Many times we receive calls from our MLM clients asking what can be done when a former distributor is poaching or cross-recruiting distributors to participate in his or her new MLM company. We will assume that the former distributor has already been terminated or resigned from the original MLM company.
This article will discuss the options a MLM company has and the strategies that should be considered when dealing with a poaching situation.
1. The Distributor List as a Trade Secret.
The best and most straight forward way for a MLM company to prevent poaching is to ensure that its list of distributors is deemed a trade secret of the company. As a trade secret, the distributor list is entitled to protection under the Uniform Trade Secret Act. Any actual or even threatened use by a former distributor of the list (or any form of it) to solicit or recruit the distributors would be unlawful under the Uniform Trade Secret Act. The Uniform Trade Secret Act has, as of the date of this article, been adopted in forty-six states. Only Massachusetts, New York, North Carolina, and Texas as well as the District of Colombia and the U.S Virgin Islands have not enacted the Act. The Act will entitle the MLM company to an injunction prohibiting any use of the list to solicit or recruit –and at times from even contacting—distributors. The injunction will also in most cases order the former distributor to return to the company any lists that the former distributor has in his or her possession, custody or control. In addition, the Act will allow the MLM company to recover damages for any prior use of the list. Damages can be large and are generally the loss profits that the company can demonstrate were caused by the former distributor’s poaching activities. In certain instances, violation of the Uniform Trade Secret Act may allow the company to recover attorney’s fees against the offending former distributor.
We have found that the prospect of litigation, along with the expenses involved, will often be enough to prevent the former distributor from poaching. Therefore, at the first sign of conduct by a former distributor of soliciting or cross-recruiting, the company should immediately send out a strong cease and desist demand letter. The demand should be clear that the company will file litigation and seek an injunction and damages against the former distributor unless the former distributor provides written assurances that it will not engage in any further such activity and will immediately return any company documents that he or she has.
If the demand letter does not do the job (which is often the case), then the company must be prepared to file litigation. Upon filing a complaint against the former distributor, the company should immediately request a temporary restraining order (“TRO”) from the court. A TRO is an emergency injunction prohibiting the former distributor from using the company’s trade secrets. We have found that prevailing on the TRO request will often result in ending the former distributor’s efforts to poach. However, losing the TRO may have the opposite effect of empowering the former distributor that he and she can go ahead and poach with impunity. Therefore, it is essential that if a decision is made to go ahead with a request for the TRO, that the company is in a position to win the TRO. This means that the company must have assembled sufficient evidence to convince a judge that the TRO should be granted. This evidence is usually in the form of declarations from other existing distributors that the former distributor has been contacting him or her in an effort to recruit him or her to the new MLM company. The rule is that without proper evidence, the TRO should not be attempted.
Whether or not the TRO is attempted, the company must move ahead to obtain the evidence necessary to prevail on its trade secret claim. This can be an expensive affair, but will also be expensive for the former distributor. As the evidence is developed and the company’s case strengthens, the former distributor’s ability to continue the poaching becomes less and less. In the overwhelming number of cases that we have litigated, once the evidence is sufficiently developed, the former distributor usually has no choice but to stop his or her poaching activity. However, even when the former distributor agrees to stop poaching, the company should not settle the case unless the stoppage is backed by a stipulated injunction whereby the former distributor is under a court order to stop his or her offending activities. By having a court ordered stoppage, the MLM company has the power of contempt against the former distributor if he or she should violate the order. Furthermore, by settling the case based on a stoppage of the offending activity only, the company will be giving up its rights to damages which many times can be significant. Therefore, before settling the company should perform an analysis as to whether it would be able to collect on an eventual monetary judgment. If so, the settlement should include a payment of money to the company as well.
Finally, in some states the assertion of a trade secret claim will pre-empt (i.e. prevent) other types of claims. In general, in some states, if a trade secret claim is brought, then any other claims that arise from the same set of facts cannot also be brought.
2. Breach of Contract by the Former Distributor.
Almost all MLM companies have agreements with their distributors. These are in the form of a written distributor agreement as well as the Policies & Procedures which are made applicable to the distributors through the distributor agreement. Many times, the agreements have language that prohibit the distributor from contacting, soliciting or recruiting distributors of the company for a period of time after the former distributor leaves the company. To the extent that these subsequent covenants not to compete are enforceable, the company can bring a breach of contract action against the former distributor.
The problem is that, in many states, these types of covenants not to compete are considered unenforceable restraints on trade. For example, in California a covenant not to compete, except under very limited circumstances, are deemed by statute to be per se void. In other states, before a court will enforce the covenant, the MLM company must demonstrate that the covenant is reasonable both as to its scope, time and geographical limits. Furthermore, enforcing these covenants under a breach of contract theory may be problematic as there are questions as to whether such covenants are supported by adequate consideration and whether the distributor had adequate and informed notice of such covenants. Also because monetary damages are usually considered adequate in a breach of contract claim, many judges will be reluctant to grant a TRO or other injunctive relief based on a breach of contract claim. Because of these unknowns regarding the MLM company’s contractual rights, we have found that the better course of action to pursue a poacher is to pursue a trade secret claim.
3. A Claim of Interference by the Former Distributor.
Existing distributors have a contractual relationship with the MLM company. If the former distributor knows of this contractual relationship and seeks to entice the distributor to terminate his or her contractual relationship, then the former distributor can be held liable for interference with contractual relationships. One hurdle in such a claim is to show that the former distributor knew of the contractual relationship between the distributor and the MLM company. If the distributors are being introduced, for instance, by third parties to the former distributor it may be difficult to prove this knowledge. Even more problematic is that fact that most MLM companies have agreements with their distributors that allow the distributor to terminate at will. The legal result of this may make it much more difficult to prove an interference claim. In such situations the courts may require the MLM company to show that the former distributor is engaging in wrongful conduct independent of the contractual interference such as using defamation to entice the distributors to terminate their contracts. Proving such independent wrongs will generally greatly complicate the case.
4. The Applicable Law Varies From State to State.
Before pursuing a former distributor, the MLM company should research the law applicable to that former distributor. Under our system every state is considered its own sovereign power, and has the right to enact its own laws. Even though there may be many similarities in the laws of states, there may also be crucial differences. For example, other states may not have the same type of per se restrictions against covenants not to compete that California has placed on such covenants. Only after understanding the law of the state involved is a MLM Company in a position to pursue its remedies.
The conduct of a former distributor in cross-recruiting existing distributors can have a devastating effect on the MLM company. The company should be vigilant in monitoring such activities and be prepared to take action to prevent such activity. Taking a proper course of action from the beginning will pay dividends many times over in the prevention of loses to the company.