We have written previously regarding the pitfalls of online contract formation, including where website operators fail to implement website terms in a manner that requires users to expressly accept such terms. A recent California case, however, shows that even a properly formed online contract may be unenforceable if its terms are overly harsh and one-sided. Given that website terms are routinely drafted to be favorable to the website operator rather than the user, this case serves as a reminder that contract formation is not the only issue that must be considered when discussing the enforceability of online contracts. 

The case, MacKinnon v. IMVU, Inc., was brought as a putative class action by plaintiff Peter MacKinnon, a user of defendant IMVU’s instant messaging virtual universe. The IMVU application allows users to create avatars that can interact with other users’ avatars. Users can also acquire products for their avatars using online credits, which are purchased with real money. The available products include audio products created by users who submit them for inclusion in IMVU’s virtual catalog.

MacKinnon joined IMVU in October 2009. Shortly after joining, MacKinnon became aware of an IMVU policy first announced in 2008 stating that, because of bandwidth issues, any “new [audio] products submitted . . . would be cut down to 20 seconds.” MacKinnon subsequently spent hundreds of dollars for IMVU audio products, which he tested to ensure that they were “full length and had not been limited by IMVU to 20 seconds.”  However, on January 31, 2011, IMVU applied the 20-second limit to all audio products, allowing refunds only for purchases made on or after December 1, 2010.

As a result, on June 6, 2011, MacKinnon filed a seven-count first amended complaint against IMVU, asserting claims for violation of various consumer protection statutes, as well as for conversion, breach of contract and negligent misrepresentation. While MacKinnon asserted a large number of claims, they were all premised on the underlying theory that IMVU misled users into believing they would be able to play the full-length versions of the audio products they purchased as long as they used IMVU. The lower court dismissed MacKinnon’s first complaint and then sustained a demurrer as to his second complaint, holding that the IMVU Terms of Service (the “Terms”) unambiguously allowed IMVU to truncate audio products. MacKinnon appealed. 

The Court of Appeal first noted that, in order to create an IMVU account, a user must click a “Create My Account” button, which is accompanied by text stating “by clicking Create IMVU Account you are indicating that you have read and agree to the Terms of Service Agreement and Privacy Policy.” A link to the Terms and the IMVU privacy policy are also provided. Unlike courts in some prior cases, the court in MacKinnon did not delve into the contract formation issues that this type of terms-of-service implementation can raise. Instead, the court seemed to take as a given that MacKinnon accepted the Terms and proceeded to interpret the meaning of the contract formed between MacKinnon and IMVU.

The court noted that the Terms expressly provided that “all virtual products are non-refundable” and that this provision would apply to the audio products in dispute. Further, the Terms unambiguously authorized IMVU to unilaterally remove or change such products without offering any compensation. If enforceable, therefore, the Terms would undermine the majority of MacKinnon’s claims, since—as noted above—the fundamental harm complained of was IMVU’s allegedly misleading and unauthorized truncation of the audio products. This is where the case gets interesting, and potentially troubling for website operators.

Among MacKinnon’s claims were that the Terms were unenforceable because they were unconscionable, and that IMVU had breached the covenant of good faith and fair dealing under California law. First the court examined whether the Terms were procedurally unconscionable. The court noted that there was at least a degree of procedural unconscionability, given that the Terms were provided on a take-it-or-leave-it basis with no opportunity for MacKinnon to negotiate, but that the availability of market alternatives to IMVU’s service, the non-essential nature of the service, and the fact that the no-refund provision was not hidden within the Terms all suggested that only a low degree of procedural unconscionability was present.

After determining that there was a low degree of procedural unconscionability, the court examined whether the Terms were substantively unconscionable. The court observed that “[s]ubstantive unconscionability pertains to the fairness of an agreement’s actual terms,” and noted that contracts must not impose terms that are “overly harsh,” “unduly oppressive,” or one-sided to a degree that would “shock the conscience.” The issue at hand was whether IMVU’s no-refund provision, which permitted IMVU to alter or even entirely remove audio products that users had paid for, met this standard for substantive unconscionability. The court held that, on the record in the case, it could not make a determination one way or the other on the unconscionability issue, which would require analysis of the no-refund provision’s “commercial setting, purpose, and effect.” Accordingly, the court concluded that the lower court had erred in holding that the Terms were conscionable (and, therefore, enforceable) as a matter of law. Given this holding, the court also rejected the demurrer as to MacKinnon’s unconscionability-based claim under the California Consumer Legal Remedies Act.

With regard to MacKinnon’s claim for breach of the covenant of good faith and fair dealing, the court noted that, where a contract grants one party discretionary power, that party is required to exercise such discretion in good faith and in accordance with fair dealing. At the same time, however, “courts are not at liberty to imply a covenant directly at odds with a contract’s express grant of discretionary power except in those relatively rare instances when reading the provision literally would, contrary to the parties’ clear intention, result in an unenforceable, illusory agreement.” In this case, the no-refund provision granted IMVU discretionary power to alter or remove audio products and, if the provision was enforceable, then “no covenant of good faith and fair dealing can be implied which forbids” IMVU from exercising that power. In light of MacKinnon’s assertions of unconscionability, however, the court held that MacKinnon had successfully stated a claim for breach of the covenant of good faith and fair dealing.

Finally, the court held that MacKinnon was entitled to amend his false advertising law and misrepresentation claims to state a cause of action based on the September 2008 announcement. In addition, the court held that MacKinnon was further entitled to reassert conversion and breach of contract claims. However, the court upheld the dismissal of MacKinnon’s breach of warranty claim under the Song-Beverly Act because MacKinnon did not purchase the audio products in California (MacKinnon resides in Utah). 

It remains to be seen how the superior court will rule on MacKinnon’s claims and, in particu lar, whether the no-refund provision in the IMVU Terms will ultimately be held to be unenforceable.  In the meantime, given that website terms often include provisions that are seemingly no more “harsh,” “oppressive” or “one-sided” than was the IMVU no-refund provision, website operators may wish to review their existing terms in light of the MacKinnon case. In particular, MacKinnon suggests that unilateral amendments of website terms that impact users’ previous purchases without adequate compensation may be suspect.