Advocare: Circumventing Common Law

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I have spent the last several months thoroughly evaluating the multilevel marketing (MLM) industry. Usually I spend most of my time encouraging everyone to stay away from all of them, at all cost, primarily due to the 98 percent failure rate. In this article I am going to look at MLM from another angle. Although many people will disagree with me, I believe companies such as Advocare present themselves as an employer, and not just the manufacturer of a product. I also  believe the government is aware such a relationship exist between the two.

A manufacturer that sells their product to another business typically does not control the means to which the product is sold, or the price. If a company such as Walmart decides to sell your product, they control how it is sold, and everything else. If you do not like it, there are thousands of people ready to take your place. If a manufacturer such as Advocare wants to provide merchandise to Walmart, they would have to significantly reduce their over bloated price. With that, they would have to hire more employees, and be subjected to the same risk as other manufacturers. Unfortunately, they are able to circumvent added costs by implementing a strategic and intentionally deceptive business plan.

Advocare and all MLM companies want the ability to control anyone that is selling their product without having to place them on their insurance plan, pay workers compensation, or have the responsibility of other expenses typically associated with an employer employee relationship. Such as what Walmart has to deal with on regular basis. If a company such as Advocare has the ability to tell you how and where to sell their product, and pays you a sum of money, are you not working for them? Does anyone really know what the law is in regards to employee employer relationships, and at what point a distributorship crosses the line? I thought we could take a look at what the government has used in the past to determine such a relationship.

The first thing we have to do is look to our local and federal government and the laws that are applicable. In this case the government has implemented a common law test to help determine whether a person is an employee or an independent contractor. Intuitively you would think it would be easy to tell the difference, but I beg to differ. If we take a look at prong one of the test, “the right to control”, I believe you will begin to see the complexity. What does it mean to have the right to control, and how much control is too much? The government has determined that if a “business has the right to control what work is done and how it gets done”, you have created an employer employee relationship. The IRS has taken it a step further and looks at the degree of control by the business. They accomplish this by organizing the types of relationship or controls into groups such as behavioral control, financial control, and the type of relationship between the two.

The subcategories for behavioral groups traditionally used by the IRS are the level of instruction and level of training provided. If a company determines where, when, and how you conduct daily operations, they are acting as your employer. If you are interested you can read the case law (S.G. Borello & Sons, Inc v Dept. of Industrial Relations (1989) 48 Cal.3d 341). Before I go any further let me associate the control mechanism with Advocare.

For example, many MLM companies such as Advocare dictate where and how you conduct your daily operations. I know, many of you that are involved with Advocare are thinking I am wrong. Well, if that is the case I think you should ship your products to Canada or maybe a country that allows Advocare. What? Distributors cannot sell Advocare outside of the United States? Go sell your products on your own blog or website not associated with Advocare without their permission and see what that gets you. Better yet, have your sister take some of the products to work with her or sell it on your Facebook. What, you cannot do that? Is it because Advocare controls that part of your business (I use the word business reluctantly)? Advocare is going to tell you that they do not have permission to sell to other countries, and that might be applicable to some areas. My instinct tells me the products are being sold in multiple countries. To tell you the truth, network marketing is not allowed in many countries such as China. I guess I should say it is allowed in China, but is significantly different. I will talk more about that later, but for now that really is irrelevant, and not the point I am trying to make.

The unfortunate truth is Advocare tells you where you can sell the products and how to sell them. The business plan requires all distributors to utilize face to face contact. There are many ways to sell the products, but they tell you how to do it, and where to do it. You cannot bring them to Walmart. You cannot put them in your place of business unless you obtain permission and you are on the property when the sale takes place. Even then, you would be surprised to find that our government has implemented laws hindering your ability to sell products via retail store without risk I will discuss later. Advocare even dictates how the products are advertised. I believe it is clear that you are not in control, they are. The next thing we have to look at is the training process and who is in control.

The IRS has declared that “an employer relationship is indicated where the business provides periodic or ongoing training”. Advocare not only provides rules and regulations pertaining to where and how a distributor can sell products, they also provide training material. Every year the company spends a plethora of money on National Success School. If you click on the link you will notice the company said in their own words “Four day business training brings more than 20,000 Independent Distributors to DFW. The intent behind the Advocare success school appears to be for training. As you can see Advocare has majority control and also provides yearly training.

The next prong of the test is to determine whether Advocare has financial control. I am not so sure even the IRS has this part mastered, but there are five areas to be considered. The first part is unreimbursed business expenses. The IRS wrote the following words, “both employees and contractors can realize unreimbursed business expenses”. That does not sound like a very good method to help determine the type of relationship. The second part looks at how much is invested by the independent contractor. According to the IRS “contractors typically invest in the facilities they use to perform services for the business”. What exactly does that mean? Unfortunately there really are no set standards, and it is not uncommon for some employees to supply their own tools or not have a significant investment. Once again, we do not have clear meaning from the IRS.

The next prong looks at the profit and loss margins. An independent contractor is more likely to be at risk of loss due to the initial investment. To me, that is an interested prong as profits are associated with investment. Investments can and do include tools of the trade, and has been considered something many employees are not reimbursed for. For instance, distributors purchase a kit from Advocare, and no other purchase is required to make money. The idea is to use the kit to lure in customers (author chuckles a little bit). Mechanics and carpenters purchase their own tools, and more often than not, are not reimbursed for the purchase. Unless a distributor gets crazy and orders a bunch of products for inventory loading purposes, they should make money on every sale. Advocare distributors also have a clause in their contract that indicates they will be reimbursed for their products and that inventory loading is forbidden (policies and procedures).

The IRS then looks to see if the independent contractor provides services to the market place. If I work for the computer repair shop at the corner, they could put in place a clause that would not allow me to compete with them, and the same could be said about an auto mechanic. That would constitute an employee relationship with the business. If you read Advocare’s policies and procedures you will notice there is a “no compete clause under 7.9 conflicts of interest. You will notice they specifically use the wording “a Competing Activity”. That leaves us with the last prong.

Method of payment by a business can be just as confusing as the rest. According to the IRS “independent contractors are typically paid by the job”. Unfortunately they also understand that there are independent contractors that are paid by the hour such as an attorney. Advocare distributors are paid commission deriving from sales to end users, or from commissions earned from others in their group. If you couple the fact that distributors are not able to compete, Advocare benefits from all sales, and pays commissions directly to distributors you would notice that an employee relationship can be implied. Not to mention payment is not based on the job, but through the fulfillment of the marketing plan implemented by the company. That brings us to the final prong of the original test.

The IRS looks at the type of relationship that has been created between the two entities. Similar to the other areas of the common law test there are other prongs that have to be considered. Let me just say this, a business does not have to meet all prongs to inadvertently create an employee employer relationship. The four sub categories are whether there is a written agreement, whether employee type benefits are provided, the term or length of relationship, and whether the independent contractors’ duties are important to the regular operations of the business. Well, let’s look at those one at a time shall we?

I think most people would agree that Advocare and their distributors sign a contract so I am not going to concern myself with that. Does Advocare offer employee type benefits in their contract? If you look at the policies and procedures you will notice they seem to be offering some time of insurance. If you look under section 6.2 insurance, you will notice that I did not make that up. Any distributor interested in obtaining insurance is directed to their personal microsite. Even if an employer does not pay for the insurance, they still have to offer it according to the new healthcare laws, but does the law actually say they have to pay the cost? I am not saying they are an employer. The fact that they offer insurance leads me to believe they are holding themselves out as an employer, even if the distributor has to cover the cost.

The next prong looks at the length of time the business and independent contractor will be working together. If a business hires an independent contractor, and the intent is to have a long lasting relationship, an employee employer relationship can be formed based on that intent. For example, Advocare requires all distributors to pay a yearly fee to continue their distributorship. The question one would have to ask is does Advocare want distributors to join and then quit, or continue indefinitely. I will let you answer that question. But that leads us with the final prong.

How important are distributors to the success of Advocare and their business? According to the IRS, “If a worker provides services that are a key aspect of the business, it is more likely that the business will have the right to direct and control his or her activities”. But for the distributors, Advocare would not sell any products. I believe that sums it up. Advocare’s business relies on the distributors to promote and sell their products. Although they primarily sell it to other distributors, and not to end users, Advocare’s key aspect of business lies solely on the distributors. So let me just give you an idea of what we just reviewed.

The IRS uses the common law test to determine whether an independent contractor is an employee and the following is a breakdown of that test.

1.    The right to control

a.     Behavioral controls (Level of control and training)

b.    Financial controls (Reimbursement, Investment, Availability of services to the public, payment type, and profit and loss)

c.     Type of Relationship (Written agreement, Benefits offered, Length of relationship, Importance of relationship to daily business)

Unfortunately I would be just as guilty as Advocare and many other MLM companies if I stopped there. There is another test that is used by the IRS referred to as the reasonable basis test. I am not going to bore you with the details but I will provide a brief summary. Basically, multilevel marketing companies even though they may qualify under the common law test, are exempt according to Section 1.3-2. Well, they are exempt so long as certain conditions are met. The following is what the IRS requires:

“Direct sellers.

This exemption applies to individuals who sell consumer products on a buy-sell or deposit-commission basis to be resold in the home or someplace other than a permanent retail establishment. It also applies to individuals who sell the products themselves in the home or someplace other than a permanent retail establishment. The exemption also applies to workers engaged in delivering or distributing

Newspapers or shopping news (including any directly related services).”

Well that is interesting don’t you think. The exemption only applies to those that sell in the home but does not apply to those sold in a retail establishment. So what does the government constitute as a retail establishment? That I will let you research, but I assure you there are no easy answers. The statute also required any direct seller that qualifies under the above statute to also meet the following two general requirements before their earnings are considered exempt.

    1.  Most of their compensation must be directly related to sales or other work output rather than the number of hours worked.

    2. Their work must be performed under a written contract providing that the individual will not be treated as an employee for federal income, social security, Medicare, or FUTA tax purposes.

Correct me if I am wrong, but most of Advocare’s commission payments are directly related to recruiting and not related to sales. That means that purchases by wholesale Customers (AKA distributor) and distributors are the primary source of income resulting from purchases by distributors. Even if some of the sales were relevant, I would venture to guess 90 percent are for personal use. That would disqualify Advocare distributors as a protected class under this statute, right? I could be wrong.

The unfortunate truth is that our own government is protecting companies that lie, cheat, and use distributors to sell their products. Companies similar to Advocare have created an employee employer relationship but are not held to the same standard as other companies. No workers compensation or healthcare responsibilities owed to distributors although they are employees according to the common law test. Advocare clearly fails the second test, as commissions are a primary result of recruiting not sales. Anyway, correct me if I am wrong but selling merchandise online would constitute retail sales would they not? 

I will leave it there for now, but things are going to get interesting in the next couples of days as I investigate other countries and their MLM rules and regulations. Remember I had mentioned China and how they have MLM. It is nothing compared to what we see here in the United States, and I believe you will be interested in what I have to say. 

As usual thank you for reading and please share your thoughts!

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