FTC rule adds complexity to salesforce loyalty and mobility
By: Brent Kugler
On April 23, 2024, the Federal Trade Commission (FTC) voted 3-2 to issue a Final Rule banning the use of noncompete restrictions to prevent workers from joining competing companies.
The FTC’s action marks the first time in more than 50 years that the Commission has issued a rule mandating an economy-wide change in how U.S. companies operate.
As expected, pro-business groups immediately filed lawsuits to prevent implementation of the Final Rule, which is set to take effect 120 days after issuance unless enjoined by a court.
Impact on Direct Sales Companies
The FTC’s ban on noncompete restrictions is the latest complication for direct sales companies seeking to balance incentivizing salesforce loyalty and restrictions on salesforce mobility.
Salesforce mobility has long been, and remains, a unique issue (and concern) for direct sales companies. This is because, at one time or another, almost every direct selling company has experienced the disruption of a top leader leaving to join a competing company.
The disruption is magnified by downline consultants that follow the leader to the other company, or worse, the leader’s solicitation of other consultants to join the other company.
Given the structure of a multi-level sales organization, a top leader’s migration to another company can (and often does) create a severe business disruption that is unique to the network marketing and social selling industry.
Trends Influencing Workforce Mobility
With the continued evolution of the gig economy and influencer/social-media-driven opportunities, there is a clear trend that company and brand loyalty have become less important to today’s workers, while flexibility and mobility have become more important.
According to a wide-scale study conducted by consulting firm Deloitte, 46% of polled Generation Z workers and 37% of Millennials said that they worked a second part-time or even full-time job in tandem to their main work.
Another study by financial services platform Bankrate.com calculated that 39% of employed American adults are currently working a second gig on the side and bringing in an extra $810 a month on average.
A second factor trending in favor of worker mobility is the ongoing attack on the independent contractor classification, as federal and state regulators seek to narrow independent contractor status and expand employee status to provide a safety net of benefits to the ever-growing population of gig economy workers.
In addition, a key criterion in independent contractor tests utilized by a number of states is the ability of the independent contractor to work for more than one company.
Strategies for Managing Salesforce Loyalty and Mobility
In light of these trends, how can a company effectively promote salesforce loyalty and at the same time prevent the disruption that occurs when a leader begins promoting another business opportunity?
A good starting point is for a company to first engage in self-evaluation of its product line and business opportunity. Is the
business opportunity still competitive? How old is the compensation plan? Are products being constantly updated or reformulated to remain competitive?
In other words, a company should take an honest look at its business and ensure that it is providing a competitive business opportunity—one that will incentivize top leaders to not look elsewhere and also attract new generations of consultants.
Still, there are situations where the disruption caused by a leader’s exit to another company—which often includes the solicitation of other consultants—is so great that the company has no choice but to pursue legal remedies to quell the disruption. This can also demonstrate to the company’s other consultants that the company is taking action to protect its business interests.
Legal Challenges and State Variations
Even if the FTC Final Rule is stayed by a court, five states currently ban the use of noncompete clauses. This means that even if your company is located in a state that currently recognizes the validity of noncompete restrictions, you will likely be unable to enforce that restriction against a consultant that lives in one of the states where noncompete restrictions are unenforceable.
Moreover, even if a company’s noncompete restriction is legally enforceable, it may still be problematic because the noncompete restriction may be viewed as a control factor suggestive of an employment relationship. This is something to keep in mind if your company imposes a noncompete restriction on consultants once they achieve a certain rank.
Consultants don’t become less of an independent contractor as they advance to the upper levels of a company’s comp plan. So even if your company can legally enforce a noncompete restriction, doing so may create a bigger problem than the one you are trying to prevent by restricting involvement in another company. If the FTC Final Rule survives legal challenge, a discussion of the pros and cons of utilizing noncompete restrictions becomes academic.
The best solution for companies to prevent disruption from a leader’s exit is a non-solicitation restriction. Importantly, a non-solicitation policy does not prevent a consultant from working for another company. It does, however, prohibit a consultant from recruiting other consultants to leave for another company. Still, companies should proceed with caution in how they draft and enforce a contractual non-solicitation provision.
The restrictions imposed by the non-solicitation restriction must be reasonable. A reasonableness inquiry typically focuses on two things: (i) the scope of the restriction (i.e., does it apply to competing companies or all companies?); and (ii) the length of the restriction (i.e., does it only apply during the contract term, or does it extend for a period of time after the termination of the consultant agreement?).
Scope and Enforcement Challenges
Scope of the Non-Solicitation Restriction. Direct selling companies often “compete” with one another regardless of whether they market similar products or services. Indeed, several courts have recognized that in the multilevel business channel all multilevel-marketing companies compete with one another to develop and maintain an effective sales force. (See PartyLite Gifts, Inc. v. MacMillan, 895 F. Supp. 2d 1213 (M.D. Fla. 2012); Pre-Paid Legal Services., Inc. v. Cahill, 924 F. Supp. 2d 1281 (E.D. Okla. 2013); and YTB Travel Network of Ill., Inc. v. McLaughlin, 2009 WL 1609020 (S.D. Ill. June 9, 2009)).
For this reason, the non-solicitation provision should define “competitors” to include other direct selling, MLM, or network marketing companies in addition to companies that offer competing products or services.
Because the concept of direct sales companies competing with one another for successful independent salespersons may not be readily apparent to a judge or arbitrator, companies should broadly define their product and service offerings to expand the category of companies that may be considered “competitors” on the basis of types of products or services sold.
Length of the Non-Solicitation Restriction. Depending on the state, a reasonable post-termination restrictive period is usually between six months and two years. However, in some states post-termination non-solicit restrictions are much more scrutinized. In California, several courts have recently held that post-termination non-solicitation provisions are not enforceable. (See World Financial Group Insurance Agency v. Olsen, 2024 WL 73056 (N.D. CA 2024); Nulife Ventures, Inc. v. Avacen, Inc., 2020 WL 718122 (S.C. CA 2021)).
Non-solicitation restrictions that apply during the term of a consultant agreement have generally been upheld, including in California. (See Youngevity International Corp. v. Smith, 2021 WL 1041712 (S.D. CA 2021)).
Enforcement of Post-Termination Non-Solicitation Restrictions. If the solicitation activity is by a former salesforce member (and the non-solicitation restriction applies for a period of time after termination of the agreement) then the only option for enforcement is to seek injunctive or interim relief from a court or arbitrator. This is usually an expensive process, and it requires the company to have solid evidence that the consultant is actually soliciting other consultants.
The fact that other consultants have also migrated to the other company is not evidence of solicitation, and this fact alone is usually not sufficient to obtain injunctive or interim relief.
Courts in some states are more likely to enforce a post-termination non-solicitation restriction if the violation involves the improper use of a company’s confidential information or trade secrets.
In some states, courts are authorized to reform or modify restrictions in a non-solicitation provision that are deemed to be unreasonable (i.e., modifying a two-year post-termination restriction to one-year post-termination restriction).
In other states, courts do not have discretion to modify a non-solicitation provision to make it enforceable.
Enforcement of an In-Term Non-Solicitation Provision. If the violation of a non-solicitation restriction is by a current consultant, a company has three options: (i) it can seek an injunction to enforce the non-solicitation restriction; (ii) it can elect instead to terminate the consultant based on the violation of the non-solicitation provision; or (iii) the company can pursue both options. As with noncompete restrictions, state laws impact the extent to which companies can rely on a non-solicitation provision.
Courts in some states, such as California, may be less likely to enforce a non-solicitation provision by injunction but more likely to affirm a company’s termination of a consultant based upon the consultant’s breach of a valid non-solicitation provision.
Today’s workforce is demanding increased mobility. Contractual restrictions on consultant movement or involvement with other companies are increasingly more scrutinized. The FTC has declared war on noncompete restrictions. At the same time, states are rewriting their statutes to narrow the definition of “independent contractor.”
Given the unique nature and structure of direct selling companies, it is critical to have enforceable contractual provisions to prevent the severe disruption that can occur when a top leader solicits other consultants to leave for another company, while also allowing consultants to work multiple business opportunities.
Companies should regularly update their independent salesforce agreements to ensure that they reflect today’s economic reality as well as comply with changes in the law and recent court rulings.
Brent Kugler is a partner at Scheef & Stone, LLP.
