People ex rel. Kelley v. Koscot Interplanetary, Inc.

• Decision Date: 14 January 1972
• Docket Number: No. 2,Docket No. 10707,2
• Citation: 195 N.W.2d 43,37 Mich.App. 447
• Parties: , 54 A.L.R.3d 195 PEOPLE of the State of Michigan ex rel. Frank J. KELLEY, Attorney General, Plaintiff-Appellant, v. KOSCOT INTERPLANETARY, INC., a foreign corporation, et al., Defendants- Appellees
• Court: Court of Appeal of Michigan — District of US

Page 43

195 N.W.2d 43

37 Mich.App. 447, 54 A.L.R.3d 195

PEOPLE of the State of Michigan ex rel. Frank J. KELLEY Attorney General, Plaintiff-Appellant, v. KOSCOT INTERPLANETARY, INC., a foreign corporation, et al Defendants- Appellees.

Docket No. 10707.

Court of Appeals of Michigan, Division No. 2.

Jan. 14, 1972.

Released for Publication March 9, 1972.

Leave to Appeal Denied March 28, 1972.

William M. Donovan, Sterling Heights, for plaintiff-appellant.

Frank J. Kelley, Atty. Gen., Robert A. Derengoski, Sol. Gen., Edwin M. Bladen, Asst. Atty. Gen., for defendants-appellees.

Before McGREGOR, P.J., and HOLBROOK and VanVALKENBURG ^*, JJ.

HOLBROOK, Judge.

In June of 1969 the Attorney General for the State of Michigan filed a complaint against Koscot Interplanetary, Inc., a foreign corporation, and its directors and agents, Elwood Eugene Rumley, Charles C. Cooper, Larry Hofmeister, and Allen Oakes, hereinafter referred to as Koscot, which sought a restraining order to keep Koscot from further sale of its distribution system for marketing cosmetic products.

Koscot is domiciled in Florida and is now licensed to do business in Michigan. Its primary business is the manufacture of cosmetic products. It maintains a national network for distribution of its products.

The primary distinguishing factor for its line of cosmetics is that they contain mink oil which is represented to be the oil that most closely resembles the natural oils of the human skin.

On June 3, 1969, the Circuit Court for the County of Ingham ordered defendant Koscot to show cause why a preliminary injunction should not be issued. On June 13, 1969, a show cause hearing was held and subsequently a consent judgment was mutually entered on June 30, 1969.

This consent judgment was amended by stipulation on November 7, 1969. On February 12, 1970, defendant moved for vacation of the consent judgment. The Attorney General answered and opposed said motion and requested the court to determine the legality of Koscot's marketing plan.

On August 10, 1970, an extensive hearing was conducted and on October 27, 1970, the court rendered an opinion as follows:

'This matter is before the court on a motion by defendant entitled as follows: 'Hearing to Determine Legality of Defendants Marketing Plan, Pursuant to Consent Judgment entered on June 30, 1969.'

'The court holds that the MARKETING PLAN is in substantial compliance with Michigan law.

'Anything in the consent judgment which conflicts with the above holding is hereby struck and held for naught.

'The motion of the plaintiff to dismiss the motion of defendant is hereby, denied. The court is of the opinion that the defendant did not, in any material manner, violate the consent judgment.

'The court is of the opinion that the MARKETING PLAN of the defendant is not a lottery; is not in violation of the Uniform Security Act; is not a fraud nor misleading and deceptive advertising in the scheme the defendant uses in recruiting representatives in Michigan.

'It is not a fraud to have one distributor to each 7,000 people (old plan 4,000). An expert witness, called by the plaintiff, testified that Avon has 20,000 sales people in Michigan. Considering the population of Michigan as being 9,000,000 people, each Avon sales representative has 450 prospective customers.

'All of the exhibits offered by both sides, except those specifically excluded heretofore, are hereby admitted.

'The special record, appearing on page 282 to page 292 of the transcript, is hereby admitted into the main or general record, and made a part thereof.

'Orders and/or judgments may enter agreeable to this opinion.'

From this opinion and subsequent judgment the people have appealed.

The issue concerning whether Koscot's marketing plan violates the Uniform Security Act has been stricken on appeal by order of this Court.

It is apparent that the selling method employed by Koscot is a dual level marketing plan. For a better understanding of how the plan works, relevant information extracted from the company's policy statement is quoted below.

'II. CORPORATE OBJECTIVES: In order to market the cosmetics and other products which it handles, Koscot intends to create a network of 40,000 distributors throughout the United States, each of whom will be a franchised independent contractor. (The Per capita limit for any given community is one distributor per 4000 population.) Working under the distributors will be 400,000 retail sales personnel, who contract with the distributors to sell products on commission. Through the use of this network, the corporation will be enabled to market each of the many lines it handles. At present there are some 14,000 distributors in the country. The company expects to reach 40,000 in the spring of 1970, whereafter no more franchises will be sold except on a replacement basis.

'III. FRANCHISE SALE METHODS: In order to acquire its desired distributor network as rapidly as possible, the corporation pays very substantial commissions to those who bring in new distributors. Financial records will show that the company realizes very little profit from the sale of distributorship-franchises, and that its retail reorder sales are the real source of income. Distributorships are now being sold in two basic ways, one being single-level and the other being Temporarily dual-level. These two plans are described as follows, and are offered to the public at meetings attended by distributors who bring friends and acquaintances.

'A. THE SINGLE LEVEL PLAN: D, who is a distributor, sponsors P, a prospect, by interviewing him, filling out and signing with P an application blank, and sending the application together with P's check for $4,500.00 to Koscot in Florida. This transaction constitutes an offer which only Koscot's own personnel have the power to accept. If the application is accepted, D is paid a commission of $3,000.00. P receives $2,500.00 worth of cosmetic product at retail, and has the right to reorder product at 35% Of retail for all future orders. P receives training which is mandatory, and supervision from D who will assist him in organizing his business, and in selecting and hiring his retail salesgirls. These salesgirls pay P $10.00 each, and are given by him $36.00 worth of retail product. Thereafter they buy from P at 60% Of retail value, and sell door to door to the public. The commission is in part a finders' fee, and in part compensation to D for the time and effort he must expend in helping P to get his operation off the ground. Of the $4,500.00 which P paid, Koscot has retained $1,500.00. It has shipped to P product whose value to the company (the standard wholesale price at 35% Of retail) is $875.00. The cost of training P, who may go through the sales and business training schools as many times as he likes at no cost to him, is approximately $300.00. The cost of extensive travel by company employees to appear at sales meetings and assist in state organizations must also come from the $1,500.00 received. Therefore, for the franchise itself, Koscot receives less than $500.00. We think that legally and economically, the rights purchased by P have a value which far exceeds this amount. Our reason for paying such large commissions is of course to stimulate the rapid accretion of the distributors we feel we need. P, by virtue of having become a distributor, has the right to sponsor other prospects So long as distributorships are available, after which he retains only the right to buy products from Koscot at the standard discount. No commissions other than the one described above are paid under this plan.

'B. THE DUAL LEVEL PLAN: In the structure of this plan, in addition to D the distributor there is a subdistributor called S, the supervisor. S purchases his product through D at 45% Of retail value; D therefore realizes a 10% (of retail) gain on all of S's sales. To earn this money, D must do actual supervision of S and assist him materially. A monthly report of this supervision must be sent by D to the company as to each supervisor under him. S organizes his retail sales girls, and sells to them at 60% Of retail, just as D does. The Supervisor franchise is sold for $2,000.00 which is sent to the company for acceptance. It Must be sponsored by a Distributor, and may be sponsored by a Supervisor as well. If the applicant, P, is accepted, a commission of $500.00 is paid to the person who brought him in, whether he be D or S. In addition, and regardless of whether the commission is paid to D or to S, D receives from the company $200.00. This is because the company will ship direct to P, as his initial order, $2,000.00 (at Retail) worth of cosmetic products, and on such a shipment D is entitled to his standard 10%. P receives the same training precisely as under the single-level plan, and may go through retraining as often as he likes. P must be personally interviewed by D prior to submitting his application, and also by S if S is to receive any commission from the company. Of the $2,000.00 received, the company has paid out $700.00, shipped product worth to it (at 35%) $700.00, and spent $300.00 on training, leaving a gross receipt of $300.00.

'S, in addition to having the right to earn commissions and purchase product at 45%, also has the right to apply for the D position. In order to do so, he must be sponsored by a D. His application is then sent, with a check for $3,000.00, to the company. If his promotion is approved, he is shipped $3,000.00 worth of product (at retail), which is worth to the company $1,050.00. A commission of $1,950.00 is paid to D in this transaction. It should be noted, however, that if he wished to become a Distributor for $3,000.00, he must first replace himself with another Supervisor. If he does not do so, he must pay an additional $1,000.00, which is retained by the company. This additional cost is imposed because in failing to recruit an additional Supervisor in the promotional...