Friday, January 3, 2014

Direct Selling Industry in India: Legal Issues and Challenges

Last month, I was reading a news-report wherein it was mentioned that the direct selling sector has registered a growth of 12.2% in financial year 2012-13. I was not surprised. Having spent quite some time in reading about the sector, I was sure that direct selling industry has a promising future. But then, there was a question that I asked to myself - whether there is a suitable legal regime which can protect the continuous growth of direct selling industry in India? To answer this question effectively, both for me and readers, I decided to write this post.

I will try to explain following key points pertaining to the existence of direct selling industry:

(i)            What actually a ‘Direct Selling’ Industry is? How is it different from other modes of selling?
(ii)          Whether Indian legal regime protects direct selling industry? What are the legal issues and challenges?
(iii)         What are the solutions which have until now been offered?


What is Direct Selling?

According to Black’s Law Dictionary (9th Ed.), ‘direct’ means straight, undeviating etc. and ‘sell’ means to transfer (property) by sale.[1]In other words, a sale, which is channelled through a straight or undeviating medium, can be considered as direct selling. For instance, presence of a buyer and a seller would be sufficient to constitute this undeviating sale or direct selling. The presence of ordinary retail shop, which one usually comes across, is not required. In retail trading, retail shop act as a part of supply chain between the seller and the buyer and is distinct from direct selling.

For the sake of convenience, let me now refer to the explanation as provided by Indian Direct Selling Association (“IDSA”), an autonomous and self-regulatory body for direct selling industry in India. According to IDSA, ‘Direct Selling’ can be understood as:


“.....marketing of consumer products/services directly to the consumers generally in their homes or the homes of others, at their workplace and other places away from permanent retail locations, usually through explanation or demonstration of the products by a direct seller.”

The above definition, as provided by IDSA, focuses on the mode which the sale of products/services takes place in. In direct selling, instead of permanent retail shops, the sale takes place at the residence, office etc. of the consumer. To make this function, the manufacturer would require sellers to sell the products. Direct selling companies recruits ‘direct sellers’, remuneration of whom is dependent on the number of products they sell.

In report titled ‘Direct Selling in India: Appropriate Legislation is the key” (2013), authored by Prof. Bibek Debroy for FICCI and Indicus Analytics, it has explained that no unambiguous definition of the term can be found. However, the report has also explained three kinds of definition which one can refer to, (i) statistical definition; (ii) definition provided by associations (e.g., IDSA), and (iii) definition provided in a specific legislation.

Among the statistical definitions, the report has referred to the classification of products as provided under United Nations Central Product Classification (UNCPC) and National Industrial Classification (NIC). Under UNCPC, sub-division 624 of division 62 includes ‘other non-store retail trade services’. While the report intends to refer sub-divisions 623, 624 and 625 as residual categories thereby including ‘direct selling’, an article cited in the same report seeks to equate direct selling with code sub-division 624.[2]So far as NIC is concerned, ‘group 479’ of division 47 provides for ‘retail trade not in stores, stalls or markets’. As provided in the report, group 479 can be considered as a residual category thereby including direct selling.

Even second category of definitions, which includes definitions provided by the associations such as IDSA (already mentioned in the post), are not sufficient to define the scope of direct selling industry in India. And the third kind of definition, i.e. legislative definition, there is none in India.

Contending that the definition of direct selling has usually been misunderstood, it has been argued that a better understanding of the industry would require one to view it from three perspectives, i.e., (i) operational; (ii) tactical and (iii) strategic.[3]So far as operational perspective is concerned, it has been said that direct selling is an interpersonal communication between two individuals. On the other hand, tactical perspective means the way of organising sales activities and selling function. This requires one to consider factors such as type of direct sellers recruited, whether selling is multi-level or single-level, manner of delivering purchased products etc. The last and the third perspective, i.e., strategic, can be understood as a means of doing business or means to gain market access.

As we move forward, it should be kept in mind that it is usually the ‘tactical’ perspective which creates problem. That is, the problem usually arises for direct selling companies that adopt Multi-Level Marketing model. This will become clearer in the next part.


Marketing Approaches: Single-Level and Multi-Level

For the practical implementation of direct selling, a company has the option to adopt both Single-Level Marketing (“SLM”) and Multi-Level Marketing (“MLM”) business models. So far as SLM is concerned, sellers are rewarded only for the sale which they personally make. That is, sellers are not remunerated for sales made by other sellers they may recruit.

The limitation of this model is apparent. For a seller, the incentive is restricted to the sales which he personally makes. With ever increasing competition and need of a more efficient business model, SLM model may or may not work. If the company is able to recruit enough sellers, it may be efficient. For this, the company would have to invest both time and money in comparatively larger quantities. Contrary to this, the work of a company becomes much more efficient and easier when the task of recruiting further sellers is also delegated to the sellers themselves. It is at this stage that the importance of MLM needs to be emphasised.

MLM is a marketing model. In this marketing model, the party which recruits another party is ‘upline’ of the recruit and the recruited party/person is the ‘downline’ of the recruiter. Depending on the nature of reward which the MLM model provides to the recruiting party, an MLM can be both legal and illegal.

In a legal MLM model, a seller, apart from receiving rewards for the sales personally made by him, is also for the sales made by the persons recruited by him. However, there can also be an illegal MLM model where participants are rewarded out of theinvestment’ and not sale made by the new participants. Schemes based on pyramid structures exhibit these qualities and are usually illegal. So far as direct selling companies are concerned, theyadopt the former model so that their businesses can be considered as legal.

For the purpose of a legal direct selling business, MLM is a ‘compensation plan’ wherein the person is rewarded not only for the sales personally made by him but also for the sales made by the persons he recruits (‘downline’). In 1945, for the first time, MLM model was implemented by Dr. Carl F. Rehnborg, founder of Nutrilite Brad, for marketing nutrition products (The ownership of Nutrilite Brand was later acquired by the popular Amway Company). The MLM model, which turned to be a success, was subsequently adopted by a number of direct selling companies and today forms the basis of dispute in many jurisdictions.

Pyramid schemes, ponzi schemes etc. frequently use MLM as their business models. Often, it becomes very difficult of identify whether a particular business, that uses MLM compensation plan, is legal or not.

Pyramid schemes and ponzi schemes, though share some similarities, can nonetheless be distinguished. In both these schemes, the investor is promised return out of the money paid by new investors. While in ponzi scheme, an investor is not actively involved after making an investment, in pyramid scheme, the investor is required to recruit new investors to the scheme. In ponzi scheme, the ‘principal operator’ manages the scheme and provides return to the investor but in a pyramid scheme, return of the initial investor is dependent on the new participants recruited by him.

As mentioned earlier, in a legal MLM, the source of reward is not the investment of new participant but the sale made by him. For example, in the MLM model adopted by Amway, the seller, apart from his personal sales, would be rewarded on the basis of sales made by his ‘donwline’ recruits and not out of investment of ‘donwline’ recruits.


Indian Legal Regime: Multi-level Marketing, Pyramid Schemes and Direct Selling – Where does the Problem Lie?

Last year, Kerala Police arrested CEO and two directors of Amway India. Not very surprisingly, the arrest was met with huge criticism from the institutions associated with direct selling industry. IDSA described the arrest as a ‘big blow’ to the functioning of the industry in India. This was not the first time when the employees of direct selling companies had to face criminal charges. This not only frustrates the morale of the companies but also adversely affects the growth of the industry. Where does the problem lie?

In India, there is no single legislation that sufficiently addresses the issues related to direct selling industry. In fact, there is no single nodal ministry that regulates the industry. Three different government departments – Department of Corporate Affairs, Department of Financial Services and Department of Consumer Affairs – are working to deal with the regulatory issues of direct selling industry. The reason is simple – direct selling industry affects the subject matters which each of the three departments are concerned with. The problem of unsystematic administration does not end here. Yet another problem arises when one tries to identify the government that is competent to deal with the issue. That is, whether state government(s) or the central government is competent to enact the legislation for direct selling industry?

According to an inter-ministerial group, the subject concerning MLM companies relates to state government and state police. Consequently, a central legislation has been ruled out by the government. In fact, the government is planning to give more powers to State Level Coordination Committees (SLCCs). The ministerial group had further observed that the impugned issues can be dealt under Prize Chits and Money Circulation Schemes (Banning) Act, 1978 (“Prize Chit Act”), Indian Contract Act, 1872, Sales of Goods Act, 1930 and Consumer Protection Act, 1986.

Last year, Union Minister of State (Ministry of Corporate Affairs), Sachin Pilot, urged Department of Consumer Affairs (DCA) to frame guidelines for direct selling industry. However, DCA vary of framing such guidelines since Department of Financial Services (DFS) had already taken up the task to amend Prize Chit Act. Unless this issue of fragmented administration is not resolved, problems will be there.

To deal with the issue of direct selling, a few Inter-Ministerial Groups (IMG)/Committees have been formed. The IMG, formed in 2012 by DCA and headed by Rajiv Agarwal, considered issues such as the need of legislation for MLM companies, appropriate amendment of Prize Chit Act etc. Draft model of The Money Circulation Scheme (Banning) Rules, 2012 was also framed. In the wake of Sharada scam, another IMG was formed to curb fraudulent money pooling activities. Establishment of these IMGs shows that government has been trying to solve the issue but it has yet to been seen whether a positive outcome can come out of the conclusions drawn by these IMGs.

While framing guidelines, one of the main problems arises when one tries to distinguish between genuine direct selling company and a fraudulent company using MLM structure. Under the guise of selling a product or service, there can be existence of an illegal MLM structure. Because of this difficulty in distinguishing the two, employees of genuine direct selling companies have faced criminal charges under Prize Chit Act. The Prize Chit Act does not exactly deal with direct selling industry. Rather, it deals with the issues concerning ‘money circulation scheme’ and ‘Prize Chit’. In the Act, there is no definition of both the direct selling and MLM structure. The applicability of the Act to direct selling company arises when the latter, operating under MLM structure, invites the elements of ‘money circulation scheme’.

In State of West Bengal v. Swapan Das Gupta (1982) 1 SCC 561, Supreme Court of India (“Supreme Court”) clarified as to what can be brought under the ambit of a money circulation scheme. It was held that “to be money circulation scheme, a scheme must be for the making of quick or easy money on any event or contingency relative or applicable to the enrollment of the members into the scheme.” In other words, the reward is dependent upon the enrolment of members into the scheme and not on the sales, as is the case in direct selling.

In India, there are some states in India which have already come out with rules for direct selling industry. For instance, Kerala Government had introduced guidelines for direct selling activities. But, following the arrest of Amway India’s CEO and directors in Kerala, some companies have started cutting down their direct selling business in the state. Similarly, Rajasthan had also issued guidelines for the activities direct selling industries. Though welcomed, these guidelines have not been able to effectively regulate the industry.


Are there any solutions?

In the FICCI report, authored by Prof. Bibek Debroy, two solutions have been offered. According to the second best solution, amendments can be made to the Prize Chit Act. The definitions of ‘Direct Selling’ and ‘Multi-Level Marketing’, which are currently absent, should be defined under the Act. This may help in distinguishing the genuine direct selling activity from money circular schemes. Apart from this, the solution envisages an explanation whereby it should be made clear that direct selling should not be interpreted as a money circulation scheme and there should also be a definition of ‘pyramid schemes’. In addition to amend Prize Chit Act, the report has also envisaged the amendment of Consumer Protection Act.

According to the first best solution, FICCI report emphasises on a separate piece of legislation, as is done in some other countries. The legislation can cover issues such as licensing cum registration system for direct sellers, restrictions on collecting money, prohibition on certain products etc. Understanding that registration system has not been a great success in unorganised sector, the report emphasise on the need to incentivise it.

Associations, such as Indian Direct Selling Association and World Federation of Direct Selling Associations, provide comprehensive guidelines in the form of ‘Code of Ethics’. These codes cover issues such as protection of consumers, conduct towards direct sellers, enforcement of code etc. They seek to protect both the consumer and the direct sellers. While enacting legislation, if there be any such step, guidance can be taken from these codes.

Let us see where the future of direct selling industry lies. Few years from now would be very crucial for the existence of the industry in India.

Concluding this post, I merely want to mention that I have tried to highlight all the relevant issues related to Indian direct selling industry. If, by any chance, something has been missed, please let me know. My e-mail address is abhinav.s@nujs.edu




[1] According to the dictionary, term ‘sale’ can be understood as ‘the transfer of property or title for a price’.
[2] Socio-Economic Impact of Direct Selling: Need for a Policy Stimulus, Arpita Mukherjee, Tanu M. Goyal, DivyaSatija and NirupamaSoundarajan [as cited in FICCI Report]
[3] Peterson and Wotruba, What is Direct Selling? – Definition, Perspective and Research Agenda, 16 The Journal of Personal Selling and Sales Management 1-16 (1996)

1 comment :

  1. The Prize Chits and money Circulation scheme Banning Act, 1978 is to be amended and Authorised officer under the Act to be decided by the state govt. The rules made by the state govt is very rigid and prosecution will not succeed by invoking the act and rules.
    V.Sethunath, Advocate, High Court of Kerala

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