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Saying Goodbye to Your Cellphone Carrier Just Got Cheaper, Thanks to a California Ruling: Why the Court's Decision was Correct, but Is Only Part of a Longer Story


Tuesday, Aug. 12, 2008

If you have a cellphone, you are probably familiar with the fact that if you cancel your contract with your carrier prematurely, you may have to pay a whopping termination fee – up to $200. If you have a family plan, that fee might be even larger. So, you often find yourself locked into a particular cellphone carrier’s service for several years at a time. However, this situation may change, thanks to a recent judicial decision that will offer cellphone users at least temporary relief.

In late July, a California court issued a preliminary ruling holding that cellphone carrier Sprint Nextel was illegally imposing early termination fees on its customers. The judge ordered the wireless carrier to repay former customers around $18.2 million in early-termination fees, and to stop trying to collect an additional $54.7 million from customers who had refused or simply had not yet paid these fees.

The ruling is only a temporary ruling, and the judge will hear additional arguments and entertain additional evidence. Still, it represents a major blow to Sprint and other carriers.

In this column, I will discuss the basis of the lawsuit and explain why, under state law, the judge’s ruling was likely correct. At the same time, I will explain why this is probably not the end of the story: Cellphone companies may push for federal regulation allowing the early-termination fees or may simply raise the cost of the phones they sell.

The Cellphone Termination Lawsuits

In 2006, cellphone users commenced a series of lawsuits again the major cellphone companies including Sprint Nextel, AT&T, and Verizon, alleging the carriers violated California’s unfair business practices law. More specifically, the plaintiffs claimed that the early-termination fees constituted an illegal penalty, rather than a lawful fee.

Cellphone carriers, in contrast, defend the fees as necessary so they can recoup the cost of cellphones which they offer to consumers at a low, subsidized price. (AT&T offers the iPhone for $199, for example, but requires customers to subscribe to AT&T’s service for two years.)

In the California case, a jury found that Sprint customers had breached their contracts by terminating their service early, but the judge’s ruling mooted the jury’s finding – for the jury found (at least as a preliminary matter) that the term of the contract that imposed the fees was illegal.

Verizon Wireless agreed to pay $21 million to settle all claims against the company in a separate lawsuit. Moreover, in light of the initial decision against Sprit, we may see other cell phone carriers settle as well.

Why The Court’s Decision Was the Correct One

Although the judge has reserved the right to reverse her initial decision, she shouldn’t; it was the right one.

Under California law, contracts may contain a “liquidated damages” clause stating the damages one side must pay if it breaches the contract. But the amount stated, under the law, must represent a reasonable estimate of damages – not what the law calls a “penalty.”

A penalty is a fee that fails the test of bearing some relationship to actual or expected damages. And according to the judge’s initial ruling, Sprint Nextel’s fees failed that test. According to the ruling, the contracts were "implemented primarily as a means to discourage customers from leaving" – not to liquidate the true costs of a customer’s leaving early. Indeed, the judge wrote, "[t]here was no evidence at trial that [Sprint Nextel] did a damage analysis that considered the lost revenue from contracts, the avoidable costs, or Nextel's expected lost profits from contract terminations.”

Early Termination Fees May Be Replaced By Other Cost Hikes

Is this the end of the story? The answer is no. For one thing, the California ruling is certain to be appealed. In addition, even if the California ruling stands, and other courts in other states rules similarly, the cellphone companies have a variety of options short of simply giving up the imposition of early-termination fees.

First, they may get relief from the federal government. The Federal Communications Commission (FCC) is currently reviewing a proposal put forth by FCC Chairman Kevin Martin that would give the FCC authority to regulate these fees. Reclassifying the fees as “rates” could allow them to be regulated by the FCC as part of the telecommunications sector. Martin has proposed a sliding scaled for termination fees – with fees diminishing the longer a customer retained her cell phone service.

In June 2008, the FCC held a hearing on the proposal. Consumer groups and peeved customers complained about the steep early termination fees. Still, if the proposal is adopted, it could permit early-termination fees – and even attempt to do so retroactively, preempting state laws like California’s as applied to past as well as current and future customers.

Even without FCC intervention or a federal law in their favor, the cellphone companies still have options. They could stop offering low-priced phones with their contracts. They could also do their homework and assess the actual costs of early cell phone termination (including non-recoupment of the discount for the low-priced phone) and set their early-termination fees accordingly.

One step toward showing the fees are not a “penalty” would be to prorate them so that customers who terminate later in their contract pay less. Verizon Wireless was the first to offer pro-rated early termination fees. Now AT&T and T-Mobile plan to do the same, and Sprint Nextel said it will do so later this year. While customers may still feel the fees are unfair, at least the companies – prompted by the recent litigation – have made a move in a fairer direction.

Anita Ramasastry is a visiting professor at the National University of Ireland - Galway and an Associate 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.

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