MLM Companies Under the Microscope: Is Your Company’s Consultant Agreement Enforceable?

For almost any company, litigation is a difficult and expensive process. For MLM companies, the microscope of litigation can reveal problematic business practices and operational gaps that expose a company to legal risk far beyond the liability exposure in a pending lawsuit. This is often a costly lesson learned, and one that’s avoidable with adequate planning and preparation.

A recurring problematic issue for MLM companies in litigation is the validity of the company’s independent consultant (IBO) agreement. Can the company demonstrate that it has a legally enforceable and binding agreement with its independent sales representatives? Whether embroiled in litigation to defend a consultant termination or restrain a rogue distributor from raiding its sales force, a company does not want to discover during the middle of a lawsuit that it cannot or is unable to enforce the terms of its consultant agreement. And yet this seemingly simple issue has proven to be problematic in litigation for numerous direct sales/MLM companies, both large and small.

One potential red flag is a flaw in the online enrollment process. All documents that comprise a company’s consultant agreement (online terms and conditions, policies & procedures, etc.) should be available, in their entirety, to a new consultant at the time of enrollment. A company should not process a consultant enrollment without creating a valid electronic record of (i) the consultant’s acknowledgment that she or he has reviewed all documents that comprise the consultant agreement; and (ii) the consultant’s agreement to be bound by the terms of all such documents. This is particularly important for companies that incorporate policies & procedures or other documents by reference into an online consultant agreement. If not done properly, a judge or arbitrator may find that the policies & procedures are not legally enforceable because the company cannot prove that the consultant agreed to those terms at the time of enrollment. This can lead to a harsh result, such as a company’s inability to enforce an arbitration provision or forum selection clause if those provisions are included in an unenforceable policies & procedures document.

Another common pitfall can occur when a company amends the terms of the independent consultant agreement but does so without providing enough advance notice of the proposed amendment. Historically, MLM consultant agreements contained provisions allowing the company to unilaterally amend the terms of the agreement at the company’s discretion. The law has evolved, however, and in a number of states a company’s attempt to unilaterally amend an independent consultant agreement without providing sufficient prior notice of the amendment will render the amendment legally invalid. Similarly, contractual amendments may be invalid unless they are expressly limited to future conduct or disputes and not applied retroactively. Failure to properly amend a consultant agreement can (and has) lead to catastrophic consequences for several MLM companies, such as the inability to enforce an arbitration provision or class action waiver to avoid a costly class action lawsuit.

A third potential enforceability issue can arise if there are similar or identical provisions in different parts of the consultant agreement (for example, a dispute resolution provision in the online terms and conditions and a second dispute resolution provision in a policies & procedures document). If a company amends one of these provisions but neglects to amend the other provision, the two provisions may conflict or otherwise be unenforceable. This very occurrence forced one MLM company to defend a class action lawsuit that could otherwise have been avoided if not for conflicting provisions in the company’s independent consultant agreement and policies & procedures. The lesson here is to eliminate redundant provisions in the documents that comprise the consultant agreement. Don’t repeat provisions in the policies & procedures that already exist in the online terms and conditions.

A fourth potential problem is whether an independent consultant agreement is void due to unconscionability. An agreement is unconscionable (and unenforceable) if it is determined to be “inherently unfair.” State laws vary, but an unconscionability analysis is usually a two-step process. The first inquiry is focused on whether the contract is procedurallyunconscionable, and the second inquiry focused on whether the contract is substantivelyunconscionable. A contract that is deemed to be both procedurally and substantively unconscionable is legally unenforceable.

Because most MLM companies utilize a standardized independent consultant agreement in which a prospective consultant is given no meaningful opportunity to negotiate the terms, the majority of MLM independent consultant agreements are likely to be deemed procedurally unconscionable. As a result, companies must ensure that their independent consultant agreements are not substantively unconscionable. In assessing substantive unconscionability, the primary inquiry is whether the agreement terms are mutual or one-sided. For example, a contract provision that requires a distributor to assert a claim against the company within one year from the date of the occurrence or breach but does not require the company to do the same is arguably substantively unconscionable. If your company’s consultant agreement contains numerous one-sided provisions that are overly favorable to the company, then the agreement (or certain provisions) may be unenforceable due to unconscionability.

Another important consideration in assessing unconscionability is whether a prospective consultant has a reasonable opportunity to review and agree to the terms of the agreement at the time of enrollment. In this regard, it is important to recognize that MLM consultant agreements are generally viewed by judges and arbitrators as consumer agreements rather than commercial agreements. Companies should draft their consultant agreements with this in mind. For example, a 40-page single-space contract may be reasonable for documenting a contractual relationship between two sophisticated business entities. The same is arguably not true for documenting the contractual relationship between an MLM company and a new consultant. Even if you have an otherwise valid consultant agreement, some judges and arbitrators are hesitant to enforce “fine print” provisions against what they consider to be unsophisticated consumers. MLM consultant agreements should therefore be shorter, not longer, and written in plain language. Lengthy consultant agreements and even more lengthy policies & procedures documents typically contain numerous provisions that are informational, guidelines or suggestions rather than binding contractual terms. Provisions that are informational, suggestions or guidelines are better suited in a “Best Practices” or “Guidelines” document rather than taking up space in the legal agreement between a company and its independent consultant.

Don’t wait until your MLM company is under the microscope of litigation to discover that your independent consultant agreement is unenforceable. Companies should regularly review and update their consultant agreements as well as the online enrollment process to ensure that a legally valid and enforceable agreement is created when a new consultant is enrolled.

Brent Kugler is an experienced Direct Selling Partner at Scheef & Stone, a full-service commercial law firm in Texas.  The firm represents businesses of all sizes throughout the United States and, through its Mackrell International network, around the world.  Learn more about Brent here.