Direct action

China has introduced a strict legal framework for direct selling to protect consumers and prevent pyramid selling. David Boitout and Beatrice de Meaux-Becdelievre report

The Regulation on the Administration of Direct Selling and the Regulations Prohibiting Pyramid Selling came into force in the People’s Republic of China (PRC) on 1 December 2005. This furthers the Chinese State Council’s aim of trade liberalisation and will open the distribution sector to foreign investment. These regulations will permit sales of consumer products away from fixed locations while continuing to ban pyramid selling.

The arrival of the direct-selling regulation ends eight years of prohibition. All forms of direct selling, whether pyramid selling or not, had been prohibited for both domestic companies and foreign-invested enterprises (FIEs) in China since 1998 as a result of scandals and frauds relating mainly to pyramid selling.

So far, only a few FIEs have been approved to engage in direct-selling business on the condition that they also operate through permanent stores. For instance, Avon and Amway, the two major players in this sector, have had to establish retail stores and outlets in department stores in addition to a sales-representatives network engaged in direct selling.

The new regulations impose strict conditions on market access for companies wishing to develop direct-selling businesses in China. Any investor involved in illegal activity in the five years preceding an application for a licence will be ineligible to engage in direct selling. Furthermore, foreign investors must have at least three consecutive years of experience in direct selling outside China.

The new rules also set high financial eligibility thresholds by requiring registered capital of at least Rmb80m (£5.6m) for direct-selling enterprises and the payment of a deposit of Rmb20m (£1.4m) at the date of formation of the company. This deposit is adjusted monthly so its value is equivalent to 15 per cent of the direct-selling company’s turnover during the preceding month, with a minimum amount of Rmb20m and a cap of Rmb100m (£7m). This deposit is mainly to guarantee remuneration due to sales personnel, to refund goods upon consumers’ request or to compensate consumers for defective goods.

The direct-selling regulation imposes more stringent licensing rules which will slow down approval procedures. This is despite the 2004 commercial measures that went some way toward easing the licensing requirements for distribution enterprises by delegating licensing powers to authorities at a provincial level.

The issue of a direct-selling licence by the authorities will not permit an enterprise to operate freely throughout China. In addition, direct-selling enterprises are required to open a service outlet in each province where they intend to carry on direct-selling business.

Application for a licence must not only be made to the Ministry of Commerce but also to each of the provincial authorities where the enterprise intends to engage in direct selling.

It is notable that, unlike the franchise measures that came into force on 1 February 2005, the new direct-selling framework does not lay down distinct rules for domestic enterprises as opposed to FIEs. The authorities have made it known informally that FIEs should serve as a model for this type of business.

The new framework also imposes operational restrictions. Only single-level direct selling has been legalised officially while multi-level selling remains banned, as an illegal pyramid scheme. Indeed, it is illegal for an operator to: hire personnel and to require its personnel to recruit other sales personnel; and to pay remuneration to the recruited personnel on the basis of sales performance and/or the number of personnel directly or indirectly hired through rolling recruitment.

The rules concerning remuneration are intended to prevent circumvention of the foregoing prohibition. Sales personnel must be paid at least monthly, with a remuneration based exclusively on a percentage of their own sales. The total amount of the remuneration shall not exceed 30 per cent of their sales figure, including bonuses, rewards or other economic benefits, to avoid disguised remuneration.

Direct-selling enterprises are only permitted to sell certain goods. Only self-manufactured goods or those produced by a parent or holding company may be sold through direct selling. However, there is no longer any restriction relating to the origin of the goods sold (before 1998, only Chinese-made goods were authorised for direct selling).

Consumer protection
The direct-selling regulation sets out various provisions to protect consumers. These reflect international regulations – for example, the direct-selling regulation establishes a period of 30 days from the date of sale during which consumers may request that goods be replaced or their money refunded.

The requirement for a network of service outlets will also support consumer rights. It will facilitate post-sales services and return of products and ensure a degree of price transparency for consumers.

Finally, it is expressly provided that, in the event of a dispute with a consumer, the burden of proof rests on the direct-selling company.

China’s next step towards achieving a complete legal framework for distribution activities will undoubtedly deal with internet and mail-order sales, and the Chinese authorities are consulting with major international players accordingly.

David Boitout is a partner and Beatrice de Meaux-Becdelievre a senior associate in Gide Loyrette Nouel’s Shanghai Office