Does the Law Allow Your ISP to Charge You High Fees When You Want to Cancel your Contract? A Washington Lawsuit Suggests the Answer May Sometimes Be No

Many Internet users rely upon high-speed connections provided by their phone or cable companies. Typically, their service contracts last for a fixed period of one year or more. But if users want to terminate the contract early, the contract imposes a fee of a few hundred dollars. Are such fees legal? In Seattle, two consumers -- the named plaintiffs in a class-action suit against Qwest - argue that the answer is no.

This suit is one of the first of its kind relating to the high-speed connection industry. However, as I discussed in a prior column, in recent months customers have fought similar early termination charges in their cell phone contracts. Lawsuits have challenged wireless carriers including Verizon, Sprint Nextel, AT&T and T-Mobile. In July 2008, a California court ruled that Sprint must refund or not collect about $73 million in early-termination fees for which it had billed its customers. Verizon settled its early-termination lawsuits for $21 million.

In this column, I will discuss the basis for the lawsuit against Qwest regarding its provision of high-speed Internet service. The suit raises two questions: Did the customers agree to a two-year contract in the first place? If so, does Washington law allow them to be charged a $200 fee for terminating before the two years expire? As I will explain, the answer to the second question will turn on facts regarding whether the amount of the fee is connected to any actual harm or damage Qwest incurs when customers terminate their service early.

Did The Customers Have a Two-Year or Month-to-Month Contract?

In the suit against Qwest, the named plaintiffs claim that when they ordered their Internet service, or upgraded it, they were never informed that they were signing up for a fixed-term contract, with a hefty termination fee of $200 - over six times the monthly $30 fee.

The first plaintiff, Ronin Vernon, alleges that the facts in her case were as follows: She subscribed in 2005, and called to cancel her service in May 2008 Qwest then billed her for $200 - the early termination fee. When she called to inquire about the fee, Qwest claimed her husband had agreed to a fixed two-year term about two years after they had originally subscribed with Qwest. Vernon asked for a copy of the written contract - and Qwest was unable to produce it. Qwest then said her husband had agreed to a two-year term orally, over the phone, but provided no recording or other evidence to prove that. Ms. Vernon alleges that one service representative even went so far as to tell her, "You'll be sorry" before abruptly hanging up.

The second plaintiff, Rory Durkin, alleges that he subscribed to Qwest's Internet service in 2004 and upgraded to high-speed in 2007. In February 2008, when his computer broke, he called to cancel his service. But Qwest told him - for the first time ever, he alleges - that he had orally agreed to a two-year contract with a $200 termination fee. To avoid the fee, Durkin kept paying for his service even though his computer remained broken. In October of 2008, he cancelled even though Qwest once again insisted he must pay the $200 fee. .

Assuming these allegations are correct, it seems that neither plaintiff agreed to - or should be bound by -- the two-year term or the $200 fee. Granted, companies do not need to spell out or read every term of a contract to customers - which would take hours or days. Typically, however, companies do need to make consumers aware of the contract's key or essential terms - and its duration and any early-cancellation fee are surely critical terms.

Accordingly, the Washington court may well hold that the termination fees are invalid and that plaintiffs' contracts were month-to-month. Such a holding may benefit other customers in situations similar to Vernon's and Durkin's.

But what about the larger question of whether companies can impose such a high termination fee if they do prominently disclose it to the customer beforehand?

If Early Termination Fees Are Disclosed, Are They Legal?

From a policy perspective, high termination fees may be undesirable because they allow companies to lock in customers and discourage competition. From a contract law perspective, their validity turns on whether they constitute illegal "penalties."

A fee (such as a cancellation fee) is a "penalty" under the law of contracts if it corresponds to some actual harm that the party imposing the penalty will suffer as a result of early termination. In the suit against Qwest, the plaintiffs contend that there is no connection between the fee and any harm Qwest suffers from termination.

In support of their argument, they note that the same fee is imposed no matter how long or short a time a service-user has been a Qwest customer. That fact, if proven, would undermine the argument that for every customer, Qwest invests initial start-up costs (such as the cost of setup and initial customer service representative time) that are then recouped each month through the monthly fee, and are only fully recouped at the two-year mark. If that were so, then the company would logically charge a customer a much lower termination fee if they used the service for twenty months, than if they used it for ten.

Suppose plaintiffs do prove the current fee is a penalty. Qwest and other high-speech Internet providers could then, for the future, adopt legal pricing policies, which would also be fairer for the very reason that they would link fees to actual damages. One option would be just to charge for installation when it occurs, rather than recouping that cost over the contract term - but that might cause the providers to lose customers who don't want to pay a large sum up front. Another option would be to simply raise monthly rates. Finally, another - and perhaps the best option - would be to use a pro-rated early-termination fee. Unlike a higher monthly fee, the pro-rated early-termination fee would be charged to only those customers for whom the company did not yet recoup account start-up costs. Assuming this approach were disclosed in advance, it might be the fairest solution of all, connecting specific customer choices and company costs to the fee incurred.

The plaintiffs in the Qwest suit may have other hurdles to clear. For instance, Qwest's contract also calls for arbitration, meaning that, if the arbitration clause is enforced, we may not see a judicial decision arise out of this suit. But based on the results and settlements in the parallel cellphone termination fee cases, the writing is on the wall: Providers of high-speed Internet should link their fees more directly to their costs, and if they don't, they may well pay the price.

Anita Ramasastry is the D. Wayne and Anne Gittinger Professor of Law at the University of Washington School of Law in Seattle and a Director of the Shidler Center for Law, Commerce & Technology. She has previously written on business law, cyberlaw, computer data security issues, and other legal issues for this site, which contains an archive of her columns.