By Kevin Grimes, J.D.

The short answer is a very precise, lawyer-like,“yes and no”.  The long answer depends upon the context of the question.

If the question is about compensation plan issues, ranks, and the rights and privileges associated with each rank, the answer is “no”.

In a direct selling model, the compensation for which someone is eligible, as well as the rank, rights, and privileges a distributor enjoys, are all a function of what he or she earns.  No one would argue (and no court would require) that a direct selling company pay and offer the same rights and privileges to its lowest ranking distributors as it offers to its highest ranking distributors.

However, if the question relates to distributor compliance issues, the answer is – well . . . let me re-phrase the question.  To be more technically precise, the real question is

“Must direct selling companies treat similarly situated distributors similarly?”

The answer to this question is “absolutely, yes.”  Direct selling companies must treat similarly situated distributors similarly.

Why?

Because contract law requires them to do so.

How?

Under all states’ common law, there is a covenant implied or imputed into every contract.  A “covenant” is another word for an agreement or a contract, but it can also mean a clause in an agreement or contract.

One of the implied covenants that is imputed into every contract in the United States is called the “implied covenant of good faith and fair dealing”.  Even though this covenant is not written into a contract, the parties to the contract must operate as if it is written into it because all courts will impute it to the contract and require the parties to comply with it.

The covenant of good faith and fair dealing requires parties to a contract to deal with each other in good faith and to deal with each other fairly.  As case law in the United States has developed, the covenant of good faith and fair dealing has been interpreted by courts to require a party (such as a direct selling company) that has the same agreement with multiple other parties (such as direct selling distributors or consultants) to treat the other parties in a fair and similar fashion.

The covenant of good faith and fair dealing does not require direct selling companies to treat similarly situated distributors identically.  It requires them to treat similarly situated distributors similarly.  The significance of this frequently arises within the context of distributor compliance.

Distributor Compliance

The most common violations of a direct selling company’s Policies and Procedures are illegal income claims and illegal product claims.

Income Disclosure Statement

Did you know that all income claims are illegal and violate state and federal law unless they are accompanied by at the same time with a proper and legal Income Disclosure Statement (IDS)?

The reason that income claims violate state and federal law without the IDS is that they are deceptive.  They are deceptive because they lead the reasonable and prudent prospect to believe that: (1) everyone makes the amount stated in the testimonial; (2) most distributors make the amount stated in the testimonial; or (3) it is easy to make the amount stated in the testimonial.  None of these assumptions are true, and hence, the deception and violation of consumer protection laws occur.

A direct selling company’s Policies and Procedures should set forth the requirements for distributors to make income claims, and direct selling companies should train their independent representatives periodically on the need to present the IDS whenever an income claim is made.

Not One And Done

For an IDS to be proper and legal, it must be updated annually by the direct selling company.

Income Claim Violations

Let’s assume that a direct selling company has two distributors who have each engaged in five instances of making improper income claims.  That is to say, each distributor has made income testimonials about his or her earnings and failed to provide each prospect with the company’s Income Disclosure Statement (“IDS”).

We will further assume that the company’s contractual documents prohibit income testimonials without providing the IDS (as they should).  Both distributors have approximately the same amount of direct selling experience, and neither has ever committed any violations of the Distributor Agreement or Policies and Procedures.

With respect to Distributor A, the company issues her a warning letter.

As regards Distributor B, the company elects to terminate his Distributor Agreement and relationship with the company.

Was it OK for the company to treat these distributors the way it did?  Probably not.

Given the facts surrounding both distributors (number of times they each made improper income testimonials and failed to provide an IDS, their direct selling experience, their lack of any prior compliance issues, etc.) the company should have treated them similarly.  By giving Distributor A a warning letter and terminating Distributor B, the company has opened itself up to a breach of contract claim (and lawsuit) by Distributor B.  The basis for his claim is that the company breached the Distributor Agreement by violating the covenant of good faith and fair dealing and wrongfully terminating him.

Product Claim Violations

Let’s assume that Distributor A has made improper product claims that the company’s dietary supplements cured her arthritis to five prospects, has a total of six months of direct selling experience, is a low-rank distributor, and has never had any compliance issues.

Distributor B also made the same arthritis-curing claims to five prospects, but has 20 years of direct selling experience, is one of the highest-ranking distributors in the company, and has had two prior instances of making improper product claims for which he received disciplinary sanctions.

Again, Distributor A receives a warning letter and Distributor B is terminated.

Was the company required to treat these two distributors similarly?  Of course not.

Distributor B not only should have known better, but he actually did know better since he already had two prior instances of making improper product claims for which he received disciplinary sanctions.  He made the claims with complete knowledge that doing so would violate federal and state law, as well as his Distributor Agreement.  This was his third episode of improper product claims, which is a very serious violation of any company’s Distributor Agreement.

The Bottom Line

Direct selling companies are not required to treat all distributors identically.  However, they are required by the covenant of good faith and fair dealing to treat similarly situated distributors similarly.

Kevin Grimes is a member of Thompson Burton, the premier direct selling law firm in the United States.  He has worked with and represented hundreds of direct selling and network marketing companies for over 24 years.   If you would like to talk with Kevin about this topic or any other direct selling legal concern, he can be reached at kgrimes@thompsonburton.com or at (208) 524-1008.