency, Second, 393. If not otherwise specified in the contract, the agent is obligated not to take actions or agree to actions during the term of the contract with persons whose interests conflict with the principal's interests in the area where the agent is engaged. Restatement of Agency, Second, 394. The law recognizes that there are no public interests that support an agent's right to compete with their principal unless otherwise agreed upon. Therefore, from a legal risk perspective, it will be quite easy for a company to "terminate" a distributor if they breach solicitation requirements. Since the risk of the company's policy being deemed unlawful is low, the distributor plaintiff will have to prove their position on facts - i.e., the distributor will have to convince the jury that they did not recruit their colleagues to another MLM company. However, if the company presents compelling counter-evidence of a violation, they will win the case. An illustrative judicial process directly addressing the court's approach to prohibitions extending for the duration of the contract is the case of Shaklee U.S., Inc. v. Giddens. Based on the evidence presented to the trial court, the Ninth Circuit Court of Appeals ruled: No factual basis was found, nor that the rule contained coercion, nor that the rule prohibiting the recruitment of other Shaklee distributors into other network companies was a subject of dispute and Giddens consciously violated the rule. Giddens did not provide evidence to cast doubt on this. Thus, Shaklee had grounds within its contractual rights to terminate the agreement with Giddens. The analysis made by the Ninth Circuit Court of Appeals in the case with Shaklee is a direct illustration of the analysis of provisions regarding the termination of relationships during the term of the contract. Nevertheless, a few words of caution are in order. Before deciding to invoke legal norms, all parties must understand that, despite the relative simplicity of the law's provisions, gathering the necessary evidence for the court is more challenging than uttering the corresponding words. As cases of distributor "termination" are surrounded by rumors and excessive emotions from all involved parties, separating facts from speculations is often a very painful and extremely costly process. Provisions Affecting Post-Contractual Relations Despite provisions regarding non-solicitation during the contract's term generally being enforceable, they do not provide most companies with the desired comprehensive protection. Ultimately, when a distributor is "terminated," they feel entitled to recruit other distributors from their former downline. What exactly is he losing - will the company "terminate" him again? Therefore, companies base their policies on using post-contractual provisions concerning non-solicitation. Post-contractual provisions typically include requirements prohibiting an ex-distributor from recruiting remaining distributors for a certain period after the contract's termination. Unlike the general acceptability of provisions imposing restrictions during the contract's term, the legality of post-contractual provisions requires a more in-depth legal analysis as they significantly affect the distributor's right to earn a living. Unfortunately, the approaches used by states in assessing the acceptability of post-contractual provisions vary widely. Therefore, the approach used by most states will be criticized below. Scope, Temporal, and Geographic Restrictions The most common approach requires an analysis of incoming factors related to the field of activity, term, and geographic areas defined by limitation. The possibilities determined by recruitment provisions typically amount to a complete prohibition on a former distributor recruiting remaining distributors to other companies. This requirement needs to be distinguished from similar provisions prohibiting the distributor from participating in a competing MLM company. Although in both cases, the same legal mechanism is often applied, the difference in approaches is significant because the requirements in cases involving competition are more stringent and therefore unlikely to be applicable. The prohibition on recruitment cannot be indefinite. Therefore, courts attempt to establish reasonable time frames dictated by circumstances to ensure the protection of companies' legitimate interests. Unfortunately, this analysis is often subjective, and courts, seeking easy and convenient ways, rely on inappropriate precedents. Thus, a two-year restriction is often accepted merely because there have been many legal proceedings using that timeframe. However, this approach does not address the central question - what factors make a specific restriction reasonable considering the incoming circumstances. In the case of MLM, we can answer this question by analyzing the company's "employee turnover." For example, if a company has an employee turnover close to 100% per year, a requirement prohibiting recruitment for one year becomes acceptable because the company has the legal right to protect the part of distributors who were active at the time the "raiding" distributor left the company. Since the former distributor has no relationship with the newly arrived distributors who joined the program a year later, he should have the right to recruit them to another company. Thus, the restriction period will vary from company to company due to differences in their "employee turnover." Geographical restrictions in the case of MLM are a complex issue. Historically, geographical restrictions arose to prevent an employee from "crossing the street" to a competitor and using the advantages associated with the network of customers of their former employer. Therefore, provisions regarding competitiveness and poaching prohibited former employees or agents from engaging in competitive activities within fixed boundaries (for example, within a 25-mile radius) from their former place of work. Accurate geographical limitation in the case of MLM is useless because even a distributor who has achieved moderate success has a downward network scattered throughout the country. It is easy and simple to call a distributor in another city and offer them to participate in another program. The law evaluates the realities from the perspective of conducting remote business contacts and tends not to apply strict geographical restrictions. This approach is well illustrated by the process in W.R. Grace & Co. v. Mouyal. Instead of geographical limitations, the Georgia Supreme Court required that the boundaries of restrictions be strictly defined so that a former employee or agent could clearly understand them. This was achieved by defining the category of individuals with whom he had relationships during his employment with his former employer. The Georgia Supreme Court ruled: The requirement to define the geographical territory in all cases does not reflect the realities of the modern business world, where an employee's "territory" knows no boundaries, as today's technologies allow an employee to serve customers scattered throughout the country and even the world. If the parameters of restrictive requirements do not exceed the scope of the formulated question, i.e. when a former employee is prohibited from post-contractual contacts with consumers with whom he dealt during his employment with the former employer, then there is no need for territorial restrictions expressed in geographical terms. Applying these principles to MLM, it becomes clear that non-solicitation provisions may restrict a former distributor from recruiting other distributors with whom he had business relationships. This group is defined quite precisely by the distributor himself as the number of individuals temporarily unavailable to him. Similarly, this logic can be applicable to a situation where a former distributor knows another distributor through their common relationship with the company, but they did not have business contacts with each other. For example, high-ranking distributors often know each other through company matters, although they do not have direct intersections. However, since the company itself created and facilitated these relationships, it is reasonable to extend the non-solicitation provisions to this situation. Test on the Principle of "Legitimate Business Interest" Another approach to assessing provisions restricting recruitment is known as the "legitimate business interest test." According to this approach, a non-recruitment agreement is valid in cases where: the employer had "close to permanent" relationships with its customers and, despite their employee status, the defendant should not have had contacts with these customers; or a former employee has acquired trade secrets or other confidential information, using their position during hiring and attempted to use it for their benefit. When determining whether relationships are "close to permanent," the following factors must be considered: - The number of years it took the company to build its clientele; - Finances invested by the company in creating clientele; - The degree of difficulty experienced in creating clientele; - The number of personal contacts made by the distributor; - The degree of knowledge the company has about its clientele; - The period during which the consumer was associated with the company; - Continuity of distributor-company relationships. Analyzing the "close to permanent" feature in the context of MLM leads to different results depending on the distributor's rank. It is difficult to classify a novice distributor or a distributor with a modest downline as "close to permanent." Staff turnover is a fact of MLM life, and distributors are most often the ones who drop out.
