unnamedWhen a distributor is terminated by his or her MLM company, he or she may claim breach of contract and seek recovery of his or her past and future commissions. After all, the distributor may have worked for months or years to build up his or her downline only to have its income stream summarily stopped and taken by the company.

In a typical breach of contract case in the context of multi-level marketing, a distributor claims that he or she was terminated from the MLM company without proper cause and without proper notice or other due process rights. The distributor may then file an action against the company and seek damages in the amount of income (i.e. commissions) that he or she would have earned but for his or her termination.

MLM companies, and the distributors working within them, are generally governed by a set of rules identified as the company’s “Policies & Procedures.” It is these Policies & Procedures that dictate what a distributor can or cannot do during the course of his or her distributorship. Likewise, the Policies & Procedures mandate the companies, themselves, follow specific rules before they can take action against a particular distributor. Companies generally rely upon provisions of the Policies & Procedures when terminating the distributor. Given the importance of these Policies & Procedures, most, if not all, MLM litigation revolves around two separate issues: First, whether the particular policy is enforceable; and second, even if enforceable, whether the distributor, or the company, were in compliance with its terms.

Many MLM companies include a limitation on damages provision in their Policies & Procedures. This means that even if the MLM company violated its own Policies & Procedures (i.e. terminating a distributor without proper cause), the damages a distributor can recover may be subject to the limitations contained in the provision. To illustrate what a limitation on damages provision typically looks like, I have provided the following sample:

“To the extent permitted by law, the Company and its affiliates, officers, directors, employees and other representatives shall not be liable for, and Distributor hereby releases the foregoing from, and waive any claim for loss of profit, incidental, special, consequential or exemplary damages which may arise out of any claim whatsoever relating to the company’s performance, non-performance, act or omission with respect to the business relationship or other matters between any Distributor and the Company, whether sounding in contract, tort, or strict liability. Furthermore, it is agreed that any damages to Distributor shall not exceed and is hereby expressly limited to, the amount of unsold Company programs, services and/or products of the Company owned by Distributor and any commissions owed to Distributor.”

[1] Mr. Wellman is an attorney with Wellman & Warren, LLP located in Southern California and represents numerous MLM clients in litigation matters.

The foregoing example constitutes a standard limitation of damages provision, which is seen in many Policies & Procedures. It is, therefore, important to understand what exactly the provision means.

First, the provision seeks to prevent the distributor from recovering “loss of profits.” This means the distributor may be prohibited from recovering any ongoing future commissions whether or not the company was justified in terminating the distributor. Second, the provision limits recovery to the value of goods and/or services that were purchased by the distributor, but not sold. This is commonly referred to as a “liability cap.” An example of a liability cap is that if a distributor purchased $300.00 worth of product at the time of his or her termination, that distributor would only be entitled to recover the value of those goods, which is $300.00, nothing more. This is essentially no different than a refund of goods purchased.

Although the provision appears to have a drastic result, it may not apply in all instances. For example, in a recent case I handled in the State of Texas, the defendant [the MLM Company] invoked the very same provision when our client [the distributor] sought lost income for breaching her distributor agreement. The Court found the loss of profits segment to be enforceable. However, in the same vein, the Court recognized that even if a distributor cannot recover his or her future income, he or she may nevertheless receive the value of his or her downline organization.

In my experience, I have learned that almost all distributors join a MLM company under what I call the “MLM Promise.” This promise essentially comprises of a representation (generally from the company’s marketing materials) that the distributor’s downline constitutes a “business” that he or she “owns.” The MLM Promise also includes a representation that if the distributor works hard to build his or her downline, he or she can eventually sit back and continue earning residual income for the rest of his or her life.

The Texas Court referenced above acknowledged these representations and found that it would be unjust for my client to be limited to a recovery of salable goods. In reaching this conclusion, the Court stated the following:

“Examining the [company’s] [Compensation Plan], the Court finds that compensation related to a distributor’s [downline organization] accounts for a significant portion of the overall compensation related to a particular distributorship . . . However, the consequence of the provision is such that the Defendant may violate a distributor agreement at the cost of a refund of the products purchased that are in resalable condition. If a distributor were a simple seller ordering and holding inventory and making sales to customers, this provision would not result in a one-sided agreement. However, this provision allows the [company] to negate the value of the distributorship’s [downline] without consequence, rendering compliance with a core purpose of the agreement (continued compensation related to the referral and purchases of other distributors) completely in the control of the [company.]”

Following this reasoning, the Texas Court mandated the parties figure the value of my client’s downline, and ordered that my client not be deprived of that sum in the event she prevailed in proving liability. Ultimately, we were able to reach a favorable settlement without having resorting to the value of my client’s downline.

Keep in mind this was a Texas court, and a different result may arise depending on the applicable jurisdiction. With that being said, I believe it is important for both companies and distributors be cognizant of the following to avoid issues with this type of provision:

Companies

  1. If you intend to enforce the damages limitation provision as a whole, do not make representations that the distributor’s downline organization is a business that he or she owns, or that it will lead to a new lifestyle where the distributor can simply live off of his or her residual income. Avoiding these types of representation will allow the company to have a better argument that the distributor was not mislead in believing that they could receive the value of their downline regardless of the provision.
  2. Make the damages limitation provision conspicuous, in bold face, and in caps. It is recommended that it appear at the very beginning of the company’s Policies & Procedures if possible. This way the distributor cannot argue that they were not aware of the provision when they signed up.
  3. Incorporate the damages limitation provision in places other than the Policies & Procedures, such as the online sign-up process to enroll as a distributor. This will also hinder the distributor’s ability to argue they were not aware of the provision.

Distributors

  1. READ THE POLICIES & PROCEDURES!!!! If you don’t like what you see you can easily opt out and choose another MLM company.
  2. If you signed up under the “MLM Promise,” be sure to inform your attorney of this, as this would allow them to argue against the enforceability of the damages limitation provision.
  3. Always check amendments to Policies & Procedures. If the company happens to slip the provision in after your signed up, you will have an argument that the provision is unconscionable. Be sure to inform you attorney of this.