Cellphone Termination Fee Cases
Not Reported in Cal.Rptr.3d, 2011 WL 976415 (2011)
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Rule of Law:
Under California Civil Code § 1671(d), a liquidated damages clause in a consumer contract is an unenforceable penalty unless the proponent proves it made a genuine, non-pretextual endeavor at the time of contracting to estimate a fair average compensation for the loss that would be sustained from a breach. A retrospective justification showing the fee was less than actual damages is insufficient to satisfy this 'reasonable endeavor' requirement.
Facts:
- Sprint Spectrum, L.P. (Sprint) offered one- and two-year term contracts for cellular service that included heavily subsidized handsets and lower monthly charges than its month-to-month plans.
- These term contracts required customers who cancelled service before the end of the term to pay a fixed Early Termination Fee (ETF).
- In 1999, Sprint studied and later implemented a $150 ETF primarily as a means to reduce its customer turnover rate, which it referred to as its 'chum' rate.
- Internal Sprint documents from that period referred to the ETF as a '$150 contract penalty fee' and a 'Penalty or Contract Cancellation Fee.'
- Sprint had no surviving documentation showing it conducted any analysis to estimate the actual damages (e.g., lost profits minus avoided costs) it would suffer from an early termination when it set the initial ETF amount.
- After merging with Nextel in 2005, Sprint increased its ETF to $200, basing the amount on Nextel's pre-existing fee, for which there was also no evidence of a cost study or damage analysis.
- The ETF was a flat fee, not prorated, meaning the customer paid the same amount regardless of when during the contract term the termination occurred.
Procedural Posture:
- Consumers filed class action lawsuits against Sprint in California state court, which were consolidated in Alameda County Superior Court, a trial court.
- The plaintiffs alleged Sprint's Early Termination Fee (ETF) was an unlawful penalty under California Civil Code § 1671.
- The trial court certified a class of California consumers who had been charged an ETF between July 1999 and March 2007.
- Sprint filed a cross-complaint against the class for breach of contract, seeking to offset any class recovery with its actual damages.
- A combined bench and jury trial was held; the judge decided the legality of the ETF, and the jury decided Sprint's actual damages.
- The trial court found the ETF was an unlawful penalty, enjoined its enforcement, and ordered restitution of $73.7 million to the class.
- The jury found that Sprint's actual damages ($225.7 million) exceeded the ETFs collected, creating a setoff that eliminated any monetary award for the class.
- The trial court then granted the plaintiffs' motion for a partial new trial on the issue of Sprint's actual damages, finding the jury had failed to follow instructions.
- Sprint appealed the trial court's judgment invalidating the ETF and the order for a new trial to the California Court of Appeal, First District. The plaintiffs cross-appealed.
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Issue:
Does an early termination fee (ETF) in a consumer wireless contract constitute an unlawful penalty under California Civil Code § 1671, subdivision (d), when the company imposing the fee did not engage in a reasonable endeavor to estimate its actual damages from a contract breach at the time the fee was established, even if the fee is later shown to be less than the company's actual damages?
Opinions:
Majority - Bruiniers, J.
Yes, an early termination fee is an unlawful penalty under these circumstances. To be valid under Civil Code § 1671(d), a liquidated damages provision in a consumer contract must satisfy a two-part test: (1) fixing actual damages must have been impracticable at the time of contracting, and (2) the amount selected must represent a reasonable endeavor to estimate fair compensation for the loss. While Sprint established impracticability, it failed the reasonable endeavor test. The court found that Sprint's motivation for the ETF was not to approximate its losses, but rather to deter customers from leaving and to match competitors' fees. The evidence, including internal documents calling the fee a 'penalty,' showed Sprint made 'no endeavor—reasonable or otherwise—to determine what losses it would sustain from breach.' The court rejected Sprint's argument that the ETF was valid because it ultimately proved to be less than its actual damages, holding that a post-hoc justification cannot substitute for the required analysis at the inception of the contract.
Analysis:
This decision solidifies the 'reasonable endeavor' test for liquidated damages in California consumer contracts, emphasizing the importance of the proponent's process and intent at the time the fee is established. It clarifies that the focus is on the contemporaneous analysis and motivation behind the fee, not merely its ultimate effect or a retrospective rationalization. The ruling places a significant burden on businesses to document their good-faith efforts to estimate potential losses when creating such fees, reinforcing consumer protections against punitive contract clauses. This precedent makes it more difficult for companies to defend arbitrarily set fees intended primarily for deterrent purposes, even if those fees turn out to be less than the actual damages sustained from a breach.
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