A judge of the Superior Court of California recently ordered Sprint Nextel to pay $18.25 million to Sprint customers who paid early termination fees (ETFs) and to cease collecting $54.75 million in charged ETFs. The judge determined that Sprint’s ETF was an unlawful penalty and, therefore, violated California unfair business practices law.

ETFs are fees charged to customers who leave their wireless contracts before the contract term ends and often range between $150 and $200. Wireless carriers assert that ETFs and long-term contracts are needed to guarantee revenue and offset the costs of subsidizing handsets.

California cellphone customers commenced a class action lawsuit against Sprint, claiming that the ETF provision in Sprint’s cell phone contracts was not a valid liquidated damages clause under California law. They sought to recover ETFs paid over a certain period and to stop Sprint from collecting any further ETFs that had been charged.

Under California law, a liquidated damages provision in a consumer contract is lawful if the “liquidated damages represent a reasonable endeavour by the parties to estimate the fair compensation for the loss sustained.” To determine whether a reasonable endeavour has been made, the courts consider the motivation and purpose in imposing the charges and the effect of the charges.

In this case, the judge found that:

  • Sprint decided to introduce ETFs to decrease customer “churn” (the number of customers who leave for another provider); 
  • in adopting and setting the rate of the ETFs, Sprint considered “whether the competition had similar contracts and ETFs, whether customers would sign up with contracts with ETFs, and how the different amounts of ETFs would impact financially”; and 
  • to assess the financial impact of ETFs, Sprint “analyzed different scenarios and considered the profitability of the proposed pricing change, but it did not estimate damages caused by a potential breach.”

Since Sprint’s motivation for introducing the ETFs was to decrease churn, and since it did not conduct a damages analysis to estimate its actual damages, the court determined that Sprint had not made a reasonable endeavour to approximate its actual damages. Therefore, the court concluded the ETF provision was not a lawful liquidated damages clause under California law.

A jury had previously found that the class members had breached their contracts with Sprint in terminating their contracts early and that Sprint suffered $226 million in damages. However, because the jury appeared to assume the ETFs were valid, the judge did not give effect to the jury’s ruling.

Sprint had argued that federal law had preempted the claims, which were based on state law. Under the Federal Communications Act, the rates charged by wireless carriers are regulated federally. The judge rejected this argument, finding that ETFs are not “rates” and therefore California law was not pre-empted. She pointed to the fact that Sprint charged an ETF when a contract was broken, not during the course of contract. In addition, Sprint’s ETF was a fixed sum that did not vary with the services provided.

McCarthy Tétrault Notes:

The Sprint decision is reportedly the first ruling in the United States to declare ETFs illegal in a state. It should be noted, however, that the decision is a tentative ruling and both parties have filed statements of objection. Thus, the judge will hear further arguments before a final decision is rendered. As well, there is the possibility that Sprint may appeal.

The Federal Communications Commission (FCC), which regulates the telecommunications industry in the United States, may also decide to step in and oversee this area. Back in June, the FCC conducted a hearing to determine whether it should regulate ETFs. At that hearing, the FCC chairman proposed that ETFs be pro-rated over the life of the contract and some cellphone carriers in the United States have adopted this practice.

In Canada, it is common practice for wireless carriers to require payment of fees when customers terminate a service contract prior to the end of the contracted term. Frequently, the customer will have received some sort of handset discount or other financial advantage by signing a multiyear agreement. The ETF is typically based on payment of the greater of a fixed amount (e.g., $100) and a variable amount (e.g., $20 per month multiplied by the number of months remaining in the service contract) and sometimes subject to an overall maximum payment amount.

The Canadian Radio-television and Telecommunications Commission (CRTC) has forborne from regulating rates charged by wireless carriers for wireless telephone services. It still does regulate rates charged by incumbent telephone companies for certain wireline telecommunications services in some areas. Where the CRTC does regulate service rates, its regulatory jurisdiction will extend to applicable ETFs that carriers may charge.

The following case illustrates how the CRTC handled a wireline service complaint about an ETF charged to a business customer. In Telecom Order CRTC 2004 307, issued by the CRTC in 2004, the CRTC ruled on a complaint by a customer of Bell Canada’s local link business telephone services. The customer terminated use of the service prior to the term of his service contract and was charged a $170 ETF. The CRTC upheld Bell Canada’s tariffed termination charge. The CRTC considered that the issue in dispute related principally to whether or not the complainant had consented to Bell Canada’s tariffed service terms on an informed basis. Ultimately, the CRTC found that Bell Canada had obtained valid consent and that the ETF was properly applied.