Clearwire Subscribers Allege Early Termination Fees are Unlawful Penalties

By Mallory Allen
Articles Editor

In Minnick, et. al. v.  Clearwire US, LLC, the Supreme Court of Washington will soon have the ability to determine the standards that should be applied to long-term subscription contracts imposed by Internet service and cellular phone service providers. Clearwire is currently in the process of being briefed before the Washington Supreme Court on a certified question from the 9th Circuit. Specifically, the 9th Circuit has asked the court to determine how to properly classify early termination fees (ETFs) in Clearwire’s contracts, in order to determine their legality. Numerous cases challenging such termination fees have been brought with varying degrees of success, but no appellate court of last resort has yet tackled the issue of how to properly classify these provisions. As the Washington Supreme Court will be one the first state court of last resort to hear this issue, it is likely that other state courts will look to the decision for guidance. As such, the Washington Supreme Court’s decision will likely have far-reaching implications across the country for similarly situated Internet and telephone providers.

Plaintiffs in this case, members of a yet-to-be-certified class of Clearwire customers, filed their complaint in King County Superior Court in April 2009. Each plaintiff had signed a one to two-year contract with Clearwire and had agreed to pay a fee if he or she decided to terminate the agreement at an earlier date. The complaint contains numerous allegations, but most importantly to the Supreme Court’s decision, plaintiffs allege that Clearwire imposes ETFs on dissatisfied customers who wish to terminate their Internet or cellular phone contracts earlier than the specified termination of the contract.

Clearwire, after removing the case to the United States District Court for the Western District of Washington, moved for dismissal of all plaintiffs’ claims. Clearwire asserted that the ETFs were enforceable as they were simply alternative performance provisions, by which the plaintiffs could have chosen to pay the ETF upon cancellation of their account or continue to pay for Clearwire service until the end of the contract term. Plaintiffs argued that the ETFs were instead, impermissible liquidated damages clauses, because they were used to penalize customers and induce them to continue to use Clearwire’s service; such liquidated damages are unlawful penalties.

The district court agreed with Clearwire that the ETFs were a form of alternative performance because the customers “could elect to fulfill their contract in one of two ways: 1) they could pay for service for the full term of the contract, or 2) they could pay the monthly fee for a shorter term plus the ETF.” See Minnick v. Clearwire US, LLC, 683 F.Supp. 2d 1179, 1183 (W.D. Wash. 2010). In coming to this conclusion, the District Court relied on Hutchison v. AT&T Internet Servs, Inc., No. CV07-3674, 2009 WL 1726344 (C.D. Cal. May 5, 2009), a similar case answering the question of whether EFTs should be classified as liquidated damages clauses or alternative performance provisions. Based on this court’s holding, the District Court predicted that California law would find that EFTs are alternative performance provisions. Importantly, when Hutchinson was decided, no California appellate-level court had actually interpreted California law on the subject. However, after oral argument and the District Court’s final decision in the Clearwire case, the California Court of Appeals rejected Hutchinson’s holding. See In re Cellphone Fee Termination Cases, 193 Cal. App. 4th 298, 122 Cal. Rptr. 3d 726 (2011).

After the District Court’s dismissal order plaintiffs filed an appeal to the Ninth Circuit. The Ninth Circuit certified the issue of how to properly categorize subscription contracts such as Clearwire’s after concluding that Washington law does not provide clear guidance on the dividing line between classifying liquidated damages and alternative performance, especially in the context of long-term subscription contracts.

In support of their position, plaintiffs argue that the distinguishing question cannot be whether there is a “choice” to either incur the damages or to continue paying the monthly payments; such a choice is present in all contractual arrangements. This false “choice” should not be the determinative factor, but the court should instead apply a two-part test. First, the court should look to the role that the ETF plays in the contractual relationship. If the ETF only becomes payable upon termination or breach of the contractual relationship by the customer, and the business ceases to perform its obligations under the contract, the ETF should be analyzed as a liquidated damages provision. Second, the court should look to the remedies that the business is entitled upon termination by the customer. If a contract gives the non-breaching party an entitlement to the ETF in the event of the other party’s breach, such an agreement is a liquidated damages clause. In addition, in order to truly be an alternative performance provision the contract must provide a realistic and rational choice of alternative performance to the subscriber. See Cellphone Fee Termination Cases, 122 Cal. Rptr. 3d at 752. A key distinction will most likely be whether early termination payments are an obligation of the contractual “breach” (i.e. liquidated damages provision) or a customer’s payment for the exercise of a right or privilege (i.e. absolving oneself of liability for breach).

The Supreme Court’s decision will determine whether the class can be certified and continue forward with its remaining causes of action, or whether under Washington law the early termination fees in question are merely alternative performance provisions and therefore legally enforceable against the plaintiffs.

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