Most Multilevel Marketing companies claim that their list of distributors is a proprietary asset of the company. When a departing distributor uses the list to solicit other distributors to follow him or her to a new company, the MLM company cries foul ball. Indeed, many MLM companies include in their Policies & Procedures provisions acknowledging the proprietary nature of the company’s distributor list (i.e. genealogy) and providing restrictions allowing use only in conjunction with the company’s business.
It is commonplace for a distributor that leaves a particular MLM company to want and take his or her downline organization to the new company. This may result in an action filed by the departing MLM company against the distributor alleging various claims including breach of contract, and misappropriation of trade secrets.
The federal government has provided a new weapon that may now be used by the MLM company. On May 11, 2016, President Obama signed into law the new Defense of Trade Secret Act. This new law provides, for the first time, a federal right to trade secret protection to be adjudicated in federal courts. What is more promising to MLM companies is that the new law allows the federal courts to issue an immediate seizure order (even in particular cases without notice) to allow federal marshals to seize property to prevent the “propagation or dissemination of trade secrets.” Imagine going to court and obtaining an order allowing federal officers to seize the computer hard drive of a distributor that is threatening to use the information in his or her downline to solicit distributors to join a new MLM company. The new federal law potentially allows for this remedy.
The new law marks a great departure from the traditional way of enforcing trade secret rights. Up to now the protection of trade secrets has been a function solely of state law. Although most states follow some version of the Uniform Trade Secret Act, there are significant differences from state to state. For example, state laws differ significantly on the issue of mobility of employees and others. The mobility issue in certain states is so important that these states restrict the right to enforce trade secrets. Because MLM companies operate in many different states, the results of any trade secret misappropriation claims differ from state to state which leads to unpredictable and different results. The new federal law promises to develop a uniform set of rules and remedies that will be applied consistently in every federal court no matter what state it may be located.
A trade secret is traditionally defined as information that is subject to reasonable efforts to keep it secret and which derives independent economic value from not being generally known to the public. The new federal law follows this definition. However, the manner in which the law is interpreted and remedies under the federal law may prove to differ from the state law depending on what state the MLM company is located.
1 Most MLM companies use the process of imposing the Policies & Procedures on distributors through a “click-wrap” agreement on the web. The agreement then incorporates by reference the Policies & Procedures which can be accessed through a link in the web page. Some states may consider this type of contractual restrictions to be an unenforceable contract of adhesion.
2 This issue of who owns the goodwill of a downline, and hence use of its data, is still subject to debate and adjudication
Another aspect of the new federal law is that it imposes a requirement to notify employees that they have immunity from whistleblowing activity. In other words, employees must be notified that they have both civil and criminal immunity for disclosing any trade secrets “in confidence to a Federal, State, or local government official, directly or indirectly, or to an attorney, solely for the purpose of reporting or investigating a suspected violation of law.” Even though distributors are considered independent contractors and not employees, MLM companies should consider including such disclosures in their Policies and Procedures.
The Defense of Trade Secret Act may indeed provide MLM companies with a new and powerful tool in federal court to protect their distributor lists and data bases. It is a complex law, however, and you should consult with your attorney regarding use of the Act and how it can protect your MLM company.
*Mr. Scott Wellman is the senior litigation partner at Wellman & Warren, LLP. Wellman & Warren specializes in the representation of multi-level marketing companies and Mr. Wellman has successfully litigated MLM cases in both federal and state and court as well as in numerous states through-out the country.