Multi-level Marketing: Scam or Legal?

Law
14-Feb-2023
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Amway is the most popular multi-level marketing example that exists in India. It is a name that every household knows and has had for a while. Now the question that arises in the minds of most people is whether multi-level marketing is legal in India or Scam. 

The concept of "multi-level marketing" or "network marketing" refers to the use of independent representatives to sell products or services door to door i.e. to family, friends, and acquaintances. MLM has been used for a wide range of products and services, including health and wellness products, household goods, cosmetics, and more. Some well-known multi-level marketing companies include Amway, Avon, Herbalife, Oriflame, and Tupperware.

What is Multi-Level Marketing?

Also known as Network Marketing, Multi-Level Marketing (MLM) is a direct selling method in which a salesperson earns commissions not only for the sales they generate but also for the sales of the other individuals they recruit to join the sales team.

The recruited salespeople, in turn, can recruit their own team, creating a hierarchical structure. The idea is to build a large network of salespeople who are all selling the same product or service, and who earn a percentage of the sales made by the people they recruit. Thus, it creates a chain of selling, with more people selling a branch or chain, is created, which is why it is called network or matrix marketing.

It's important to note that MLM is often criticized for being a pyramid scheme, in which the majority of participants lose money and only a few at the top of the pyramid make substantial profits. There are so many companies that say on the face of it that they are into multi-level marketing whereas, in reality, they are just pyramid schemes.

Before getting involved in multi-level marketing, it is important to do your research and fully understand how it works, as well as the potential risks and drawbacks.

How it started: Concept of MLM

The concept of Multi-Level Marketing can be traced back to the early 20th century. One of the earliest forms of MLM was a buying club started by Carl Rehnborg in the 1930s. Rehnborg sold health supplements and recruited others to join the club and sell the supplements as well. The members of the club earned commissions on the sales they made and on the sales made by the people they recruited to join the club.

The modern form of MLM as we know it today developed in the 1950s and 1960s when companies such as Amway and Nutrilite began using the direct selling model to distribute their products. The model has been adopted by many other companies, and MLM has become a widespread way of selling products and services through a network of independent salespeople.

It's important to note that while multi-level marketing has been around for many decades, it has also been controversial and the subject of much debate. Some people view MLM as a legitimate way of starting a business and earning an income, while others view it as a pyramid scheme that preys on vulnerable people.

As we know, often MLM is associated with the terms "Ponzi scheme" and "pyramid scheme."

Ponzi Scheme

A Ponzi scheme is a fraudulent investment scheme where returns are paid to existing investors from funds contributed by new investors, rather than from profit earned by the individual or organization running the scheme. Therefore, this scheme relies on constant investments by new investors and breaks down or falls apart when this investment flow ceases. 

It is significant to understand the concept of the Ponzi scheme, in this scheme a single person controls the whole fund money, and the money is transferred from one person to another without even making any actual or real investments. The person perpetrating the Ponzi scheme tries to gain investors' confidence, and once investors start investing and become confident in the Ponzi scheme, the fraudster disappears with all the investments. In contrast, in a pyramid scheme, the person who initiates this game will recruit investors and it shall be their role to recruit further investors. 

Pyramid Scheme

In India, a pyramid scheme is described as a type of investment scam where participants are promised high returns for recruiting others into the scheme. As more and more people are recruited, the original participants earn money from the investments made by those they recruit, rather than from any actual profit-generating business activity. Now, this other person is required to invest a fixed amount of money which is paid to the initial recruiter and in order to make returns on the invested amount, the new members have to recruit further new members who will now invest fixed amounts of money thereby forming a chain of pyramids. 

Recently, the Reserve Bank of India released a statement spreading awareness among the people against such fraudulent schemes that promise high returns and run on big member subscription fees. As stated by the RBI, payment structure schemes and chain marketing promise easy or quick money. The RBI's recommendation was to avoid being tempted by MLM companies that offer high returns through network marketing, pyramid schemes, or chain marketing.

Is MLM a Scam or is it legal in India?

Multi-Level Marketing (MLM) is not inherently a scam, and it is legal in India. However, like any business model, it is important to do thorough research and understand the MLM before getting involved, as some MLMs may have characteristics of scams such as pyramid schemes or Ponzi schemes.

The Indian government has established regulations for MLMs, including the Prize Chits and Money Circulation Schemes (Banning) Act of 1978 and the Direct Selling Guidelines, of 2016, which are designed to prevent pyramid schemes and other types of fraudulent investment schemes. The act prohibits any scheme that promises returns solely from enrolling new members, rather than from selling products or services.

However, despite these regulations, there have been instances of illegal pyramid schemes operating in India under the guise of MLMs. It is important to exercise caution and do your research before getting involved in any MLM. Consider the company's track record, the products and services being sold, the compensation plan, and the people running the business, among other factors. If something seems too good to be true, it might be true.

Laws Governing Multi-Level Marketing

  • Prize Chits and Money Circulation Schemes (Banning) Act, 1978

The Prize Chits and Money Circulation Schemes (Banning) Act, 1978, is an Indian law designed to regulate and ban certain types of investment schemes, including pyramid schemes and Ponzi schemes. The act was enacted in response to the growing number of such schemes, which promised high returns to investors but ultimately defrauded them.

The act defines a "money circulation scheme" as any scheme that promises to return money to members, with or without any monetary consideration, and by enrolling more members. The act prohibits such schemes and imposes penalties on those who participate in or promote them.

Under the Prize Chits and Money Circulation Schemes (Banning) Act, any person who is found to be running a money circulation scheme can be punished with imprisonment for a term that may extend to three years, and/or a fine. The act also empowers the central government to attach the assets of the promoter of the scheme and to order the winding up of the scheme.

The Prize Chits and Money Circulation Schemes (Banning) Act is intended to protect the public from fraudulent investment schemes and to promote transparency and accountability in investment activities. It is important for individuals to thoroughly research any investment opportunity before committing their money, and to be wary of schemes that promise high returns with little or no risk.

  • The Direct Selling Guidelines, 2016:

The Direct Selling Guidelines, 2016, is a set of regulations in India that govern the direct selling industry, including multi-level marketing companies. These guidelines were issued by the Ministry of Consumer Affairs with an aim to provide a framework for regulating the direct selling industry in India and to protect consumers from fraudulent practices.

The Direct Selling Guidelines, 2016, define direct selling as the "selling of goods or providing of services as a part of a network of direct selling other than through a permanent retail outlet". The guidelines specify that direct selling companies must register with the central government and provide certain information, such as their business model, products, compensation plan, and history of litigation, among other things.

These guidelines are intended to provide a regulatory framework for the direct selling industry and to ensure that consumers are protected from fraudulent practices. It is important for individuals considering involvement in an MLM to familiarize themselves with the guidelines and to thoroughly research the company and its business practices before getting involved.

Other Laws

  • Guidelines of The Ministry of Consumer Affairs

The Ministry of Consumer Affairs in India has issued a set of guidelines for Multi-Level Marketing (MLM) companies that aim to protect consumers from fraudulent practices and provide a framework for regulating the MLM industry in India. The key provisions are:

  • Registration: All MLM companies must register with the central government and provide certain information, such as their business model, products, compensation plan, and history of litigation, among other things.
  • Fair pricing: MLMs must sell products or services at fair prices, without any pressure or undue influence on the consumer.
  • Clear and complete information: MLMs must provide clear and complete information to potential direct sellers and consumers about the products, compensation plan, and business opportunity.
  • Cancellation and refund: MLMs must provide an option for the consumer to cancel the order within 14 days and receive a full refund.
  • Termination: MLMs must allow direct sellers to terminate their association with the company at any time and without penalty.
  • False, misleading, or deceptive claims: MLMs and their direct sellers are prohibited from making false, misleading, or deceptive claims about the products or business opportunity.
  • Advertising: MLMs must comply with the advertising codes of the Advertising Standards Council of India (ASCI).
  • Grievance Redressal: MLMs must establish a mechanism for resolving consumer complaints.
  • The Indian Contract Act, of 1872

Under the Indian Contract Act, a contract is defined as an agreement between two or more parties that is enforceable by law. For a contract to be valid, it must meet certain requirements, such as consent of the parties, the capacity of the parties to enter into a contract, the legality of the object of the contract, and consideration.

In the context of MLM, the contract between the MLM company and its direct seller is known as a distributor agreement. This agreement outlines the terms and conditions of the relationship between the MLM company and the direct seller, including the compensation plan, product purchase and sales requirements, and the rights and obligations of each party.

The Indian Contract Act, of 1872, provides the legal framework for enforcing the terms of the distributor agreement. If either party fails to fulfill its obligations under the agreement, the other party may have the right to terminate the agreement and seek compensation for damages suffered as a result of the breach.
 

  • The Consumer Protection Act, 1986

The Consumer Protection Act provides legal recourse for consumers who feel they have been wronged or misled by a multi-level marketing company. For example, if a consumer feels that they have been misled into joining a multi-level marketing program, or that they have been promised certain benefits that were not delivered, they can file a complaint under the Consumer Protection Act.

The act provides for the establishment of consumer forums at the district, state, and national levels to hear complaints and provide relief to consumers. In the case of multi-level marketing companies, consumer forums can take up cases relating to issues such as false or misleading representations, non-payment of commissions, or fraudulent practices.

The Act provides a legal framework for the protection of consumer rights, it is up to the consumer to take the initiative and file a complaint. Consumers should carefully evaluate any multi-level marketing opportunity and be cautious of companies that make unrealistic promises or use high-pressure tactics to get them to join.

  • The Income Tax Act, 1961

Multi-level marketing companies operating in India are required to comply with the provisions of the Income Tax Act and to file regular returns with the Income Tax Department. Participants in multi-level marketing programs are also required to report their income from these programs on their tax returns. It ensures that MLM companies comply with all relevant tax laws. In case of failure to pay taxes can lead to fines, penalties, and other legal consequences.

In conclusion, the Income Tax Act plays a crucial role in regulating the taxation of income from multi-level marketing activities in India and ensures that individuals and companies comply with their tax obligations.

  • The Companies Act, 2013

In India, private limited companies are required to be registered under the Companies Act, 2013, and must file regular returns with the Registrar of Companies. They must also comply with the provisions of the act relating to the appointment of directors, the holding of meetings, and the maintenance of proper books of account.

Individuals participating in multi-level marketing programs should ensure that the company they are joining is in compliance with the provisions of the Companies Act, 2013. This will help to ensure that the company is operating legally and that its interests as participants are protected.

How to Identify Whether a Company is Genuine?

Identifying a genuine multi-level marketing company can be a challenging task, as there are many companies that engage in fraudulent or misleading practices. Here are some key factors to consider when evaluating a multi-level marketing company:

  • Product or service: Start by evaluating the product or service being offered by the company. Is it of good quality and in high demand? Does the company have a strong reputation for delivering quality products or services?
  • Compensation plan: Carefully review the compensation plan offered by the company. Does it appear to be based on realistic expectations and achievable goals? Are the commissions and bonuses paid in a timely manner?
  • Business model: Evaluate the company's business model. Is it transparent and easy to understand? Does it rely on the recruitment of new participants to generate income, or is there a genuine market for the product or service being offered?
  • Company history: Research the company's history and reputation. Have there been any legal or regulatory issues in the past? Are there any negative reviews or complaints about the company online?
  • References and testimonials: Ask for references and testimonials from current participants. Do they speak highly of the company and their experiences with the program?
  • Company registration: Ensure that the company is properly registered and licensed to operate in your jurisdiction. This information can usually be obtained from the relevant government department or regulatory body.

Conclusion

Although multi-level marketing can offer individuals the opportunity to earn income through sales and recruitment, it is important to thoroughly research and evaluate any opportunity before joining. When evaluating a multi-level marketing opportunity, we should consider the factors such as the quality of the product or service, the compensation plan, the company's business model and history, and the availability of references and testimonials.

Ultimately, the success of a multi-level marketing program will depend on many factors, including the individual's effort, determination, and ability to sell the product or service. Before joining a multi-level marketing program, it is recommended that individuals carefully consider their financial goals, sales and marketing skills, and the time and resources they are willing to commit.


Author Bio: Advocate Anup S Dhannawat has been practicing and handling cases with a well-trained team of lawyers with a result-oriented approach. He has immense expertise in service matters, educational matters, administrative tribunals, Civil and criminal matters. Advocate Anup also provides services in various fields of Property Matters, Consumer Matters, Insurance Matters, Corporate Matters, Cyber Crime related Matters, Family related Matters, and drafting and vetting of various agreements and documents. He has more than 25 years of experience in Corporate and Educational field work with degrees in Engineering, Master in Business Administration, and a professional degree in Law.