Analysis of Various Provisions in Cell-Phone Contracts

I. Introduction

A. Background

Cell phones are ubiquitous.  They are people’s preferred method of communication, and they are almost essential to surviving in this world.  However, at any given time, most cell-phone users are in a “cell-phone jail.”[1]  They are locked into their cell-phone contracts,[2] so they cannot behave like rational consumers in a market economy: they cannot go out and buy a new cell phone when there is a good deal; they cannot switch cell phone carriers if a competitor is offering a better deal.[3]  This is because cell-phone service providers usually charge “early termination fees” (ETFs) for canceling service.  The fee, which ranges from $175 to $200, is usually big enough to discourage users from canceling or switching service providers.  The element of competition ensures companies to keep improving themselves to survive.  Without it, companies have no motivation to enhance their service, and as a result, consumers suffer.[4]

ETFs are not the only injustice in cell-phone contracts.  Late fees, various surcharges, mandatory arbitration, and unilateral contract modification pose problems to consumers as well.  The problem is exacerbated by the adhesionary nature of these contracts;[5] consumers are unable to negotiate over these terms that are possibly damaging to their interests.

In 2002, Senator Charles Schumer from New York recognized this problem and proposed “The Cell Phone User Bill of Rights.”[6]  He stated, “For years, cell phone consumers were forced to stick with bad service or expensive contracts” because they did not want to lose their phone numbers.[7]  The proposal was aimed at “improving wireless service and making competition an ingrained part of the wireless industry”[8] by adopting number portability[9] and allowing consumers to switch carriers more freely.[10]  Since then, number portability has become a standard practice.  Also, in May 2004, California became the first state to adopt consumer protections for cell phone customers,[11] and now other states are trying to adopt similar cell phone users’ bills of rights.[12]

B. Scope of This Article

This article covers late fees, early termination fees, contract modification clauses, and mandatory arbitration clauses in cell-phone contracts.  These four types of clauses draw the most attention and are likely to have tangible effects on consumers.  In addition to these, a typical cell-phone contract contains many other clauses, including assignability, severability, disclaimer of warranties, limitation of liability, indemnification, full integration, and third-party beneficiary clauses.[13]

In addition to what is specified in cell-phone contracts, deceptive practices employed by wireless providers also pose a threat to consumers.  Send-to-end billing policy[14] may be deceptive since the actual timer displayed on the screen starts counting once the call is picked up or goes to voicemail, not as soon as the send button is pressed.  Another example is AT&T’s data plan.  If customers make changes to their data plans, they cannot view their data usage until the next billing cycle.[15]  Thus, they are unable to check how many texts they have sent, and thus are more likely to exceed their monthly limits and incur expensive overage charges.  These deceptive practices employed by wireless providers are not within the scope of this article.

This article assesses the fairness of various cell-phone contracts written by the ten largest wireless service providers.  Part II summarizes what each contract provision specifies.  Part III analyzes relevant cases and settlements to see how the courts are interpreting the contract provisions.  Part IV suggests possible improvements that could make the provisions fairer.  Part V is a conclusion.

II. Summary of Findings

A. Late Fees

Late fees imposed by cell-phone companies are pretty standard—usually either $5 or 1.5% of the balance due.  The exception is MetroPCS, whose contract states that MetroPCS may suspend or terminate a user’s account if the monthly payment is late.  However, all that the contract specifies regarding this matter is this: “If your Service is terminated and you promptly pay amounts that are overdue, MetroPCS, in its sole discretion, may reconnect your Service after you have paid any reconnection fees we have imposed.”[16]  Thus, MetroPCS technically has no late fees.[17]  If a users misses a payment due date, his or her service will automatically be interrupted until the payment is made.[18]  However, if a user misses a payment twice in a row or if the payment is more than 30 days late, MetroPCS will charge a reconnect fee.  It has been reported that customers get charged for their monthly service—and late fees if applicable—even after the phone has been disconnected.[19]

The wireless providers without long-term contracts—TracFone, MetroPCS, Virgin Mobile, and Cricket—do not charge late fees.  With TracFone, a wireless carrier with only prepaid phones, the concept of late payment does not exist because no monthly payment is required (although prepaid minutes may expire after a certain period of nonpayment).[20]  However, the other three carriers have plans in which users are required to make monthly payments.[21]  As stated above, MetroPCS charges a reconnect fee if a user misses his or her payment twice in a row or if the payment is more than 30 days late.[22]  Cricket’s contract suggests that a user will always be charged either a reconnection or reinstatement fee if his or her payment is late.[23]

B. Early Termination Fee

A typical cell-phone contract lasts for 2 years.[24]  An early termination occurs when a cell-phone user ends his or her service before the contract term expires.  In addition to voluntary cancellation by the customer, a termination can occur if the service provider receives a request to port a number to a new service provider,[25] if the user breaches the contract, or for any reason that the company deems a “good cause.”[26]

For the four major wireless carriers, the early termination fees are either $175 (Verizon[27] and AT&T) or $200 (Sprint and T-Mobile). U.S. Cellular charges an early termination fee specified in the user agreement.[28]  All of them are prorated; the longer the user has been in the contract, the less he or she has to pay for terminating early.  For example, Verizon and AT&T subtract $5 from their ETFs ($175) for each month that the user has been in the contract.[29]  Sprint, T-Mobile and U.S. Cellular use different proration policies, but the end result is similar.[30]

The wireless providers without long-term contracts do not charge early termination fees.

C. Contract Modification

All cell-phone service providers reserve the right to modify their contracts at any time.  Where they differ is whether they will notify their customers and how long they allow their customers the option of terminating without paying ETFs.  Customers usually agree to be bound by the changes by continuing to use the service.[31]  If a change is material and adverse—including any kind of price increase—customers can terminate early on that ground without paying the ETF.[32]  For instance, Verizon allows its customers 60 days, and the others, 30 days.[33]  Most providers will notify you of material changes[34]; however, TracFone and Cricket are not required to notify their customers of material changes, and any modification to the contract becomes effective once it is posted on their websites.[35]  Cricket may choose to notify its customers instead of posting the changes on its website.[36]

D. Mandatory Arbitration

Arbitration is a method of dispute resolution alternative to lawsuit.  It was first introduced as a cheaper and speedier substitute for litigation in court, but it has its own disadvantages as well, which will later be explored.  A mandatory arbitration clause, which is included in most cell-phone contracts, prevents customers from pursuing their claims in court.  In addition to agreeing to arbitrate every claim, consumers usually waive their rights to jury trial and class action[37] when they sign up for cell-phone service.[38]  Virgin Mobile is the only provider whose contract does not have a mandatory arbitration clause.[39]  Cricket’s contract has an arbitration clause, but it does not require customers to waive their rights to jury trial or class action.  Interestingly, T-Mobile and Cricket offer their customers the option to opt out of the arbitration clause.[40]  In hopes of eliminating the prohibitive effect their class action waivers may have on customers’ small claims, the four major wireless providers—Verizon, AT&T, Sprint, and T-Mobile—agree to pay the filing and administrative fees for arbitration.[41]

Most of these mandatory arbitration clauses are stated in bold, capital letters.  Some contain warnings like “Please read this carefully. It affects your rights.”  Until recently, Cricket’s arbitration clause was written in a smaller font than the rest of the contract, but they have since amended their contract to take care of that problem.[42]

In addition to arbitration, wireless providers—with the exception of TracFone and MetroPCS—allow customers to take their claims to small claims court, which is faster and cheaper than normal litigation but has an award cap (usually $5000).[43]

III. Case Law

A. Late Fee

In 2006, Prince George’s County Circuit Court judge approved Bell Atlantic’s (now Verizon) settlement that had been revised three times.[44]  Two prior attempts at settlement were criticized by attorneys of some of the class members as attempts by class counsel to maximize its take of the settlement at class members’ expense.  The final settlement granted the class members $16.8 million, about $7 per customer.[45]

Two years ago, California customers filed a class-action lawsuit against Verizon (Gellis v. Verizon Communications, Inc.).  One of the plaintiffs’ attorneys, Peter Fredman, stated that “Verizon Wireless may be entitled to charge a fair interest rate for the period of time the payment is late, but that’s all they can charge in situations like this, where the fee is imposed without any human action at no discernible cost to Verizon.”[46]  In addition, a consumer-rights law firm is currently investigating Verizon’s possible violations of California law in the way the company charges late fees.[47]

On May 15, 2009, in Barahona v. T-Mobile US, Inc., a Washington District Court ruled that the question of whether late fee imposed by wireless providers fall under “rates”—whose regulation belongs to the Federal Communications Commission (FCC) under the Federal Communications Act (FCA)[48]—or “terms and conditions”—which may be regulated by states—must be resolved by the FCC.[49]  The court stated that referral to the FCC on this issue would avoid disparate or conflicting requirements for wireless providers and promote uniformity.[50]

However, in a brief supporting plaintiffs’ motion for 28 U.S.C.§ 1292(b)[51] certification, plaintiffs, challenging the court’s May 15 ruling, stated that many other courts had determined whether late fees were “rates” without deferring to the FCC.[52]  “For example, the courts in both Gellis v. Verizon Communications, Inc., and Brown v. Washington/Baltimore Cellular, Inc.[53] held that late fees were not ‘rates’ but rather were part of ‘other terms and conditions of service,’” which states may regulate.[54]  In Tillman v. Bulkmatic Transp. Co., “the court refused to defer an issue to the [relevant regulatory agency] . . . because it found no evidence that the [agency] . . . desires to exercise its authority in this matter.”[55]  Likewise, plaintiffs contend that the FCC has not instituted any proceedings regarding the wireless providers’ late fees, and that, although proceedings regarding preemption of ETFs have been pending for four years, the FCC has not yet issued a ruling, despite numerous courts’ holding that ETFs did not fall under “rates.”[56]  The motion is still pending.

B. Early Termination Fees

1. Cases and Settlements

In July 2008, Verizon settled a class-action ETF lawsuit in California Superior Court for $21 million.[57]  Soon after, Judge Bonnie Sabraw from the Alameda County Superior Court held that Sprint’s ETF was illegal.[58]  Encouraged by this ruling, Scott Bursor, lead plaintiff’s counsel for the Alameda case, filed a $1 billion class-action ETF lawsuit against Sprint in San Francisco federal court.

On December 4, 2008, Judge Sabraw ruled that Sprint could not collect the unpaid ETFs of $225.6 million.  A week later, Sprint had a nationwide settlement for $17.5 million preliminarily approved by a New Jersey federal court on December 11, 2008.  This settlement excludes the Alameda County case, but includes Bursor’s $1 billion lawsuit.  Currently, the approval of the settlement is postponed due to improper notice.[59]

In the Alameda County case, Ayyad v. Sprint, Judge Sabraw first determined whether the ETF was designed to be part of Sprint’s rate structure or treated as a liquidated damages provision.[60]  The Federal Communications Act (FCA) states, “No state . . . shall have any authority to regulate . . . the rates charged by any commercial mobile service . . . except that this paragraph shall not prohibit a state from regulating the other terms and conditions of commercial mobile service.”[61]  In addition, if the ETF concerns a matter that the states traditionally occupied and regulated—which includes liquidated damages in consumer contracts—there is a presumption against federal preemption.[62]  Thus, to determine whether the ETF fell under “rates” or “other terms and conditions,” the court analyzed the function it served: (1) if the customers often paid ETFs to get out of their contracts, the ETF would be part of the company’s rate structure[63]; (2) if the ETF served to limit Sprint’s damages to the agreed amount and relieve Sprint of the need to calculate its actual damages, the ETF would be acting as a liquidated damages clause.[64]  Here, for 80% of the customers who were charged ETFs, the termination was initiated by Sprint.[65]  This showed that the ETF was not a voluntary option that customers often exercised to cancel their contracts, but a device that facilitated the calculation of Sprint’s damages due to early terminations.  Thus, the court concluded that Sprint did not meet its burden of demonstrating that the FCA preempts California state law, and that the ETF was a liquidated damages provision within the scope of the California Civil Code § 1671(d), a consumer protection statute that regulates the amount of damages Sprint can recover for breach of contract.[66]

Under the California Civil Code § 1671(d), for a liquidated damages provision to be valid, the calculation of actual damages has to be impractical, and the amount has to be the result of a reasonable endeavor on the company’s part.[67]  In determining whether Sprint’s endeavor was reasonable, the court considered Sprint’s motivation and purpose in setting the ETF.[68]  The evidence showed that Sprint only considered whether its competitors had similar ETFs and not what losses it would sustain from the breach.[69]  From this evidence, the court concluded that Sprint’s motivation and purpose in imposing the ETF was to discourage its customers from taking their cell-phone service to its competitors, and thus preventing a substantial loss in revenue to Sprint.[70]  Consequently, the court held that Sprint’s ETF was not a valid liquidated damages provision.[71]

Even though Sprint’s liquidated damages clause was found to be void, the consumers are still liable for the actual damages caused by their breaches.[72]  The jury found Sprint’s actual damages to be $225 million, but Sprint agreed to waive any affirmative recovery if the court set off the consumers’ recovery against Sprint’s.[73]  Thus, although the court ruled in favor of the consumers, neither the class nor Sprint was entitled to any monetary recovery.[74]  However, approximately two months later, Judge Sabraw ordered a new trial, in which the court will take a fresh look at the damage calculation.[75]  This is possibly a chance for consumer-plaintiffs to win a bigger award, because the evidence showed that Sprint was unable to prove any real damages.[76]

Similarly, T-Mobile recently proposed to settle a class-action lawsuit over ETFs for $11.5 million.[77]

2. Key Arguments

The main argument for the companies in support of ETFs is as follows: “the fees are to recover the cost of cell phones, which they subsidize in exchange for customers signing up for long-term contracts.”[78]  They claim that customers would have to pay more upfront for phones.[79]  However, according to expert testimony at the FCC hearing on ETFs,[80] a typical ETF is twelve times the actual subsidy, which averages about $15 per phone.[81]

Another argument for the companies is loss of profits.  From a user’s early termination, the company loses what it would have earned through the user’s subscription. However, Dr. Lee Selwyn, who testified in Ayyad v. Sprint, stated that carriers only lose about $0.70 per month on customers who terminate contracts early.[82]  Thus, if a customer who has ten months left terminates, the service provider only loses $7 in profits, which is far less than the $150+ fee that company would charge the customer for leaving its service early.

In addition, according to Verizon’s recent response to FCC’s inquiry into their ETF hike to $350 for advanced devices, ETFs also help pay for marketing costs, network infrastructure costs, and store costs and commissions.[83]  Some believe that these costs should be shouldered by the wireless provider, not the customers.[84]

C. Contract Modification

In Iberia Credit Bureau, Inc. v. Cingular Wireless LLC[85], the Fifth Circuit examined the validity of change-in-terms provisions that most companies include in their cell-phone contracts.  Such provisions allow wireless companies to unilaterally change the terms of the agreement.  The plaintiff argued that Cingular’s change-in-terms provision rendered the agreement illusory and rendered the arbitration clause unconscionable.

The court noted that there were several federal cases that had invalidated arbitration agreements that gave the company the right to alter the terms of the agreement at any time, at least when the company was not required to give notice of the changes.[86]  The court first observed that the change-in-terms provisions at issue required the companies (Cingular and Sprint) to notify customers.[87]  In addition, the court held that, since customers are given the option to reject the changes, any notice of modification would be an “invitation to enter into a relationship governed by the new terms.”  Thus, the company’s reservation of the right to modify the terms does not indicate that the company, as plaintiffs argued, was never bound by the agreement.  Similarly, the fact that a company could later alter its arbitration clause to be more oppressive does not mean that the arbitration clause, as it stands, is unconscionable.[88]

The court also noted that “if a customer was compelled to accept a burdensome change in the terms on the pain of forfeiting a deposit or paying a termination fee, that might show that the attempt to change the terms was unconscionable or otherwise unenforceable.”[89]  However, early termination fee was not an issue in the case at hand.[90]

Recently, Laster v. T-Mobile USA upheld a contract modification that made the mandatory arbitration clause in T-Mobile’s cell-phone contract more favorable to customers.  The California District Court was examining T-Mobile’s arbitration clause, and plaintiffs argued that the court should look at the original arbitration clause instead of the one that was revised after the commencement of the litigation.  The court noted that a New York court had refused to enforce a contract modification that was retroactively imposed upon certain plaintiffs who were not subject to an arbitration agreement at the beginning of the litigation.  The court distinguished the current case by noting that the modification was directed at all of    T-Mobile’s customers, not just a targeted group, and that plaintiffs here were already bound by the arbitration clause before the commencement of the lawsuit.  In addition, California contract law recognizes the power of change-in-terms provisions, as long as the modification  is consistent with the covenant of good faith and fair dealing.[91]  Noting that the change did not add a new term but merely modified an old one, and that the modified arbitration clause was more favorable to plaintiffs, the court determined that the modification was not unreasonable under California law.[92]

Similarly, in Communication Systems, LLC v. West, the Supreme Court of Alabama, in determining that the mandatory arbitration clause did not apply to the customer’s claim, hinted that a contract modification was enforceable as long as the company properly followed contractual procedures for amending its service contract.[93]  A modification to an agreement can also have a retroactive effect if the modified agreement clearly establishes their intentions.[94]

D. Mandatory Arbitration

1. Background

The validity and enforceability issue of mandatory arbitration clauses arises every time a consumer sues wireless providers because the company will try to compel arbitration, pointing to the mandatory arbitration clause in its cell-phone contract.  The judge must then decide whether or not the clause is enforceable before granting or denying the company’s motion. Thus, mandatory arbitration clauses receive the most action in court.

In 1925, Congress enacted the Federal Arbitration Act (FAA) to ensure that “private agreements to arbitrate are enforced according to their terms.”[95]  Section 2 of the FAA states that arbitration clauses can be invalidated only for generally applicable contract defenses, such as fraud, duress, or unconscionability.[96]  Consequently, any state law that disfavors the enforcement of arbitration clauses is preempted by the FAA.[97]

Ever since, the validity of arbitration clauses has been disputed many times in court.  Indeed, the circuit courts and state courts are split over the enforceability of class-action waivers, which are often contained in mandatory arbitration clauses.[98]  The First and Ninth Circuits have invalidated arbitration clauses, while others have upheld them.[99]  Some of the states that have invalidated arbitration clauses include: California, Illinois, Missouri, and New Jersey.  Some of the states that have upheld arbitration clauses include: Louisiana, West Virginia, Florida, Arkansas, and New York.

The legal doctrine that courts commonly employ in invalidating arbitration clauses is the theory of unconscionability.  Unconscionability can be found either in the way the parties contracted (procedural unconscionability) or in the contractual terms that are one-sided or particularly oppressive (substantive unconscionability).  Some courts require both, while others just require one.  The courts that require both seem to employ a sliding-scale approach, where the greater the degree of procedural unconscionability, the lesser the degree of substantive unconscionability needs to be in order for the arbitration clause to be unenforceable, and vice versa.[100]  Although an unconscionability argument is not a plaintiff attorney’s primary choice of legal theory on which to pursue a claim, it has proven to be the best tool available to limit the scope and use of onerously restrictive arbitration clauses.[101]

In addition, determining whether an arbitration clause is unconscionable is a fact-specific inquiry.[102]  For example, a court may find a class-action waiver unconscionable as applied to a $5 late-fee claim, while upholding a similar waiver as applied to a $100,000 breach of contract claim.[103]

2. Survey of Cases

(a) Circuit Court Decisions

The First and Ninth Circuit have invalidated arbitration clauses in cell-phone contracts, while the other Circuits have upheld them.[104] 

In Shroyer v. New Cingular Wireless Services, Inc., the Ninth Circuit held that Cingular’s arbitration clause was unconscionable, and thus unenforceable.[105]  Under California law, a contract provision is unenforceable due to unconscionability only if the provision is both procedurally and substantively unconscionable.[106]  “Whether a specific class arbitration waiver is unconscionable under California law turns on (1) whether the agreement is a consumer contract of adhesion drafted by a party that has superior bargaining powers; (2) whether the agreement occurs in a setting in which disputes between the parties predictably involve small amounts of damages; and (3) whether it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money.”[107]  Under the first prong of the analysis, the court found that the agreement for cell-phone services constituted a contract of adhesion in which Cingular presented the terms to the consumer without giving the consumer a chance to negotiate.[108]  Next, comparing the amount of individual damages in this case, which were in the hundreds of dollars, to the $1,000 damages that was previously held small enough to satisfy the second prong of this test,[109] the court held that the agreement occurred in a setting involving small amounts of damages.[110]  And finally, the court found that the complaint clearly alleged “that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money.”[111]  The satisfaction of all three prongs of this test rendered the class arbitration waiver procedurally and substantively unconscionable.

On the contrary, in Boomer v. AT & T Corp., the Seventh Circuit held that a state-law challenge to the validity of AT&T’s arbitration clause was preempted by the Federal Communications Act.[112]  In the case, a customer filed a class action against his telecommunications supplier, alleging that it overcharged its customers for contributions to the federal Universal Services Fund, arguing that the arbitration clause, which prohibited class actions, was unconscionable.[113]  The court, relying on the congressional intent behind the FCA that customers receive uniform terms and conditions of service, stated that allowing a state-law challenge to the arbitration clause would result in customers receiving different terms based on their locality.[114]  However, several courts have since disagreed with or declined to follow the Boomer court’s holding.[115]

(b) State Court Decisions Invalidating Arbitration Clauses

(i) California

Although California has upheld class-action waivers found in arbitration clauses,[116] the majority of recent cases show that California will likely invalidate such clauses today.[117]  In fact, getting an arbitration clause upheld in California has become really difficult.[118]

In Gatton v. T-Mobile USA, Inc., the District Court of Central District of California found T-Mobile’s arbitration clause procedurally unconscionable and held that its class-action waiver was substantively unconscionable.[119]  Although the court rejected plaintiffs’ argument that the arbitration clause was hidden away and too small to read, the lack of opportunity to negotiate the terms was enough for the court to conclude that the arbitration clause was procedurally unconscionable.  Thus, under California law, conspicuously displaying the arbitration clause in bold, capital letters is not enough to escape procedural unconscionability.  In addition, the court rejected most of plaintiffs’ arguments regarding substantive unconscionability[120] and only found the class-action waiver substantively unconscionable.[121]  Although the court upheld the arbitration clause after determining that the class-action waiver was severable, recent changes to cell-phone contracts would require the court to invalidate the entire arbitration clause.[122]

Another court characterized the “take it or leave it” basis with no opportunity to “opt out” as “quintessential” procedural unconscionability.[123]

(ii) Illinois

In Kinkel v. Cingular Wireless LLC, the Supreme Court of Illinois held that Cingular’s class-action waiver was substantively unconscionable, and thus unenforceable.[124]  In the case, a customer brought a class action against Cingular, alleging fraud and breach of the service agreement regarding the early termination fee.[125]  After surveying other state court decisions, the Illinois Supreme Court stated, “If there is a pattern in these cases it is this: a class-action waiver will not be found unconscionable if the plaintiff had a meaningful opportunity to reject the contract term or if the agreement containing the waiver is not burdened by other features limiting the ability of the plaintiff to obtain a remedy for the particular claim being asserted in a cost-effective manner.”[126]  The court reasoned that if the agreement placed such burdens on customers, the “right to seek class-wide redress is more than a mere procedural device.”[127]  The court stated that class-action lawsuits may be the only device that could provide effective remedy for plaintiffs with small claim amounts.[128]  Although the court found the class-action waiver unconscionable, it ruled that the class-action waiver was severable and enforced the arbitration clause without the class-action waiver.[129]  However, Cingular (now AT&T) has revised its cell-phone contract so that the entire arbitration clause is null and void if its class-action waiver is found unenforceable.[130]

(iii) Missouri

In Whitney v. Alltel Communications, Inc., a Missouri Court of Appeals found that Alltel’s arbitration clause was unenforceable.[131]  In the case, a customer claimed that the provider violated the Merchandising Practices Act by improperly including an 88-cent charge on his monthly bill.[132]  In finding procedural unconscionability, the court pointed to how (1) the terms were mailed to the customer with his bill on a “take it or leave it” basis, (2) the clause was in fine print on the back of the bill, (3) the wireless provider was in a much superior bargaining position, and (4) there was no negotiation between the parties.[133]  In addition, the court concluded that (1) the class-action waiver, (2) prohibition of any incidental, consequential, punitive, or exemplary damages as well as attorneys’ fees, and (3) prohibitively high cost of arbitration rendered the arbitration clause substantively unconscionable.  Having found the arbitration clause both procedurally and substantively unconscionable, the court refused to enforce the arbitration clause and denied Alltel’s motion to compel arbitration.[134]

(iv) New Jersey

It is worth noting that in Halprin v. Verizon Wireless Services, LLC, a New Jersey court indicated that Verizon’s arbitration clause would be valid under New Jersey law, citing Homa v. American Express.[135]  While it was only in dicta, it is important to note that Homa has since been overruled, and now courts might rule arbitration clauses in similar context unconscionable under New Jersey law.

(b) State Court Decisions Upholding Arbitration Clauses

(i) Louisiana

In Iberia Credit Bureau, Inc. v. Cingular Wireless LLC, a Louisiana court upheld the arbitration clause in Cingular’s wireless service contract.[136]  The court observed that, in order to be invalidated as unconscionable under Louisiana law, a contract provision must possess features of both adhesionary formation and unduly harsh substance.[137]  First, the court rejected plaintiffs’ fine-print argument, noting that parts of the arbitration clause was actually written in a larger font than the rest of the contract.[138]  In addition, noting that there was strong federal and Louisiana policy favoring arbitration, and that the Louisiana Unfair Trade Practices Act, which was one basis of plaintiffs’ claims, did not permit individuals to bring class actions, the court concluded that prohibiting class proceedings did not render the arbitration clause unconscionable.[139]

(ii) West Virginia

In Schultz v. AT & T Wireless Services, Inc., a West Virginia court held that AT&T’s service contract, which precluded all class-action lawsuits, was not unconscionable because there was no evidence that the arbitration cost would be prohibitively high.[140]  The customer sought more than $75,000 in damages, and thus, given the circumstances, the class-action waiver did not function as a shield to protect the corporation from wrongs that amounted to small sums of money.  Similarly, in a case where the claim exceeded $75,000, another West Virginia court ruled that AT&T’s arbitration clause was not unconscionable, since it allowed consumers to pursue small claims actions and did not limit their rights to attorneys’ fees.[141]  However, in State ex rel. Dunlap v. Berger, the court invalidated a mandatory arbitration clause as unconscionable, where the claim amount was small.[142]

(iii) Arkansas

In Davidson v. Cingular Wireless LLC, an Arkansas court upheld Cingular’s arbitration clause.  After finding that a valid contract between the customer and Cingular existed, the court rejected plaintiffs’ argument of unconscionability.  The court stated that the arbitration clause was not procedurally unconscionable because (1) the customer had enough time to consider the arbitration clause, (2) she agreed to two more contracts since the commencement of this lawsuit, and (3) she has not opted to reject the arbitration, as allowed by Cingular’s subsequent revision to the contract.[143]  In addition, the court held that the arbitration clause was not substantively unconscionable, based on the availability of small claims actions and Cingular’s agreement to pay the full cost of arbitrating any non-frivolous claims.[144]

(iv) Florida

In Fonte v. AT & T Wireless Services, Inc., a Florida court held that AT&T’s arbitration clause was not procedurally unconscionable—although the clause was on page 38 of the 40-page booklet—since (1) the customer had carefully examined different wireless service providers, (2) there was no evidence that the customer was in a vulnerable state, (3) the customer had a period of time to cancel the contract, and (4) the customer did not have any prior investment in the wireless provider’s equipment.[145]  In addition, the court held that the class-action waiver did not defeat any of the remedial purposes of the Florida Deceptive and Unfair Trade Practices Act, which was one basis of the customer’s claims, and thus was not unconscionable.[146]  The court added that legislature did not intend to confer non-waivable right to class representation,[147] and that there were numerous other mechanisms which could protect consumers other than class actions.[148]

However, in another case, the same court held that Bellsouth Mobility’s (now AT&T) arbitration clause was substantively unconscionable, where the provision (1) required customers to give up many specific legal remedies, (2) limited the company’s liability to actual damages even when punitive damages might be appropriate, (3) removed the company’s exposure to class-action suits, and (4) bound customers to arbitration while granting the company the option of pursuing court action in some instances.[149] 

(v) New York

In Ragan v. AT & T Corp., an Illinois court, applying New York law, held that the class-action waiver in AT&T’s arbitration clause was not unconscionable.[150]  The court noted that “a contractual proscription against class actions is neither unconscionable nor violative of public policy.”[151]  The court further stated, “The fact that a class action lawsuit may be a less costly alternative to arbitration did not alter the binding effect of the valid arbitration agreement.”[152]

3. Statutes

In addition, some states have enacted statutes that specifically target arbitration clauses.  Oklahoma statute singles out class-action waivers as suspect class and applies higher judicial scrutiny.[153]  New Mexico enacted statutes that prohibit the use of arbitration clauses in contracts between “a consumer, borrower, tenant or employee and another party.”[154]  These statutes have not yet been challenged, but their enforceability is questionable, since the FAA does not allow states to target arbitration clauses specifically.  In fact, in Northwest Corp. v. National Union Fire Ins. Co., the court held that Montana’s arbitration statute, which listed the kinds of arbitration agreements that were valid, was preempted by the FAA and stated that the statute could not be used to resist motion to compel arbitration.[155]

In contrast, Utah has enacted statutes that uphold class-action waivers.[156]  Likewise, it is questionable whether these statutes would withstand a judicial challenge, although there is no equivalent of the FAA that discourages the enforcement of arbitration clauses.

4. Recent Development

Recently, in Coneff v. AT & T Corp., a Washington District Court examined the validity of the arbitration clause in AT&T’s cell-phone contract.[157]  The provision in question was probably the most pro-consumer arbitration clause in existence.  It provided customers with many incentives to bring claims: (1) cost-free arbitration wherein AT&T agree to pay for filling, administration, and arbitrator fees; (2) the option to bring a claim in small claims court; (3) the availability of punitive damages; (4) a guaranteed minimum recovery of at least $5,000 under certain conditions; and (5) the availability of double attorneys’ fees under certain conditions while AT&T simultaneously disclaimed its right to seek attorneys’ fees.[158]  An expert witness testified that he had “never seen an arbitration provision that has gone as far as this one to provide incentives for consumers and their prospective attorneys to bring claims.”[159]

Nevertheless, the court held that the arbitration clause was substantively unconscionable, and thus unenforceable, for five reasons.  First, the class-action waiver within the arbitration clause served to protect AT&T “from legal liability for any wrong where the cost of pursuit outweighs the potential amount of recovery.”[160]  In this case, some claims for damages went as low as $4.99.[161]  Second, AT&T overstated how pro-consumer its arbitration clause really was.[162]  Cost-free arbitration will probably not make it worth the time, energy, and stress for a customer to pursue small claims.[163]  Third, such “pro-consumer” provisions are not having their intended effect.[164]  Since 2003, fewer than 200 consumer arbitrations involving AT&T have been conducted nationwide, and only 256 small claims court cases have been filed against AT&T nationwide.[165]  Considering that AT&T has over 70 million customers, it is clear that the “percentage of customers utilizing AT&T’s pro-consumer provisions represent an infinitesimal amount.”[166]  Fourth, class action lawsuits are necessary to vindicate the public’s rights.  Although the actual award given to individuals that comprise a class may be nominal, class action lawsuits have another purpose of allowing “[p]rivate citizens [to act] as private attorneys general in protecting the public’s interest against unfair and deceptive acts and practices in trade and commerce.”[167]  Lastly, recent jurisprudence views class-action waivers unfavorably.  The court pointed to numerous courts that had refused to enforce class-action waivers since the beginning of 2008.  Subsequently, the court rejected AT&T’s FAA preemption argument by citing Shroyer[168] and Lowden.[169]

5. Summary of Arguments

Initially, arbitration was implemented as a method of dispute resolution alternative to a lawsuit.  The main appeal for arbitration is that it is less expensive and less time-consuming.  Arbitration also achieves judicial efficiency, as it will lighten the load for the already overburdened courts.  To encourage arbitration, Congress enacted the FAA so that states could not subject arbitration clauses to higher scrutiny.  However, being cheaper and faster does not necessarily mean better: (1) arbitrators may not apply laws that a court would; [170] (2) arbitration proceedings lack the formal discovery process necessary to establish facts and to gain documents; [171] (3) arbitration proceedings do not have to be in public and are often conducted in secret; (4) arbitrators need not follow judicial rules of evidence; (5) the outcome of an arbitration proceeding is subject to very limited judicial review.  Recently, the National Arbitration Forum was sued for “misrepresenting its independence” and hiding its “extensive ties” to the collection industry.[172]  However, if a valid contract between the parties exists, these limitations do not form a basis upon which courts can invalidate arbitration clauses.[173] 

When customers bring a lawsuit against a wireless service provider, they often do so as a class, having joined similarly-situated customers.  Thus, the class-action waiver is often the first to be examined by courts.  Arguments for upholding class-action waivers include: (1) customers can still recover attorney’s fees if they win, thus the filing and administrative fees do not discourage valid claims; (2) customers need to show that the arbitration cost would be prohibitively high, because many companies pay the filing and administrative fees for arbitration.  Arguments for invalidating class-action waivers include: (1) it protects the companies from liability (they can get away with cheating millions of people of small amounts of money); (2) even if the cost of arbitration is entirely paid for, time, energy, and stress may discourage potential plaintiffs; (3) it is essentially one-sided because a wireless provider would never bring a class proceeding against its customer.[174] 

Apparently, wireless providers would rather have a class action lawsuit than a class arbitration.  Most cell-phone contracts state that the arbitration clause becomes null and void upon finding its class-action waiver unenforceable.[175]  Thus, if the companies decide to remove the class-action waiver from their cell-phone contracts, the entire arbitration clause may disappear with it.

IV. Possible Improvements

A. Late Fee

Wireless providers should be allowed to charge no more than fair interest rates for late fees.  Currently, most companies charge a minimum fee of $5 for late payments.  A $5 charge to a $50 monthly bill that is a day late would be 10% daily interest, which would amount to 1500% monthly interest.  On the other hand, a $5 charge on a $100 bill that is a month late would be 5% monthly interest.  Given that it might be hard for wireless providers to account for daily interest, they should charge late fees at a flat monthly interest rate.  As several courts have ruled that late fees are penalties rather than part of the rate plan, the compensation provided to wireless providers should be limited to their actual loss, which is easily calculated, since their only loss from receiving late payments is that they lose out on the interest they could have made during the delay.  Without the $5 minimum charge, most companies would be left with the 1.5% monthly interest rate (18% annual).  Under this change, $50 and $100 monthly bills would incur late fees of 75 cents and $1.5, respectively.

B. Early Termination Fee

1. Possible improvements

Customers definitely enjoy the benefits of long-term contracts.  Cell phones cost a lot more without a service plan; for example, Sprint charges $49.99[176] for a BlackBerry Curve 8330 Red with a service plan and $349.99 without.[177]  Thus, customers who cannot afford to spend hundreds of dollars on a BlackBerry can get one for $50 if they sign up for a long-term contract.  It would be unfair to wireless providers if customers could simply keep their cell phones without paying any fees.  That does not mean the current ETFs are fair to both parties.  Wireless providers should be entitled to charge their fair loss of profits, but no more.

Recent consumer challenges against wireless providers’ flat ETF policies triggered all the companies to prorate their ETFs.  Although these new ETF policies are yet to be challenged and examined by courts, there are several possible improvements that could be made.

First, the trial period should be mandatory and long enough for customers to effectively evaluate the service.  Early termination often occurs due to inability to pay bills, better deals offered by competitors, or poor service.  Admittedly, a customer’s inability to pay the monthly bills is never a good reason to get out of paying ETFs.  Also, giving up the flexibility of being able to jump on better deals offered by competitors is the very bargaining chip customers use to get lower rates and brand-new phones at a cheaper price. However, customers should not be locked into long-term contracts with poor service.  Especially since wireless service providers do not guarantee quality service, customers should be given an honest opportunity (at least 30 days) to test-drive the consistency and quality of the company’s cell phone service before they are locked into the contract by the ETFs.  Verizon and AT&T currently offer 30-day trial periods.  Sprint does not mention a trial period in its cell-phone contract, and T-Mobile provides a 14-day trial period (30-day for California customers).

Second, ETFs should vary depending on the cost of the phone.  If phone cost subsidy is wireless providers’ main argument for charging ETFs, it makes sense to vary the ETFs depending on the actual subsidy provided by the company.  For example, if a company pays $200 upfront and the customer agrees to pay the company back on a 2-year plan, it makes sense to make the customer pay $100 if he or she terminated after paying only $100 (cost of subsidy minus the amount paid back by the customer).  Some people even call the whole process loans, not subsidies.[178]  The concept of loans makes sense because the more you have paid off, the less the penalties for defaulting should be.  Following this logic, the ETF charged by the companies should vary depending on the cost of the subsidy paid upfront by the companies, because the wireless providers tend to provide a higher discount for phones that are more costly.  For example, the new iPhone 3GS (30Gb) costs $300 with a two-year contract and $700 without, which amounts to a $400 discount.  However, phones that originally cost $150 would at best get a $150 discount.  Given the clear disparity, it makes sense to make the customer with the iPhone pay more for terminating early than the customer who got the $150 phone for free.  This argument, however, hinges on whether the amount of subsidies actually differ.  If the subsidies provided by the companies are the same for each phone, differentiating ETFs might not make sense.[179]  In that case, the ETFs should be limited to that amount, plus any unavoidable loss of profits incurred by the early termination.

Third, wireless providers should be prohibited from extending customers’ contracts every time they request a change to their plans.  Currently, if customers change plans or phones, cell phone companies might renew their cell-phone contracts without telling them.[180]

Lastly, abolishing the early termination fees altogether is an option.  Some criticize this option as being too extreme.[181]  If a customer wants the flexibility of being able to switch wireless carriers whenever he or she wants, there is always the pre-paid phones.  Eliminating ETFs entirely will result in higher rates and higher phone costs, which will inevitably lead to a discussion of how to lower phone costs for consumer, and eventually re-adoption of long-term contracts and the ETFs.

2. How to Terminate Cell-Phone Contracts Without Paying ETFs

Even if ETFs are unfair for customers, there are ways to terminate wireless service contracts without paying the fee.  Bad service is not enough to let you off the hook; cell-phone companies generally do not guarantee availability of wireless network or perfect quality of service.[182]  So far, the only situations in customers can free themselves of their obligations under the contract without paying the ETFs are (1) if an adverse, material change is made to the contract terms, (2) if you move outside the company’s coverage area, (3) if you die, and (4) if you find someone else who can take over your contract.[183]  Since (2) and (3) are not viable options, (1) and (4) will be further explored in detail.

Under contract law, one party cannot unilaterally modify the contract terms without the other party’s consent.  Thus, when wireless providers notify its customers of a price increase, customers can either accept the new change or reject it and terminate the contract.[184]  However, customers are often unaware of this opportunity, and wireless providers seem to exploit that.[185]  Some recent examples include: AT&T and T-Mobile’s text message price changes, Verizon’s administrative charge increase from $0.40 to $0.70, AT&T’s increase in unpublished number fee,[186] and Sprint’s per-line regulatory fee increase to $0.40.[187]

In addition, a customer who wishes to terminate early can simply have someone else complete the contract term.  Wireless providers are generally accommodating when it comes to contract transfers.  Once the customer finds a buyer for the unexpired cell-phone contract and contacts the wireless provider, the provider will perform a credit check on the buyer.  If everything goes well, the contract transfer will take place. There are many websites that facilitate cell-phone contract transfers,[188] including Celltradeusa[189] and Cellswapper.[190]

C. Contract Modification

Most cell phone companies will notify customers of any material change to the service contract.[191]  One area in need of improvement is how they notify customers of these changes.  Some carriers choose not to notify customers at all.[192]  In addition, some cell-phone contracts state that the changes are binding once they are posted online.  Binding upon publication on website is not enough because customers should not be expected to check the company’s website daily. Even if customers knew about their right to reject material, adverse changes, it might be too late to reject them by the time they find out about the changes.  Wireless providers should, at the very minimum, be required to notify the customers either by phone, email, or mail.  Attaching a modified contract on the back of the billing statement does not give sufficient notice to customers because many customers have gone paperless and do not even receive paper statements.

D. Mandatory Arbitration

As some companies have done, arbitration clauses should be bolded and have a clear warning.  Although Iberia ruled that they need not be more conspicuous than the rest of the contract, arbitration clauses concern important legal rights, and given the general tendency to gloss over details contained in lengthy consumer contracts, attention should be drawn to the provision.

In addition, customers should be given an opportunity to reject the mandatory arbitration clauses. Currently, two of the top ten wireless providers allow this option (their combined market share is 13.8% of all cell phone users[193]).  But in practice, the number of customers taking advantage of this option is probably low.  An arbitration study that included 800 American adults revealed that over 2/3 of the participants did not know that they were subject to mandatory arbitration clauses contained in contracts that they had signed with credit card companies and cell phone service providers.[194]  Just as some arbitration clauses make you initial next to the provision, there should be a separate space for the opt-out option (for example, a checkbox that says, “Would you like to opt-out of the mandatory arbitration clause? [Y/N]”).

Although courts have said that there is no per se ban on class-action waivers,[195] class-action waivers should be eliminated.  These waivers shield wireless providers from liability and allow them to illegally collect small amounts of money from a large number of customers.  The fact that prorating of ETFs—which was one of the major improvements in cell-phone contracts— was a result of successful class actions and settlements shows the importance of class actions in vindication of consumer rights.

V. Conclusion

Technically, consumers do not have to enter long-term cell-phone contracts; they can choose pre-paid phones.  They do not have to subject themselves to mandatory arbitration; they can choose T-Mobile and opt out of it.  However, those alternatives may be more expensive or not as widely available as Verizon or AT&T (whose combined market share is 61%[196]).  The goal should be to improve the standard practices in the entire cell phone industry, because it is unlikely that a customer would choose Virgin Mobile over other wireless providers solely because it does not have a mandatory arbitration clause.  In fact, consumers are very unlikely to know about all these options.  Cell-phone contracts are long and filled with legal terms that ordinary consumers may not be familiar with.  Many cell phone users do not know when their contracts end, and very few of them know the specifics of their legal rights.  Market competition will not fix anything unless the consumers are making informed choices.  This can be remedied by the efforts of consumer organizations in bringing public awareness to the unequal bargaining power and their contractual rights.  The fact that most wireless providers offer similar terms exacerbates the problem.  Thus, litigation and legislative actions are very important in achieving fair contracts in the wireless industry.

Indeed, the consumer movement in the cell phone industry has come a long way:  number portability has been adopted, flat ETFs have been eliminated, and arbitration clauses now provide customers various incentives to pursue claims.  However, as explored above, there is still a lot of room for improvement.  Also, these changes were not initiated by the wireless companies out of the goodness of their hearts.  They are the results of consumer-initiated litigation and the efforts of various organizations and agencies.  In reality, most cell phone customers do not complain about late fees.  Most of them do not bring claims against their service providers.[197]  Most of them ignore or fail to notice the fee increases that service providers unilaterally apply.  With consumer organizations and cell-phone customers working together and caring a little more about their rights, improvements to cell-phone contracts might take place much sooner.