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WHEN IT’S ILLEGAL TO OFFER AN INCENTIVE FOR REFERRALS

WHEN IT’S ILLEGAL TO OFFER AN INCENTIVE FOR REFERRALS

If you’re trying to grow your business or want to bring more customers to your door, at some point you’re bound to consider implementing a referral program and incentives for making referrals.

Referral incentives involve offering a reward to your customers for sending new customers to you. Every time they refer someone (like their friends, family and colleagues) to your business and that person becomes a customer, you will give your existing customer something.

For example:

  • “Refer 5 friends and receive 25% off your next purchase”
  • “Sign up, refer 3 new clients and receive $200”
  • “Receive a free 5 year extended warranty if 2 friends you refer purchase a car from us”

Some referral selling practices are prohibited under Australian consumer protection laws.1 These laws apply to many businesses including financial services.

What is referral selling and why is it illegal?

Referral selling is when a person is persuaded (and often induced) to buy goods or services with the promise that they will receive a benefit, rebate or commission. Often referral selling can involve helping a business to offer or sell their goods or services to someone else.

The problem with referral selling is that it often means a person pays an inflated price, or one they cannot afford, for something. They do this because they believe they can recruit other customers and take advantage of the benefit, rebate or commission to reduce the overall cost of the product or service to them.

While some of these referral arrangements do offer legitimate rewards for referring customers, if they’re not structured correctly they can be illegal. There are stiff penalties for operating an illegal referral selling program. The penalties can be up to $1.1 million for a company, or $220,000 for an individual.2

There is a fine line between legal and illegal referral programs

In some situations, illegal referral arrangements may require a person to make a financial commitment upfront - buy this product or use our service. It’s that upfront payment that is often inflated. Once the person has parted with their money they can start to refer others and earn discounts, rebates or commissions.

Another type of referral program that is also illegal is when the person referring must purchase more before they can access their incentive. For example, “refer 5 friends and if they spend $100, we’ll give you a 25% discount off your next purchase”.

At the other end of the spectrum, legal referral arrangements are not as prescriptive. For example, spotter’s fees are legal because a person only refers potential prospects. The incentive is given when the referred person makes contact with the business, not when they buy anything. Essentially, a spotter’s fee isn’t a guarantee that you’ll win more business.

The simpler the referral arrangement the less likely it will be a problem. The key is making sure that there is a material connection between giving someone’s name and receiving the reward.

If the reward is only paid if you purchase products or services before or after the referral is made, then it’s important to seek legal advice.

How to set up a legal referral program

Here are several things you can do to make sure your referral program is legal:

  • Draft your terms and conditions well: Be clear how the referral program works and explain how a customer who refers someone can receive their reward. Doing this will help you identify if the arrangement may breach the law.
  • Keep the purchase separate from the reward: Make sure that the person’s decision to buy from your business is not related to their reward for helping you recruit new customers.
  • Identify the referrer: Ask the customer who has been referred to identify the person who referred them. This helps to create a material connection between the referral and the payment of the reward.

These tips can help you put together a legal referral program but they’re not a ‘cure-all’. All the elements of a referral program must support that there isn’t a material connection between the referral and the reward. It’s also important to make sure that your customers aren’t locked into any other unfair pricing or sales models.

If you are not sure whether your referral program is legal or would like advice on how to set one up, get in touch with Charmian Holmes or Anjelica Balis. We’d be happy to help.

Author: Anjelica Balis

March 2018

1 For financial services businesses, section 12DH of the Australian Securities Investments Commission Act 2001 (Cth) (ASIC Act) and other businesses, section 49 of Schedule 2 of Competition and Consumer Act 2010 (Cth) (the Australian Consumer Law).

2 These are the penalties under the Australian Consumer Law. Under section 12GB of the ASIC Act, they can be $2.1 million for a corporation and $420,000 for an individual.

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