Legality of Multi-Level Marketing

In Depth

Legality of Multi-Level Marketing

Deepak Arora | April 2010

With enhanced competition reigning the market, companies are strategising and re-organising themselves, but at times, manipulation replaces marketing…

Multi-level Marketing (MLM), (also called “network marketing”) is a kind of structure designed to create a marketing strategy, whereby, participants are given opportunity to build a residual income in a flexible way by becoming a distributor. Under the scheme of network marketing, the company sells products to the customers and the consumers in turn can sell the products to their peers and earn commission out of the sale. However, companies have manoeuvred this marketing technique to make quick money by amalgamating dubious techniques such as ‘pyramid’ structure.

MARKETING OR MANOEUVERING?

In India, the birth of network marketing cannot be exactly traced back. However, it can be said that it is still in its adolescence. Having said that, there was effervescence around late nineties, about network marketing companies and their money making schemes such as, Japan Life, etc; some of them were able to successfully defraud the Indian public. Interestingly, the mechanics and dynamics of the scheme prepared in deceptive manner have resulted in deception.

The business model used to defraud involves the exchange of money primarily for enrolling other people into the scheme without a legitimate product or service being delivered. In other words, no net cash flow into the pyramid organisation, and therefore the people at the top make a quick fortune by taking money from people lower down in the organisation. If people at the top get rich, then it follows that people at the bottom must lose out, because the net cash contained within a static organisation stays constant. People find themselves trying to recruit new people to bring new cash into the organisation, so that they can cancel their debts. This is the only way that new money can enter the pyramid. As soon as recruiting stops, the entire organisation folds and those who got in too late lose everything. This kind of business model is called ‘pyramid structure’ adopted in network marketing.

ISSUES OF LEGALITY

Network marketing is not illegal per se; it is illegal only when it is structured in pyramid manner. It is important to mention here that network marketing with intrinsic pyramid structure is banned in most of the countries. Thousands of victims had invested their money in pyramids that promised them extraordinary interest rates. Interestingly, the available data from the companies themselves suggests that the loss rate for recruiting MLM’s is approximately 99.9 per cent; i.e., 99.9 per cent of participants lose money after subtracting all expenses, including purchases from the company. The lack of regulation laws allowed those pyramids to grow excessively during several years.

PYRAMID STRUCTURE: JUDICIAL STANDPOINT

The Indian legislation in this regard was evolved prematurely in 1978 i.e. Prize Chits and Money Circulation Schemes (Banning) Act, 1978 (the Act). The Act aims at restricting all kinds of fraudulent schemes, which lure public at large in quick money game. Section 2 (c) of the Act, defines “Money Circulation Schemes” as, such schemes by whatever name they are called that promises that one would receive or would make quick or easy money by enrolment as members into the scheme. Further, Section 3 bans money circulation schemes or enrolment as member to any such scheme or participation in such scheme. Sections 4 and 5 are penal provisions and prescribe punishment.

Now the question emerges, whether network marketing comes in the purview of the Act or not? In State of West Bengal v. Swapan Kumar Guha, the Supreme Court for the first time made an in-depth analysis of section 2(c) of the Act. Hon’ble Justice A N Sen, rendered the leading judgment interpreting it in the following words:

there must be a scheme;
there must be members of the scheme;
the scheme must be for the making of quick or easy money on any event or contingency relative or applicable to the enrolment of members into the scheme, or there must be a scheme for the receipt of any money, or valuable thing as the consideration for a promise to pay money on any event or contingency relative, or applicable to the enrolment of members into the scheme;
the event of contingency relative or applicable to the enrolment of members into the scheme will however not be in any way affected by the fact whether or not such money is derived from the entrance money of the members of such scheme or periodical subscription.

CONCLUSION

It is quite apparent that once a person gets into the scheme, he will find it difficult to come out of the web and it becomes a vicious circle for him. By promising payment of commission on the business turned out by the down-line members sponsored, either directly or indirectly by the up-line members (which constitutes an event or contingency relative to enrolment of members), the first petitioner is earning quick or easy money from its distributors, apart from ensuring its distributor earn quick or easy money.

In other words, there has to be a community of interest in the happening of such event or contingency. Thus, a person, who makes quick money legitimately by the use of his wits and wisdom and no moral turpitude, will not fall under the purview of the Act. If the companies make sure that the commissions are earned only on sales of the company’s products or services, then, they will not fall under pyramid structure.