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 the ‘investment’ 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)
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.
ReplyDeleteV.Sethunath, Advocate, High Court of Kerala