An interesting decision came out of the United States District Court for the Northern District of California that involved a liquidated damage clause. The plaintiff purchased an annual subscription to a suite of software services called the “Adobe Creative Cloud” (referred to hereafter as the Creative Cloud) for $49.00 per month from the defendant, a multi-national software maker. Shortly thereafter, the plaintiff cancelled his subscription and paid a 50 percent cancellation fee, as per the contract, which contained an early termination fee provision. The provision stated: “We’d hate to see you go, but if you cancel within the first 30 days, we’ll give you a full refund. Otherwise, you’ll be billed 50 percent of your remaining contract obligations.”

The plaintiff filed the lawsuit claiming that the cancellation fee violated the California Civil Code §1671(d) because it was an unlawful liquidated damages provision, and therefore was void and unconscionable. The plaintiff further contended that because the Creative Cloud was void under §1671(d), it was an unconscionable contract provision, prohibited by California Consumer’s Legal Remedies Act, Civil Code §1750.

The defendant filed a motion seeking dismissal of all of the plaintiff’s claims under the rationale that the Creative Cloud service provided customers with the option to either continue to receive services under the subscription plan or cancel and pay 50 percent of remaining obligations under the contract. The court also pointed out that under California law liquidated damages are defined as, “An amount of compensation to be paid in the event of a breach of contract, the sum of which is fixed and certain by agreement.”

The court stated that when a contract for a specified period of time permits a party to terminate the agreement before its expiration in exchange for a lump sum monetary payment, the payment is considered an alternative to performance and not a penalty. The court also pointed out that the Creative Cloud service permitted the subscriber to cancel his or her year-long subscription at any time, provided that the subscriber paid 50 percent of the remaining obligations, and thus was not entitled to a liquidated damage clause.

During proceedings, the court referred to a California court of appeals case involving an alarm company. In this case, the plaintiff signed a three-year contract for a security alarm system and attendant services. The contract provided that if the plaintiff terminated the agreement prior to the end of the of the three-year term, the plaintiff would have to pay “an early cancellation fee as liquidated damages” of $750, or the amount the plaintiff owed on the remainder of the contract, whichever was lesser. The plaintiff ended the contract before the three-year term was up and filed suit to have the early termination fee declared unenforceable under §1571(d). The California Court of Appeals held that the early termination fee was not barred, even though the terms of the contract described it as a “liquidated damage clause.” This was because the early termination fee was “an alternative to performance that allowed the plaintiff to choose whether to fulfill the three-year contract or pay an early termination fee.”

In referring to the case, the court pointed out that “It is clear that the early termination fee provides defendant’s customers with the power to make a rationale choice — to continue using the alarm company’s monitoring and alarm services or to pay an early termination fee. The early termination fee is thus an alternative to performance rather than an unlawful penalty.” The court thereby granted the defendant’s motion to dismiss.

QUESTION:

Our company has a four-year contract with a residential subscriber, who is a senior. The subscriber has indicated that she is planning to move to a retirement home and wants to cancel the contract. Can we pursue the balance of the contract?

ANSWER:

Depending on what state you are doing business in, there may be laws that prohibit or limit you from pursuing collection. My advice is that you speak to your subscriber and see if you can arrive at a mutually agreeable termination figure. If you cannot, then I would suggest you write off the balance and do not pursue any action against your subscriber. If this is a normal residential contract, you certainly would have the right to pursue a loss of profit. However, if you’re dealing with a subscriber who is clearly one who is going into a retirement home or a convalescent home, you would be well advised to write off the balance, if you cannot arrive at a mutually agreeable termination agreement. It is worth noting that various states have dealt with this situation and many are considering legislation to protect the elderly. Our best advice is that you do nothing that could encourage your subscriber to file a complaint against you with the Better Business Bureau or any of the state or local authorities who regulate the industry.

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