Guest author Jeffrey A. Babener is the principal attorney in the law firm of Babener & Associates. As a law firm, Babener & Associates also serves as an important and informed resource on the direct selling industry. For more than 25 years, he has advised leading U.S. and foreign companies in the direct selling industry, including many members of the Direct Selling Association. He has lectured and published extensively on direct selling. Jeffrey is a graduate of the University of Southern California Law School.
Guest Post by Jeff Babener
BurnLounge Decision: Window of Opportunity for FTC and Industry
Perhaps the Glass is Half Full Rather than Half Empty…
In the aftermath of the seminal Burnlounge Appeal Decision (FTC v. Burnlounge, June 2, 2014, U.S. Court of Appeals, Ninth Circuit), the combatants retreated to their respective corners. The FTC claimed victory, as it should have, because the Appeals Court affirmed its lower court victory. However, the direct selling industry applauded the Appeals Court recognition that “personal use” purchases by distributors are, in reasonable amounts, legitimate sales to “ultimate users”, quite the opposite of the FTC litigation position for more than a decade, including its rejected legal position in the BurnLounge case.
Contrary to the polarization that could set in between the FTC and the industry, perhaps the decision provides the window of opportunity for a consensus position between the two. And that consensus could turn on an out of court position of the FTC in a 2004 Advisory Opinion to the Direct Selling Association, which recognized the legitimacy of distributor “internal consumption”. Its Advisory position is quite at odds with its “in court” litigation position (rejected by the Ninth Circuit) that distributor personal use purchases should not count in pyramid analysis.
And if the FTC follows the BurnLounge Court and its 2004 “out of court” position on personal use, it will find itself quite in sync with the direct selling industry as well.
The Importance of the BurnLounge Appeal Decision
The BurnLounge decision will become a guiding legal precedent in the direct selling field and will become known for several significant legal signals, including the following:
(1) The operative facts of the BurnLounge program made it a pyramid scheme, primarily because of forced purchase of product to qualify for MLM recruiting rewards followed by recruitment of others to do the same.
(2) The court ended a multi-decade legal debate on “personal use,” in which it recognized that “personal use” of product/service by distributors as a legitimate end destination for product/service in which distributors are accepted as “ultimate users” under a long line of cases that differentiates pyramid v. legitimate direct selling based on an analysis of whether or not program rewards are “unrelated to sales to ultimate users.”
(3) The court established a going forward pyramid test that is fact-driven, and which balances whether distributor payments and commissions are driven by recruitment, on the one hand, or sales to ultimate users on the other hand, i.e., are distributor product/service purchases primarily for the purpose of qualifying for rewards in the MLM opportunity, and therefore incidental to the business opportunity.
In the simplest and most blunt terms, the bottom line question is: When distributors pay money or “buy”: What do they pay and why do they pay it?
A Modest Proposal for Reconciliation between the FTC and the Direct Selling Industry
The time may be appropriate for a joint federal legislative effort of the direct selling industry and the FTC. For a starting draft discussion, it is submitted that the following model pyramid language, incorporating the BurnLounge Ninth Circuit discussion on personal use, might serve as a synthesis of trending state legislation, the 2004 FTC staff advisory, the direct selling industry position and the reasoning set forth in various federal and state court opinions:
Pyramid Scheme means a program in which participants pay money or valuable consideration that is primarily motivated to obtain the right to receive rewards for recruiting other participants into the program, and those rewards are unrelated to the sale of products or services to ultimate users. A prohibited pyramid payment, or consideration, does not include payment for non-commissionable not for profit or at cost sales and marketing materials support. For purposes of this definition, sale of products or services to ultimate users include sales to participants, in reasonable amounts, for actual personal or family use in which purchases are not merely incidental to the business opportunity.
The adoption of such “reconciliation” language would provide a great service to the direct selling industry and its distributors and customers to avoid the continuing rehash of whether or not such businesses are legitimate or pyramid schemes.
For a more detailed analysis of BurnLounge case by Jeffrey A. Babener, please click here.