State Ex Rel. Corbin v. Challenge, Inc.

Citations: 725 P.2d 727; 151 Ariz. 20; 1986 Ariz. App. LEXIS 562Docket: 1 CA-CIV 7435

Court: Court of Appeals of Arizona; March 20, 1986; Arizona; State Appellate Court

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The Court of Appeals of Arizona addressed an appeal concerning a consumer fraud action against Challenge, Inc. and its officers, following a partial summary judgment that found the defendants liable for multiple violations of the Arizona Consumer Fraud Act. The court granted injunctive relief and ordered the defendants to pay over $2.5 million in civil penalties, restitution, costs, and attorney's fees. Key issues in this appeal included the existence of substantial material facts that could have prevented the granting of summary judgment, whether Challenge, Inc.'s marketing program constituted a "pyramid promotional scheme" or deceptive practice under Arizona law, and the appropriateness of the relief awarded. 

The facts indicated that Challenge, Inc., established in 1979, conducted motivational courses and marketed them through a structured recruitment process. The company's operations heavily relied on various seminars designed to recruit new sales trainees, which were integral to participating in its marketing program. The appeal highlighted the methods used to entice individuals into the sales structure, emphasizing the recruitment techniques that obscured details about the program's operations.

Sales Trainees earn a 20% commission on their own course sales, but cannot earn from fellow trainees. No purchase of courses is mandatory for this level, but sponsorship by an independent sales agent is required. Transitioning to Independent Sales Agent status—where commissions rise to 50% on personal sales and 30% on trainees’ sales—requires selling $5,000 worth of courses, approval from the sponsoring agent, attending a costly workshop, and recruiting two trainees. Sales figures show only 84 out of 4,908 courses sold to non-trainees by August 1, 1980. Independent agents in Arizona had all met the $5,000 sales requirement through personal course purchases. Affidavits indicate trainees were pressured to buy courses to validate their commitment and facilitate sales, with claims that success in selling is nearly impossible without personal purchase. Leadership and peer pressure strongly discouraged those who did not buy courses, effectively ostracizing them from the program. The cost of the Adventure Series was $4,600, plus $400 for promotional materials. Trainees faced challenges in selling courses to others, and within 60 days, they needed to meet the requirements to advance. Recruiting others was emphasized as more lucrative than retail sales, with potential recruits introduced to the program through seminars and workshops.

Sales trainees in the Challenge marketing program were instructed to assess whether prospects would find it worthwhile to invest $130 and two days of their time to learn about a potential income of $1,000 to $3,000 monthly from part-time work. Trainees were encouraged to project success and enthusiasm without disclosing details of the program. Their main goal was to recruit prospects and their spouses to attend related seminars and workshops, where prospects' interest in the money-making opportunity would be heightened, ultimately leading to their enrollment as sales trainees and pursuit of independent sales agent status. 

Affidavits indicated that recruitment was more challenging than suggested by Challenge leaders, and trainees were advised they could claim to have earned $1,000 through commissions on their own purchases of course materials. The state initiated legal action against the appellants and others on September 23, 1980, leading to a temporary injunction and extensive discovery. The state then sought partial summary judgment against certain defendants, which the trial court granted, directing the state to prepare findings and a judgment that included a proposed $1 million civil penalty, $1,510,100 in restitution, and $53,117.97 in costs. 

Appellants objected and requested reconsideration of the summary judgment, but their motions were denied. On appeal, they argued that genuine material facts existed that should have prevented the summary judgment. The court must view evidence favorably towards the opposing party and reverse the judgment if reasonable people could draw different conclusions regarding material facts. The state argued that Challenge’s program was fraudulent, citing two theories: it constituted a "pyramid scheme," which is inherently deceptive, and it involved misrepresentation of a legitimate money-making opportunity. Both parties cited varying standards for defining a "pyramid scheme" in their arguments.

The state relies on Federal Trade Commission (FTC) decisions and federal case law, guided by A.R.S. 44-1522(B), to determine violations of Arizona's Consumer Fraud Act. Pyramid schemes, while not explicitly defined in the federal law, are deemed inherently illegal due to their potential for deception. Federal cases identify two main characteristics of pyramid schemes: participants pay money for the right to sell a product and for the right to earn rewards from recruiting others, which are not tied to actual product sales. 

In contrast, Arizona's previous statute, A.R.S. 44-1731, defines a "chain or pyramid distributor scheme" as an illegal sales device requiring an investment for the right to recruit additional participants. This statute encompasses any profit gained through recruitment, irrespective of the presence of sales commissions. The state argues that Challenge's marketing plan fits this definition of a pyramid scheme. 

The court indicates it will use Arizona's definition rather than federal case law due to the legislature's explicit determination that such schemes are unlawful under A.R.S. 44-1522. Appellants failed to identify specific disputed material facts that would prevent summary judgment, instead generally referencing disputes in their opening brief.

The superior court determined that Challenge's sales marketing program and the retail sale of its courses were distinct activities and found no misleading or deceptive statements were made during the marketing. The court deemed the courses to be fairly priced. However, it improperly overlooked significant factual disputes, warranting a reversal of its partial summary judgment. Appellants argue that Edward Rector's affidavit, which includes positive testimonials from past participants, raises genuine issues of material fact. Although these testimonials counter negative statements, they do not legally affect whether Challenge's program constitutes a pyramid scheme. The court rejected the idea that Rector's claim about Challenge's efforts to be fair and truthful could raise genuine issues, as such conclusions are insufficient under Rule 56(e). Furthermore, claims regarding the confidentiality of course attendee lists and the intent behind the marketing program were deemed immaterial. The trial court's ruling that Challenge's marketing plan was a pyramid scheme was premature, as there remain significant doubts about factual disputes, especially regarding whether becoming an independent sales agent required purchasing courses. The principle established in previous cases dictates that any doubt about factual disputes should be resolved in favor of a trial.

Larry Seymour's affidavit regarding the Shooting Star Seminar states that attendees were informed they did not need to purchase courses to become salespersons, although the organization believed the courses were beneficial for personal and familial development. While they suggested course purchases, the decision was left to the individuals, most of whom reportedly waited about a month before buying. The purchase form clarified that it was solely for the items listed and did not grant rights to sell or receive compensation from Challenge, Inc., framing it as a retail sale. Quality control interviews confirmed participants understood there was no obligation to purchase to sell or train. The court's review is focused on whether there was a genuine issue of material fact and if only one inference could be drawn from the undisputed facts under Rule 56(c) of the Arizona Rules of Civil Procedure. The trial court's conclusion that Challenge's marketing program was an unlawful pyramid scheme under A.R.S. 44-1731 was deemed a reversible error for granting summary judgment. The North Carolina court case cited does not apply here as it defined pyramid schemes differently, emphasizing the need for participants to pay for recruitment opportunities. The evidence indicated that North Carolina participants had to purchase seminars to qualify as Independent Sales Agents, which raises questions about the existence of a condition requiring investment to recruit others. Additionally, there were genuine issues regarding the potential deceptiveness of earnings representations made during the seminars.

Mary Beall's affidavit indicated that Richard Mailman encouraged her to borrow money for purchasing Challenge courses, suggesting she could earn enough to repay the loan within six months. David Mills' affidavit noted statements from Larry Barnett and Larry Seymour of Challenge, Inc. claiming it was "not too difficult" to make money. However, given the evidence, it was not concluded that the representations were solely deceptive. The Shooting Star Seminar script warned that most people fail to earn significant money due to lack of effort, and the Monday Workshop instructed against using terms like "millionaire," "investment," or guaranteeing income. Alan Oakes' affidavit claimed a commission of $2,300 was possible with sufficient work. The court determined that genuine issues regarding material facts existed, making summary judgment inappropriate regarding potential deceptive statements in Challenge's marketing. Consequently, the judgment was reversed and remanded for trial, leaving unresolved the appellants' arguments about the judgment's relief provisions. While appellants sought attorney's fees on appeal under A.R.S. 12-348, the court clarified that this statute applies only to parties prevailing by adjudication on the merits, distinguishing it from A.R.S. 12-341.01. The request for attorney's fees was denied without prejudice, allowing for potential future requests if they prevail on the merits.

The trial court's judgment is reversed, and the case is remanded for further proceedings. Judges Greer and Haire concur with this decision. 

Key legal provisions discussed include A.R.S. § 44-1522, which defines unlawful practices involving deception or misrepresentation in the sale or advertisement of merchandise, regardless of whether any party was actually misled. It emphasizes the intent of the legislature to allow courts to consider interpretations by the Federal Trade Commission (FTC) and federal courts regarding similar deceptive practices under 15 U.S.C. § 45. 

Beekman and Mailman, who separately appealed, subsequently dismissed their appeal, which was officially ordered on March 30, 1984. The Federal Trade Commission Act also identifies unfair or deceptive acts as unlawful. 

A.R.S. § 44-1731, which was recently amended, maintains that violations prior to the new version's effective date are still prosecutable under the previous statute. The amended § 44-1732(C) states that violations of § 44-1731 are also unlawful under § 44-1522.

The text analyzes the requirement for sales trainees to attend a $375 ISA Workshop, suggesting it may constitute an "investment" related to A.R.S. § 44-1731(C), but notes that neither the state nor the trial court viewed this alone as evidence of a pyramid scheme. The critical issue is whether becoming an independent sales agent required a $5,000 self-purchase of the Adventure Series courses, with affidavits indicating that this was likely necessary to achieve the sales volume requirement.

Finally, A.R.S. § 12-341.01 allows for the award of reasonable attorney's fees to the prevailing party in contested contract actions.