MLM Cross-Sponsoring Rules

by Jeffrey A. Babener
MLM Legal Attorney
©2011

Most network marketing companies have adopted some sort of cross-sponsoring prohibition. Under this rule, distributors may not cross-sponsor their distributors into other company programs or market products of other companies to their distributors, with the exception of their personally sponsored distributors.

There are a variety of business reasons pro and con regarding such restrictions. From the company standpoint, the company wishes to stop raiding of its organization. From the distributor standpoint, distributors resent intrusion into their independent contractor status. The smart network marketing company knows that, irrespective of the legal issues, such rules must be applied with sensitivity and good judgment so as not to label the company a bully, nor destroy morale among its distributors.

Despite the business reasons pro and con on such restrictions, it is frequently asked whether or not such a restriction is an unlawful restraint on trade under antitrust laws. The short answer is probably that such restraints by network marketing companies are legitimate restraints under the antitrust laws.

Cross-sponsoring rules would probably come under antitrust laws which regulate "exclusive dealing" contracts. Exclusive dealing contracts between a distributor and a manufacturer are reviewed for enforceability under the principles of antitrust law. This type of clause could be considered a violation of the Sherman Act as an unlawful refusal to deal, or a violation of the Clayton Act as exclusive dealing.

In general, antitrust laws do not prohibit a manufacturer from choosing to deal with distributors who promise to devote sufficient time and energy to the manufacturer's product, at least where there is no evidence that the agreement substantially lessens competition or tends to create a monopoly.

In one case involving Vacuousness, the court held that a dealer completely failed to show the existence of an exclusive dealing arrangement where Vacuousness required the dealer to sell other manufacturers' products from a separate salesroom. The determinative fact was that Volkswagen did not require the dealer to purchase only Volkswagen products, it merely required the dealer to sell them from a different facility. In addition, the dealer failed to show that the limitation on dealing products of others would "substantially lessen" competition or tend to create a monopoly in any line of commerce.

Most MLM companies do not prohibit a distributor from selling the products of other companies. They merely require that the distributor not sell others' products to customers that were not personally sponsored by the distributor or at company meetings. This is similar to the limited restrictions involved in the Volkswagen case. It is akin to requiring the distributor to sell other products from a separate showroom.

Even if a court found the restriction to constitute an exclusive dealing arrangement, the arrangement would not violate §1 of the Sherman Act unless it was found to be an unreasonable restraint of trade. An exclusive dealing arrangement does not constitute a per se violation of the Sherman Act. It is, therefore, analyzed under the antitrust "rule of reason."

Under a rule of reason analysis, several factors are examined in reaching a determination of the reasonableness of a restraint on competition:

  1. Nature of the restraint. How restrictive is the restraint and how is it enforced?
  2. Market power of seller. The key to this factor is not the ability of the seller to coerce an agreement to an exclusive dealing arrangement, but the effect of the arrangement on competition in general. If the seller is a new entrant to the marketplace or a failing business, the arrangement may be viewed as procompetitive. On the other hand, if the seller is dominant in the industry, the arrangement may tend to have an anticompetitive effect and be judged unreasonable.
  3. Nature of the industry. What is the nature of competition between brands in the industry and who are the competitors? This poses the problem of defining the relevant market. Most courts will reject the contention that the product of a particular seller constitutes the relevant product market for antitrust analysis. One example is a case in which the court rejected the plaintiff's contention that Cadillacs constituted a definable submarket by stating "the Cadillac is interchangeable with other luxury automobiles on the market." It would seem that the relevant product market in the typical MLM case would be multilevel marketing programs in general as the company does not seek to prevent the marketing of competing products, just the manner in which they are marketed.
  4. Interbrand competition. What is the nature of interbrand competition in the industry and who are the competitors? In the MLM case, the competition between multilevel marketing programs is vigorous.
  5. Purpose of the restriction. Is the purpose of the restriction to increase market share, or to maintain quality control? The restriction in the MLM case would seem to be more in the nature of maintaining quality control of the sales force, with a secondary purpose of increasing market share. The nature of the business is such that a sales staff that is focused on one product is a key to success.

As applied to this situation, the exclusive dealing arrangement would likely not constitute an antitrust violation unless a court believed it probable that performance of the contract would "foreclose competition in a substantial share of the line of commerce effected."

In addition, it is unlikely that any distributor could show a substantial lessening of competition in the product line or business (for example vitamins, cosmetics) resulting from the restriction on company distributors. This is especially true because most companies do not restrict the sale of other products, just the manner of sale.

Therefore, as it would not appear that the restriction on MLM distributors prohibiting them from selling other programs or products to company distributors other than their personally sponsored distributors would lessen competition in either the specific product line of commerce or between multilevel programs in general, the restriction is most likely enforceable and not an unreasonable restraint of trade under the Sherman and Clayton Acts.

CONCLUSION
Notwithstanding the likely legality of cross-sponsoring restrictions, enforcement of restrictions on the independent livelihood of distributors should be used with great caution. Most network marketing companies promote their opportunity with a very proud proclamation that distributors are their partners, not their employees, and secondly that distributors should have the opportunity to build their own independent business. The more prudent MLM company will use such provisions to prevent unethical raiding of its organization and will generally shy away from arbitrarily restricting the ability of distributors to conduct their own independent business. A MLM company can only maintain its distributors through their perception of morale, leadership, bonding with a company and excitement about the product and program. Any company that believes it will be able to maintain the loyalty of its distributors in the long run through the use of a "shotgun wedding," will ultimately see erosion in the ranks of its distributors.

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About the Author:

Jeffrey A. Babener, the principal attorney in the Portland, Oregon law firm of Babener & Associates, represents many of the leading direct selling companies in the United States and abroad. His firm has focus on startup and emerging MLM companies. He has been adviser to such companies as Avon, Nikken, Discover Toys, NuSkin, Excel, Fuller Brush, Cell Tech, Kaire, Sunrider, Melaleuca, etc. He is editor of the industry resource internet site www.mlmlegal.com.  He is a frequent lecturer and has been interviewed on the industry, and published, in many publications. Babener & Associates, 121 SW Morrison, Suite 1020 Portland, OR 97204, www.mlmlegal.com.

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