In a consumer class action against a defendant wireless telephone carrier, The Superior Court of Alameda County of California found early termination fees (ETFs) charged by the carrier to customers terminating service prior to expiration of defined contract periods to be unlawful penalties and granted restitution/damages to the plaintiff class action. The carrier appealed.

Under California law, liquidated damage clauses in consumer contracts are presumed void, and the burden is on the advocator of the clause to rebut that presumption. Decisions interpreting this statute have created a two-part test for determining whether a liquidated damage provision is valid: 1) fixing the amount of actual damage must be impractical or extremely difficult, and 2) the amount selected must represent a reasonable endeavor to estimate fair compensation for the loss sustained. Absent either of these elements, a liquidated damage provision is void.

In discussing the case on appeal, the appellate court indicated that the utility made no endeavor — reasonable or otherwise — to determine what losses it would sustain from breach or to estimate a fair average compensation for such losses. The ETF amounts were set not on the basis of any actual or estimated loss, but “from a competitive standpoint.” The purpose in adopting the ETF was to control churn and was implemented “primarily as a means to prevent customers from leaving.”

The defendant wireless telephone carrier placed its confidence in the case of Better Food Markets vs American District Telegraph contending that Better Food imposed an entirely objective effect test. The plaintiff in Better Food was a grocery company that contracted with the defendant to install a burglar alarm system, then monitor that system, and notify the police if the alarm were triggered. It sued for damages when the defendant failed to do so and the store suffered a large loss. The Supreme Court reversed a directed verdict for the defendant, but it also held that any recovery for the plaintiff would be limited to $50, the amount set forth in the form contract’s liquidated damage provision. The court reiterated the rule that the amount of liquidated damages, “must represent the result of a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained.”

It also held that even though the liquidated damages provision was found in a form contract, “the parties agreed to the liquidation provisions, and there was no evidence that they were not fully aware of circumstances making it desirable that liquidated damages be provided for.”

The court did point out, however, that in Better Food, the court dealt with a commercial contract and focused on the impracticality of fixing actual damages and the parties’ agreement to the liquidated amount at the time of contracting.

The court therefore found that the defendant wireless telephone carrier had not established its burden that the predominant effect of the ETF provisions was to provide consumers with an alternative means of performing their contracts and the judgment of the trial court was affirmed.

Alarm dealers can rely on the Better Food Market case, as in that case the court determined that although liquidated damage provisions are void pursuant to the Civil Code, the liquidated damage provision will be upheld if it was difficult or impossible to determine what the damage might be at the time that the contract was entered into, which is a very important distinction.

Readers Ask

Q: I am in the process of negotiating an agreement for the installation of a burglar alarm system at a commercial establishment. The proprietor insists on including an arbitration provision in the agreement in the event of a dispute. I know that in the past you have suggested that we do not have a mandatory arbitration provision in our contract. What should I do?

A: You may have to make a business decision, but from a legal standpoint I would definitely not include an arbitration provision. In your contract you have provisions that protect you in the event there is a loss, i.e., a liquidated damage clause, a limitation of liability provision and a third party indemnification provision. In the event there is a loss, your customer is bound by these provisions. Frequently a trial court may choose to ignore these provisions and rule against the alarm company. However, on appeal, the appellate court will most always abide by the law and uphold these provisions.

The problem with a binding arbitration provision is that an arbitrator is not bound by the law. An arbitrator can rule in equity and totally overlook the otherwise enforceable provisions of your agreement. I would therefore suggest that you hold your ground and avoid the arbitration provision in your contract.

To ask Les Gold a question, e-mail sdm@bnpmedia.com.