Amway/Quixtar Arbitration Agreement Slammed
in US District Court in California

"The ADR deck could not possibly be stacked
more in Quixtar's favor than it is here."

wm5.jpg (15664 bytes) On March 31, 2008, The judge in the class action case "Porkorny" in California issued a 45 page opinion pdf_icon.gif (914 bytes)grand slamming the Amway/Quixtar arbitration agreement. 

"CONCLUSION

For the foregoing reasons, the Court finds that the arbitration agreement contained in the Registration, the BSMAA,and the DM Terms and Conditions, and incorporating the RoC, is procedurally and substantively unconscionable, and therefore unenforceable."

 

 

1.      Understand what this lawsuit is about in the first place.  This case is not about the whole Team/Orrin Woodward fiasco.  It's a separate lawsuit pled as a "class action" seeking to hold Amway/Quixtar legally responsible for promoting a fraudulent pyramid scheme or illegal endless chain referral scheme in violation of California criminal law.  The fact that this is in California is very significant, because the state law in question, Calif. Penal Code, section 327, defines an illegal scheme in a manner that may be easily and readily applicable to the "buyers' club" business model of Amway/Quixtar.  The code defines an endless chain scheme as:

        any scheme for the disposal or distribution of property whereby a participant pays a valuable consideration for the chance to receive compensation for  introducing additional persons into participation in the scheme or for the chance to receive compensation when a person introduced by the participant   introduces a new participant. Compensation . . . does not . . . include payment based upon sales made to persons who are not participants in the scheme        and who are not purchasing in order to participate in the scheme.

It's the California legislature's definition of "compensation" that potentially spells huge legal troubles for Amway.   The statute is written to make MLM legal only where compensation is paid for sales to persons who are not participants in the scheme.  In other words, the statute's definition of an illegal chain referral scheme would easily be applied, for example, to an MLM in which the focus is on recruitng people to buy the products moreso than sell them, resulting in only 3.4% of the products being sold to "persons who are not participants in the scheme and who are not purchasing in order to partcipate in the scheme."  This is how this statute has been applied and understood by a California appeals court.  In People v. Bestline Prods., 61 Cal.App.3d 879 (Cal. App. 1976), the court explained:

        The Bestline plan, as alleged in the complaint and found by the court, offered compensation for recruitment based upon sales to the recruits. This element      of the Bestline plan, which is what makes it a chain scheme under California law, serves to increase the certainty of deception by diverting the effort of all   distributors from retail sales to the sales of distributorships. A pyramid sales plan under which the compensation for recruitment is limited to "payment       based upon sales made to persons who are not participants in the scheme and who are not purchasing in order to participate in the scheme," does not     come within the definition of endless chain schemes set forth in Penal Code section 327. The section, however, declares the policy of this state that such       schemes are deceptive when compensation is offered "for introducing one or more additional persons into participation in the scheme" based upon sale to         the person introduced. It is on the basis of this policy that participation in such schemes is made criminal.

In addition, the class action plaintiffs in the Pokorny suit are suing based on the federal defintion of an illegal pyramid scheme from Koscott Interplantary and as expounded upon by the Ninth Circuit Court of Appeals in its Webster v. Omnitrition opinion and a Nevada federal district court judge in In re Equinox.  The latter two unequivolcally held that an MLM that does not adequately enforce its rules to ensure that compensation is paid primarily on sales to outside consumers rather than on products bought for the participants' own use was an illegal pyramid scheme.

2.      The court refused to enforce the arbitration clause.  Like Judge Dorr, the federal judge in the Missouri lawsuit brought by Kenny Stewart and others, the Pokorny court found the arbitration agreement by which Amway was hoping to avoid lawsuits like this was "procedurally" and "substantively" unconscionable and therefore legally unenforceable.  In other words, the court held that even if the participants validly signed and entered into the aribtration agreements as part of their contract, the arbitration scheme, as it was pushed on them and as it was designed was so unfair and one-sided that Amway could not enforce it.

3.      Amway was planning on hiding these sorts of claims in aribtration.  The upshot is that unless the district court is reversed on appeal by the Ninth Circuit Court of Appeals, Amway will not be able to have its hand-picked aribtrators bail them out of this case, nor keep the proceedings or its results a secret.  This may spell especially big trouble for Amway since part of the case is based on a state endless scheme statute that seems to be directly tailored to make illegal an MLM business in which only a tiny fraction of the products are sold to consumers who are not paricipants in the scheme.

4.      This is not over.  The district court's opinion overruling the arbitration will be appealed to the Ninth Circuit court of Appeals.  Fromt there, the losing party can ask the United States Supreme Court to review whatever decision the Ninth Circuit hands down.  

5.      The substantive claims - fraud, pyramiding, operating an endless chain scheme - are not decided or resolved in the court's opinion.  The opinion solely deals with the issue of whether those claims will have to be brought in Amway's confidential arbitration scheme rather than in the public federal court.

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"In such a scenario, allowing the most senior IBOs to "negotiate" the rights of all other IBOs would be leaving the proverbial fox in charge of the henhouse."

"The Quixtar arbitration agreement is simply too tainted to be saved through minor adjustments. Therefore, though mindful of the strong state and federal policies favoring arbitration, the Court holds that the entire Quixtar ADR scheme is unconscionable and unenforceable."

Thus, if Quixtar initiates the dispute, it is not required to engage in Informal or Formal Conciliation, and if an IBO initiates a dispute against Quixtar, that party must go through additional steps it would not have to take, under the same rules, if the dispute were with another IBO. The mutuality Quixtar claims is illusory.

The RoC (Rules of Conduct) cuts the window for seeking relief at both ends. At the front end, the IBO cannot initiate an arbitration against Quixtar until at least 90 days after the claim arises, because it must go through Conciliation first. At the back end, the IBO only has two years to initiate the arbitration (or less if the applicable statute of limitations is shorter).

These two factors alone are enough for the Court to distinguish Allen and to follow Nyulassy in finding the prearbitration provisions of the Quixtar process unconscionable.

However, even if an IBO goes through both stages of Conciliation and prevails, Quixtar has the unilateral right to reverse or modify the Hearing Panel's decision, and there are no standards governing whether Quixtar does so. Under RoC 11.3.3, "After consideration of the entire file and completion of any independent investigation, the Corporation will issue a final decision and may accept, reverse, or modify either the Hearing Panel's recommendation or the IBOA International Board's recommendation as appropriate." Id. at D-41, RoC 11.3.3. Unlike the Hearing Panel itself, Quixtar is not even nominally required to make a decision in line with the RoC. The parties debate extensively whether the Hearing Panel or the IBOAI Board is a true "neutral" for thepurposes of Conciliation. This debate seems irrelevant, however,given that neither the Hearing Panel nor the IBOAI Board has any actual authority. Quixtar is ultimately the only one to make a decision in the process. That Quixtar's final decision on the matter is non-binding does not salvage the rest of the process.

Quixtar makes the incongruous argument that, because it only has the final decision in cases where it is a party, and not in disputes between IBOs, this somehow makes the process better.

Quixtar Reply at 9-10 ("The feature calling for Quixtar's 'final decision' applies only to conciliations in which Quixtar is itself a party, not where the conciliation involves a dispute among IBOs"). It does not. To the contrary, it means that Quixtar has an advantage in the process that no other party has. If Plaintiffs were on the receiving end of a complaint and were unsuccessful at the Formal Conciliation stage, they would not be able to reverse the Hearing Panel, and they would not be able to appeal to Quixtar. Only Quixtar has that right.

Finally, the Court agrees with Plaintiffs that because the entire Conciliation process is governed by, and intended to perpetuate, the RoC, it cannot serve as a fair and meaningful system for challenging the RoC. Quixtar claims that "there is no limitation on disputes that may be taken into conciliation" because the scope of the ADR process is broad.

Quixtar Reply at 8. That the process may ostensibly be used to address "any issues related to" an IBO's Quixtar business does not make it a useful or fair vehicle for doing so. The defect is not that the RoC has a limited scope. Rather, it is that the RoC is self-perpetuating and therefore inherently biased against the IBO challenging it.

The only standard guiding the Hearing Panel during Conciliation is compliance with the RoC. See VanderVen Decl. Ex. 2 at D-40 to D-42, RoC 11.3.1, 11.4. As the RoC itself cannot be in violation of the RoC, an IBO that wishes to challenge the process has no meaningful chance to succeed. Quixtar asserts that the "remedies available are broad enough to accommodate rules challenges, and there is nothing in the conciliation process to prevent rules changes." Quixtar Reply at 8. This is implausible, as the Hearing Panel is not authorized to fashion remedies which modify the RoC. See id. at D-42, RoC 11.4 ("Any resolutions, remedies, and sanctions recommended by the Hearing Panel or the IBOA International Board should promote and further the goal of compliance and must be consistent with the IBO Plan and Rules of Conduct."). At most, the Hearing Panel could recommend a change to the RoC, but as explained above, Quixtar has no obligation to accept that recommendation.

The Court finds, without reaching every possible defect identified by Plaintiffs, that the RoC requirement that an IBO engage in Informal and Formal Conciliation prior to arbitration is substantively unconscionable, and exceedingly so. The ADR deck could not possibly be stacked more in Quixtar's favor than it is here. Having already concluded that the agreement is procedurally Because the arbitration procedures are included in the same agreement as the conciliation procedures, the procedural unconscionability analysis above is equally applicable here. See supra Section V.C. 31 unconscionable because the Plaintiffs did not have a chance to negotiate its terms, the Court holds that the pre-arbitration provisions of the agreement are unconscionable, and declines to enforce them.

To begin, some of the defects in the Conciliation process are equally applicable to the arbitration process, and therefore weigh in Plaintiffs' favor. As noted above, the arbitration provision is non-mutual. Nothing in RoC 11.5 requires Quixtar to enter the ADR process in the first place.

Quixtar may be forced into ADR if an IBO initiates the dispute, but if Quixtar initiates, it is free to do so in court. Requiring one party to arbitrate its claims, but not the other, is the paradigm of onesidedness, and a prime example of substantive unconscionability.

The lack of mutuality regarding mandatory arbitration carries over into the statute of limitations dispute. The relevant portion of RoC 11.5 states: "Demand for arbitration shall be made within two years after the issue has arisen, but in no event after the date when the initiation of legal proceedings would have been barred by the applicable statute of limitations." VanderVen Decl. Ex. 2 at D-42, RoC 11.5. If Quixtar has a complaint against an IBO, it may initiate legal proceedings after the two year limitation expires because it is not required to arbitrate. This imbalance is significant.

Practically speaking, a "loser pays" provision makes arbitration a much greater financial risk than litigation. The RoC thus requires an IBO to incur greater risk in the prosecution of statutorily-protected rights. This undoubtedly discourages IBOs from demanding arbitration, and therefore favors Quixtar substantially.

The Stewart court was able to sever easily because it found only one provision unconscionable under the applicable law. See Stewart, slip op. at 9-10. The same is not true here. Severing the offending provisions would remove the Informal and Formal Conciliation requirements, the non-mutual arbitration requirement, the reduced statute of limitations, the confidentiality requirements, the arbitrator selection process, and the fee shifting provisions. Even if the Court chose to "enforce" the remainder, it would have virtually no effect. Where an arbitration agreement is so permeated with unconscionable provisions, the Court may refuse to enforce the agreement as a whole, rather than severing specific provisions.