A district court rules that a mandatory arbitration requirement in Blockbuster, Inc.’s online contract is illusory and unenforceable against customers because Blockbuster maintained the right to modify the terms of the contract at any time.

In its opinion in Harris v. Blockbuster, Inc., No. 3:09-cv-217-M (N.D. Tex., April 14, 2009), the federal district court for the Northern District of Texas refused to enforce the arbitration provision in Blockbuster’s “Terms and Conditions” online user agreement because the agreement also included a provision that permitted Blockbuster to modify the terms of the agreement at any time and that the modifications would become effective immediately upon posting. According to the court, such unilateral power rendered the arbitration provision both illusory and invalid. In reaching its decision, the court relied on the fact that the Blockbuster agreement did not expressly state that modifications would apply only prospectively. It is a common business practice for social networking websites, online services, and other websites to reserve the right to modify their online contract terms at any time. While the Blockbuster decision could be interpreted narrowly to apply only to arbitration provisions, a broader reading suggests that any provision in a contract in which the website owner/service provider has reserved such a right to modify terms unilaterally, and even the contract as a whole, could be challenged as being illusory.

Background

The Blockbuster case arose out of a prospective class action lawsuit filed last year by Cathryn Elaine Harris, a Texas resident, against the video rental company Blockbuster, Inc., in which Harris alleged that Blockbuster violated the Video Privacy Protection Act of 19881 by transmitting to third parties information about customers’ video selections.

Blockbuster’s website enables customers to rent videos that can be either downloaded or delivered via postal mail. As part of an advertising initiative with the social networking website Facebook.com, a Blockbuster customer’s video rentals were automatically posted on that customer’s Facebook profile and shared with Facebook friends of such customer. Harris argued that this initiative violated the Video Privacy Protection Act.

The Video Privacy Protection Act was enacted into law after the video rental records of U.S. Supreme Court nominee Robert Bork were leaked to the press. This federal law prohibits video rental companies from disclosing personally identifiable information, including movie selections, without the informed written consent of the customer, and it provides for liquidated damages in the amount of $2,500 for each violation.

Upon the filing of Harris’ lawsuit, Blockbuster tried to move Harris’ complaint out of the courtroom by relying on the alternative dispute resolution provision in its website’s Terms and Conditions. In its motion to compel arbitration, Blockbuster asserted that, as a precondition to using the services offered via Blockbuster’s website, customers are required to click on a box certifying that they have read and agreed to Blockbuster’s Terms and Conditions, which include a requirement that “[a]ll claims, disputes, or controversies … will be referred to and determined by binding arbitration.”

Harris argued that the arbitration provision in Blockbuster’s Terms and Conditions was unenforceable because Blockbuster had reserved for itself the unilateral right to modify its Terms and Conditions.2 The district court agreed. “In Texas, a contract must be supported by consideration, and if it is not, it is illusory and cannot be enforced,” the court explained in its decision.

Analysis

In reaching its decision, the Blockbuster court analyzed the Fifth Circuit court’s recent opinion in Morrison v. Amway Corp.3 In Morrison, Amway, a seller of household products, was sued by a group of Amway’s distributors who alleged a variety of tort claims against Amway. Each distributor had entered into a distributorship agreement with Amway, in which the distributor agreed to abide by Amway’s Code of Ethics and Rules of Conduct “as amended and published from time to time.” Distributors were required to renew their agreements annually, either through automatic renewal or by submitting a renewal form. After some disputes had arisen between Amway’s distributors and Amway, Amway amended its Rules of Conduct to include an arbitration agreement and notified distributors that the amendment would take effect at the beginning of the following year. The distributors filed a lawsuit against Amway after the amendment had become effective, alleging claims that had arisen before the amendment had become effective. Amway sought to enforce the arbitration requirement and the district court for the Southern District of Texas stayed the lawsuit pending arbitration. After the arbitrator had made its ruling, the distributors appealed the initial order compelling arbitration. In its analysis, the Fifth Circuit cited two prior Texas Supreme Court cases, including one in which the Texas Supreme Court had upheld an arbitration requirement in which one party had the unilateral right to modify the underlying agreement, because the agreement expressly permitted disputes arising prior to the date of modification to be adjudicated, and, another in which the Texas Supreme Court had invalidated another arbitration provision as “illusory” because it failed to so provide for handling prior disputes. The Fifth Circuit focused on the fact that Amway’s reserved right to modify terms did not expressly exempt disputes arising, or arising out of events occurring, before the effective date of the amendment. For that reason, the Fifth Circuit declared the purported arbitration requirement illusory and unenforceable and remanded the case for further proceedings.

Applying the Morrison precedent, the Blockbuster court focused on the provision in Blockbuster’s Terms and Conditions that gave Blockbuster the power to unilaterally modify any part of the contract:

Blockbuster may at any time, and at its sole discretion, modify these Terms and Conditions of Use, including without limitation the Privacy Policy, with or without notice. Such modifications will be effective immediately upon posting. You agree to review these Terms and Conditions of Use periodically and your continued use of this Site following such modifications will indicate your acceptance of these modified Terms and Conditions of Use. If you do not agree to any modification of these Terms and Conditions of Use, you must immediately stop using this Site.

The Blockbuster court noted that “[h]ere, as in Morrison, there is nothing in the Terms and Conditions that prevents Blockbuster from unilaterally changing any part of the contract other than providing that such changes will not take effect until posted on the website.” Therefore, the Blockbuster court concluded, “the Blockbuster arbitration provision is illusory for the same reasons as that in Morrison.”

The Blockbuster court rejected Blockbuster’s attempt to distinguish the Blockbuster case from the Morrison case based on the fact that the unilateral modification clause was never actually invoked. Unlike Amway, Blockbuster was not trying to apply an arbitration provision that had been added to the agreement after the fact — customers had agreed to be bound by Blockbuster’s arbitration provision as part of Blockbuster’s online registration process. According to the Blockbuster court, the distinction is irrelevant because it was not Amway’s attempt to apply the provision retroactively that led the Fifth Circuit to declare the provision illusory in Morrison; rather, it was Amway’s ability “to unilaterally change the rules of the game” at any time. The Blockbuster court concluded that “the Morrison rule applies even when no modification has been attempted.”

Conclusion and Recommendations

It is too early to tell how influential the district court’s decision in this case will be — decisions of district courts do not hold precedential value — or how this ruling will fare on appeal to the Fifth Circuit; however, companies should examine their online contracts (including terms of use, acceptable use policies, privacy policies, and other user agreements) in light of the Blockbuster holding.

Arguably, the holding in Blockbuster is a very limited one relating solely to the unenforceability of the arbitration provision in Blockbuster online service terms. The opinion specifically states that the court “concludes that the arbitration provision of the Blockbuster contract is illusory and unenforceable” (emphasis added). In this regard, this case is similar to other precedent — a number of courts have taken a critical view towards dispute resolution clauses in online consumer contracts.4

However, dicta in the Blockbuster opinion suggests that other provisions, or even the Terms and Conditions in its entirety, may be found to be illusory because of Blockbuster’s reserved right to unilaterally modify contract terms. The court specifically mentions in its opinion that Blockbuster’s Terms and Conditions also required users to waive their rights to commence any class action; however, despite the fact that Harris intends to proceed as a class action lawsuit, the court does not discuss further this waiver and whether it also is illusory.5 Also, in one sentence of the opinion, the Blockbuster court broadly states that it has determined that the “Blockbuster contract is illusory,” suggesting that the court found the contract as a whole unenforceable because of Blockbuster’s right to modify unilaterally the terms at any time.

A recent Ninth Circuit court decision made it advisable for service providers to provide notice to customers prior to modifying online contract terms.6 The Blockbuster decision goes a lot further, calling into question the very standard business practice of including in online contracts the right to change the contract’s terms unilaterally. By maintaining a unilateral modification right, there is a risk that a court will find some — and perhaps all — provisions of the contract illusory.

A company that decides to keep a unilateral modification right in its online contracts pending future case law development should, at a minimum, take the following steps:

  • Limit the scope of the right. The Blockbuster case makes it advisable for companies to make it clear in their online contract terms that any amendment applies only from the date on which it is added to the contract and that amended dispute resolution procedures do not apply to any dispute of which the parties had actual notice on or prior to the date of the amendment.
  • Include a severability provision. A severability provision states that if parts of the contract are held to be illegal or otherwise unenforceable, the remainder of the contract should still apply. The Blockbuster opinion does not address severability, however, depending on the nature of the contract and the contract’s governing law, a severability provision arguably could mitigate a company’s risk.7