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Official Gazette

Tuesday, October 22, 2019

Traps for the unwary: protecting consumers from multi-level marketing schemes

Updated: 10:32’ - 27/07/2010

Tran Si Vy[1] & Alex Thomas Larkin[2]

Multi-Level Marketing (“MLM”) has long been a popular business activity in developed countries and has been the subject of constantly-evolving schemes to take unfair advantage of unwary participants. MLM enterprises have, in recent years, found fertile ground for their schemes in Vietnam. With its large population, rapidly-increasing affluence, and strong entrepreneurial spirit, Vietnam has become a prime target for MLM enterprises. Countless Vietnamese aspiring businesspeople have fallen prey to the latest dubious developments in MLM schemes, and the advancement of legal protections for MLM participants in Vietnam has failed to keep pace with the MLM enterprises’ savvy in exploiting legal loopholes.

This article is not intended to disparage the entire MLM industry or to imply that all MLM enterprises pursue the schemes discussed here. Conceptually, employing multiple levels of marketing with individual participants pushing products and services at a localized level, is a meritorious business model. Rather, this article seeks to shed light on particular MLM activities designed to take unfair advantage of trusting individuals deceived into believing they have discovered an opportunity to achieve financial independence.

As discussed further below, Vietnam has adopted laws regulating MLM, and such laws generally address prior MLM schemes which were the subject of substantial litigation and lawmaking during recent decades in other countries. Vietnam should, however, adopt a broader-reaching legal framework for the protection of consumers and to allow for strong legal recourse against MLM enterprises that unfairly push the boundaries of statutory law.

The Legally-Turbulent History of Multi-Level Marketing

Perhaps no country has a longer and more sordid history with MLM schemes than the United States. MLM experienced its first real boom in the United States during the 1970s, with such direct selling icons as Amway and Tupperware. The United States Federal Trade Commission (“FTC”), and other law enforcement agencies, have expended considerable effort to distinguish legitimate direct marketing enterprises from illegal pyramid schemes and pursuing legal action to protect MLM participants. An illegal pyramid scheme is a distribution scheme in which a participant pays for the chance to receive compensation for introducing new persons to the scheme, as well as for when those new persons themselves introduce participants.[3] While purporting to focus on the sale of goods or services, pyramid schemes actually rely on recruitment of new participants as the primary basis for compensation. 

Ms. Debra A. Valentine, General Counsel for the FTC, has stated that: “There are two tell-tale signs that a product is simply being used to disguise a pyramid scheme: inventory loading and a lack of retail sales.”[4] Inventory loading occurs when a company’s incentive program forces recruits to buy more products than they can reasonably be expected to sell. When this happens, the people at the top of the pyramid receive substantial bonuses for the sale of inventory, despite the fact that the inventory is not being sold on the open market. Rather, the inventory is being purchased by the MLM participants themselves to satisfy certain sales requirements called for in their participation contracts. All too often, the products are of poor quality and are overpriced, leaving participants with inventory they cannot move.

The FTC and the United States federal courts eventually adopted a test for determining whether a marketing enterprise is an illegal pyramid scheme.[5] The test, known as the “Amway safeguards”, comprises three parts: (1) The 90% buy-back, which requires participants to buy back, from any person they recruited, all saleable, unsold inventory upon the recruit’s departure from the enterprise at a price not less than 90% of the recruit’s original purchase price; (2) The 70% rule, which requires every participant to re-sell at least 70% of the products bought in a given month in order to receive a bonus for that month; and (3) The 10 customer rule, which requires each participant to submit proof of retail sales made to ten different consumers in order to receive a bonus for that month.  If an enterprise has procedures in place to comply with these safeguards and actually enforces those procedures, it is a legitimate direct marketing enterprise and not an illegal pyramid scheme.

The overall goal of these safeguards is to ensure that direct marketing enterprises encourage their participants to focus on the sale of goods or services to actual consumers, rather than on recruitment of new participants and rather than participants purchasing inventory themselves for which there is no real demand. 

Existing Regulations on Multi-Level Marketing

In developing a regulatory framework in the area of MLM, Vietnam has essentially adopted the Amway safeguards described above and has in fact taken further steps to make sure that direct marketing enterprises remain focused on the sale of goods rather than on multiple layers of recruitment.

MLM activities were first introduced to Vietnam in 1998.[6] These activities stirred an overwhelming interest by participants, prompting the government to adopt regulations to curb possible abuses by MLM enterprises. Specifically, 2005 saw the enactment of the Law on Competition (“LOC”) and Decree 110/2005/ND-CP, dated August 24, 2005 (“Decree 110”). Clause 1, Article 3 of Decree 110 and Clause 11, Article 3 of the LOC, define MLM activity as follows:

“Multi-level selling of goods means a marketing method in order to conduct a retail sale of goods which satisfies the following conditions:

(a)   Marketing in order to conduct a retail sale of goods is implemented via a network of participants comprising a number of different levels and branches;

(b)   A participant markets goods directly to a consumer at the residence or working location of the consumer or at some other place which is not the regular retail sales location of the enterprise or participant;

(c)   A participant in the network for multi-level selling of goods will receive commissions, bonuses or other economic benefits from the results of marketing sales of goods by himself or herself and by other persons below the participant in the network organized by such participant and approved by the enterprise engaged in multi-level selling of goods.”

Clause 2, Article 5 of Decree 110 further provides that goods to be offered for sale by an MLM enterprise or by its participants must satisfy legal standards for quality, safety, and hygiene, must clearly identify the source, country of origin, function and use of the goods, and must correctly label the goods in accordance with law.

Article 48 of the LOC and Article 7 of Decree 110 both explicitly prohibit enterprises from paying any participant commissions, bonuses, or other economic benefits in exchange for the participant enticing other persons to participate in the marketing enterprise. While enterprises themselves are permitted to aggressively recruit new participants, there can be no direct economic incentive for participants to recruit.

In addition to prohibiting compensation for recruitment of new participants, the Vietnamese regulatory framework includes a number of other important restrictions on MLM. Enterprises may not require participants to pay a deposit, purchase an initial quantity of goods, or pay any amount of money in exchange for having the right to participate in the MLM enterprise.[7] Enterprises must buy back goods, from a participant whose contract has terminated, at a purchase price of at least 90% of the original selling price, so long as the goods are resalable and no more than 30 days have passed since the date the participant received the goods.[8]

Further protections for participants provided for in Article 7 of Decree 110 include prohibitions against enterprises from providing untruthful information about the benefits of participation in the MLM enterprise and from providing false information about the nature and use of the goods.

In adopting Article 48 of the LOC and Decree 110, Vietnamese lawmakers have clearly anticipated, and attempted to prevent, common abuses by MLM enterprises in taking unfair advantage of MLM participants. The legal framework of Vietnam indicates a strong preference for compensation based on the actual sale of goods rather than on recruitment. To its credit, Vietnam appears to have pre-empted the pyramid scheme issue.

What was not anticipated, however, was the ability of diabolical MLM enterprises to identify legal loopholes and to innovate new schemes to cheat eager and trusting participants.

The Two-Contract Loophole

As discussed above, the Vietnamese legal framework pertaining to MLM, as set forth in Article 48 of the LOC and in Decree 110, expressly prohibits any requirement that a participant purchase an initial quantity of goods in order to “participate in the multi-level selling of goods.” To get around this restriction, MLM enterprises have devised a clever “two-contract” scheme. New participants are presented with two separate contracts. The first is a “Marketing Contract” and the second is a “Purchase Contract.” The deceptive intention of the enterprise is for the Marketing Contract to be the sole contract subject to the legal framework on MLM, while the Purchase Contract remains a separate and distinct contract which is in no way related to the MLM operation. This distinction, however, is not presented clearly to the participant. The Marketing Contract includes all of the required promises and obligations as set forth in the LOC and Decree 110, while the Purchase Contract merely obligates the participant to purchase a certain type and quantity of goods from the MLM enterprise.

The unsuspecting participant has no reason to distinguish the two documents as separate and distinct contracts, and likely thinks nothing of signing more than once. The enterprise views the Marketing Contract as the only contract related to the MLM operation. That contract does not include any obligation to purchase goods as a pre-condition or condition precedent to participating in the MLM activity. The Purchase Contract, however, not only obligates the participant to purchases goods from the MLM enterprise, but invariably includes a no-return provision stating that the goods cannot be returned under any circumstances. The Purchase Contract creates precisely the obligation of the participant to purchase goods that the LOC and Decree 110 seek to prohibit.

The two contracts should be interpreted legally as a single contract, since the MLM enterprises typically will not allow a participant to enter into the Marketing Contract unless the participant simultaneously agrees to the Purchase Contract as well. Legally speaking, entering into the Purchase Contract and actually making the initial purchase of goods, is a condition precedent to allowing the participant to engage in marketing activities for the enterprise. The enterprise should not be permitted to change the spirit of the parties’ intentions merely by decoupling the requirement to make an initial purchase of goods and labeling it as a separate contract. The two contracts are inextricably intertwined and one is really just one provision of the other. It is likely that the MLM enterprises have chosen to employ this two-contract scheme in Vietnam because it is not clear how the courts of Vietnam would construe the contracts and because many potential participants lack the legal savvy to recognize the potential risk of entering into the contractual arrangement presented by the enterprise. Additionally, Vietnamese people are generally not comfortable with litigation and MLM enterprises recognize the very low likelihood of legal action being asserted against them.

To the outsider, the amount of money paid by the participant to the enterprise under the terms of the Purchase Contract may appear to be a relatively small amount of money, typically on the order of around VND five million (USD 275). To the participant, however, such an “investment” is a substantial expense, often constituting more than two-month’s salary in the line of work they believe MLM will liberate them from. In fact, many participants actually borrow money from friends and relatives in order to make the required payment.

At the time of the initial purchase of goods from the enterprise, the participant has every reason to believe he or she will make that money back many times over by selling the goods at a significant profit margin. It is only after receiving the goods, and beginning marketing efforts in earnest, that the participant begins to have cause for concern. The participant soon realizes that the price paid to the enterprise for the goods was exorbitant and that consumers can purchase superior goods at a lower price on the open market. Other than a few naïve consumers and the occasional family member or friend who may be willing to lend a compassionate hand, the participant simply cannot find buyers for the over-priced goods.

In addition to the market barrier created by their high cost, the goods purchased from the MLM enterprise are very often of substandard quality and of unknown or questionable origin. The participant is not only left with a stockpile of poor-quality, high-priced product for which there is no real market, but he or she is also faced with the embarrassing situation of having been swindled into pre-paying for the goods, often with borrowed money. At this point, the participant may choose to suffer in silence and accept the loss of the money they paid to the enterprise for the goods, or he or she may pursue some kind of legal recourse.

Limited Legal and Contractual Recourse for the Participant

Having come to realize that the goods purchased have no market, the participant often approaches the enterprise seeking to terminate “the contract” and to request that the enterprise buy-back the goods pursuant to the terms of the Marketing Contract. It is at this point that the enterprise explains to the participant that the purchase of goods did not occur under the Marketing Contract, which in fact includes the legally-required buy-back provision. Rather, the goods were purchased under the separate and distinct Purchase Contract which does not include any such provision.

Certainly, the enterprise typically has no objection to the participant’s desire to terminate the contract. The enterprise is happy to walk away from its relationship with the participant having received full payment for the grossly-overpriced goods, with no contractual obligation to buy them back.

The participant, obviously feeling cheated, may look to Vietnam’s judicial system for potential legal recourse. Under the existing legal framework, however, the participant finds no legitimate opportunity for justice. The Civil Code, and other laws, certainly allows for someone in the participant’s position to file a lawsuit against the enterprise, asserting various causes of action. Such a course of action, however, is entirely impractical as the amount of money at issue simply cannot justify the legal fees and costs associated with a lawsuit.

Practically speaking, the participants’ legal options are quite limited. Pursuing legal action in the civil courts against the enterprise is simply not feasible, given the small amount of money at issue. 

Recommendations and Conclusions

In many western jurisdictions, such as the United States, legal action of this sort would likely be the subject of a particular type of lawsuit known as a “class action lawsuit.” A class action lawsuit is one in which the plaintiffs consist of a large group of persons having essentially the same claim against the defendants. The plaintiff class is typically represented by one, or by a few, individuals who take an active role in prosecuting the case. Generally, for a court to allow a civil action to go forward as a class action, the plaintiffs must show: (1) that the number of individual plaintiffs is so large as to make individual lawsuits impracticable; (2) that there are common legal or factual questions as to all plaintiffs; (3) that the claims asserted by the plaintiffs are the same; and (4) that the interests of the plaintiffs will be adequately represented.

Nearly all class action lawsuits are handled by lawyers on a contingency fee arrangement, where the law firm representing the plaintiff class receives a percentage (typically 35%) of any judgment ultimately awarded, and receives nothing if no judgment is awarded.

In the “two-contract” MLM scheme described in this article, there are likely thousands of potential plaintiffs. There may even be tens of thousands or more, with the total defrauded amount in millions of US dollars. Such a situation is well-suited for a class action lawsuit. Vietnam’s current legal framework does not provide a clear path to a civil class action lawsuit. While the Civil Code and Civil Procedure Code do not preclude such legal action, they also do not provide a clear framework for one.[9] Likewise, the concept of a class action lawsuit has not been tested in the courts of Vietnam. There is no precedent upon which to rely. Without a more clearly-defined legal framework for class action lawsuits, there is little incentive for plaintiffs to organize themselves into a class or for lawyers to take such a case on a contingency fee arrangement.

In addition to class action lawsuits, private citizens in most western jurisdictions also have the benefit of specific consumer protection legislation. Such legislation usually includes the possibility of punitive damages, designed to punish the defendant by including damages in the judgment above the actual damages sustained by the plaintiff. Consumer protection legislation normally includes provisions for the plaintiff to recover their legal fees and costs if they prevail in the lawsuit. By allowing an award of punitive damages and by allowing for recovery of legal fees and costs, plaintiffs have an incentive to pursue legal action even where the amount of money actually lost is limited.

The Decree on handling of administrative violations in the competition domain[10] and the LOC provide some limited opportunity for MLM participants to pursue legal action against enterprises. The overall legal framework to address the type of wrongdoing committed by the MLM enterprises described in this article is simply inadequate to protect consumers.

The Law on Consumer Protection, expected to be adopted later this year, is an excellent opportunity for Vietnam to put forth a legal framework to address the types of issues discussed here. Relevant governmental authorities should seize this opportunity to create a powerful legal framework for the protection of consumers, by including a clear path for class action lawsuits as well as specific consumer protection provisions.

Not only would such regulation discourage the continuation of current MLM schemes, but could, if drafted well, go far in protecting consumers in many respects from other fraudulent and deceptive business practices. Once an appropriate legal framework is in place, presumably with the adoption of the Law on Consumer Protection this year, Vietnam should endeavor to educate the public about consumer rights, including the right to pursue legal action in the courts. Such legal protections will encourage the entrepreneurialism and financial risk-taking necessary to advance the nation’s economy and achieve true financial independence for Vietnamese citizens.-



[1] Associate Attorney-at-Law; (Leadco Legal Counsel, Hanoi, Vietnam); LL.M (International Law, Transnational Law & Business University, Seoul, Korea, 2009); B.A. (Economic Law, Hanoi Law University, 2005).

[2] Senior Associate Attorney-at-Law; (Leadco Legal Counsel, Hanoi, Vietnam); Juris Doctor (Seattle University School of Law, Seattle, Washington, USA, 2005); B.S. (Mechanical Engineering, University of Washington, Seattle, Washington, USA, 1995).

 

[3] Black’s Law Dictionary, Seventh Edition.

[4] Prepared Statement of Debra A. Valentine, General Counsel for the U.S. Federal Trade Commission on “Pyramid Schemes”, presented at the International Monetary Fund’s Seminar on Current Legal Issues Affecting Central Banks, Washington, D.C., May 13, 1998.

[5] In re Amway Corp., 93 F.T.C. 618 (1979), Webster v. Omnitrition, 79 F.3d 776 (9th Cir. 1996).

[6] MLM in Vietnam: practices and recommendations - Research Report, Trade & Business Information Centre, Young Business Association of Hanoi (2008).

[7] See the Law on Competition, Clause 1, Article 48 (2005).

[8]  See the Law on Competition, Clause 2, Article 48, and Decree 110/2005/ND-CP, Clause 1, Article 11.

[9] See the Civil Procedure Code, Article 38 for ability of the courts to consolidate similar civil cases.

[10] See Decree 120/2005/ND-CP.

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