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Penalty Clauses and the Nexus One

Dave Hoffman

Dave Hoffman is the Murray Shusterman Professor of Transactional and Business Law at Temple Law School. He specializes in law and psychology, contracts, and quantitative analysis of civil procedure. He currently teaches contracts, civil procedure, corporations, and law and economics.

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19 Responses

  1. Earl says:

    Don’t we need to know what early termination fees the carriers are charging in connection with the Nexus One in order to properly evaluate whether Google’s charges are fair?

  2. Thisson says:

    It doesn’t matter whether the customer agrees that it’s not a penalty. In NY, penalty clauses are unenforceable, and the determination as to whether the amount represents a “penalty” or liquidated damages is for the court to decide.

  3. Earl says:

    Okay, so here’s the scoop. Early termination fees with the Nexus One through T-Mobile are up to $200. So, if you terminate within the first 120 days, you’re going to get hit with the Google fee ($350) plus a $200 T-Mobile fee. If you cancel after the first 120 days, you’ll be responsible for “only” the $200 fee. I recently purchased a Droid through Verizon and their fee for “smartphones” is $350, so $200 is comparatively reasonable IF you can get through the first 120 days.

  4. Dave Hoffman says:

    Thisson,
    That’s not just the law in NY, which is why I don’t think the language of agreement is dispositive. That’s not to say that it won’t have any influence on a court’s decision of enforceability, since it might suggest (in another case) that the parties considered the actual damages they were likely to face.

    Earl,
    We do have a sense — as the link I put in the post made clear — that the ETFs from the carriers + the difference could *easily* exceed the nominal list price.

  5. Dave Hoffman says:

    Earl,
    Thanks for the follow-up.

    The difference between the 119th and 121st day in terms of the penalties paid by the consumer is pretty good evidence that this is a penalty clause, not a measure of anticipated or actual damages.

  6. Earl says:

    Dave, my understanding is that you can return the phone with no penalty within the first 30 days. So, really what we’re looking at here is a potential $199 charge on top of the unlocked phone price if you cancel within a 90-day window (after the expiration of the first 30 days). The unlocked price of the phone is $530. Charges for cancellation within the first 120 days will equal $179 (cost of phone with plan) + $350 (google charge) + $200 (T-Mobile) = $729, so customers who cancel within that window will have a legitimate complaint. After the expiration of the first 120 days, a customer who cancels will only end up paying $179 + $200 to T-Mobile and end up with a $379 phone that ordinarily runs $530, am I right?

  7. Mike says:

    You say, “As many have noted, customers will end up paying more in termination fees than the cost of the phone (since both google and the carrier can charge in this model).” This is technically true, but you haven’t told the entire story. The cancellation fee to google covers the price the customer would have had to pay google for the phone without a carrier contract. The cancellation fee to the carrier is liquidated damages in lieu of the service fee the customer would have paid over the full life of the contract that the customer signed. The full service fee over the life of the contract plus the full price of the phone are greater than what the customer pays upon “early termination” a/k/a breach of the contract. They are just trying to keep unscrupulous people from gaming the system. I see nothing inequitable here.

  8. Dave Hoffman says:

    Mike:

    But what are Google’s actual damages if the phone is sold early? Presumably, it’s the lost (?) ability to sell to *another person* the phone at the inflated price (the “price the customer would have had to pay Google for the phone without a carrier contract”.) But it has to be true that since essentially no one is paying the list price for the phone, google doesn’t get to say that it’s actual damages are really the difference between list and sales price. In an event, LD law isn’t really about ex post equity, it’s about ex ante reasonableness.

    Earl. I think you are reading it right. Up to 30 days, the customer pays no penalty. From 30 through 120 days (probably, when most people discover they dislike the phone and try to cancel) they have a slam dunk case that they are being charged a penalty. Starting on the 120th day, they have no evident claim against google but retain a claim against the wireless company.

  9. Mike says:

    The $529 price is not inflated — it is the price point Google has set for its product in the absence of a carrier contract. By breaching the contract, the customer is getting the phone without the contract. Do you honestly believe selling the phone for $179 without other revenue streams attached is a sustainable business model? While the phones are probably produced in China on the cheap, a lot went into R&D, marketing/advertisidng and fixed costs. I guess I come from the school that an innovator should be allowed to price its products how it sees fit, and let the market decide.

    As for your comment to Earl, if a person can’t figure out within 30 days that he doesn’t like his shiny new phone, then the problem lies with that person.

  10. TJ says:

    Dave,

    Someone correct me if I am wildly off-base. But it seems to me that Google has a perfectly good argument that its expectation damages in a lawsuit for breach of contract will not be the manufacturing cost of the phone plus administrative overhead, but rather the amount that the consumer would pay to the carrier over the 2 year life of the contract (or rather, however much of a cut Google gets from the carrier).

    In short, it seems you are using a tort measure of actual damages, but Google is entitled to base its liquidated damages calculation on a contract measure of expectation damages. And expectation damages from canceling in the fourth month of a 2 year contract will easily exceed $350.

  11. Dave Hoffman says:

    TJ,
    Not wildly off-base. But let’s assume that google argues it lost the difference between what it would have made (actual sale price + hypothetical kickbacks from carrier). I have no idea what the cut is. But let’s say it is 5% of the contract. What’s the argument for that compound sum to approximate zero in days 1-30, rise immediately to $350 in days 30-120, and fall back to zero in days 120-730? I don’t see it.

    Doesn’t this seem much more like an attempt to punish early termination & resale, which would undercut google’s ability to continue to make it seem like they are giving folks a deal on the web? The problem is even if this was a legitimate interest, it still is the case that the penalty clause isn’t triggered by resale, but rather by cancellation of the contract.

  12. Dave Hoffman says:

    Mike,

    I agree. The innovator should price as they want, and let the market decide. However, I guess what you are saying is that this isn’t really a $129 sale, but rather is better seen as a lease of the phone for a term of two years. So construed, Google’s price is appropriate, and the early termination fee is simply Google’s way to get compensated for loss of property google still owns.

    I don’t think that Google advertises the program this way, and I don’t think the law sees it this way either. My point is that expressed legal structure matters. If it is structured as a sale of goods, it needs to comply with the UCC provision on liquidation of damages. In my view, it simply hasn’t. This isn’t about fairness, it’s about the willingness of courts to permit parties to decide for themselves the amount of damages that follow from breach. Courts are suspicious of penalty clauses because (in part) they threaten to punish breach rather than to compensate it, impeding freedom of contract.

  13. 2L says:

    “Is google’s new slogan ‘Don’t be evil. But if you must be evil, be really good at it?’”

    I’m not sure about that, Dave. Because if you’ve correctly spotted the appropriate contractual issues which this agreement raises, then I think your slogan, however eye-catching, would actually be a misnomer.

  14. Dave Hoffman says:

    2L. That’s why I wrote: “[t]he clause is so riddled with obvious legal issues that I started to wonder whether google wrote it seeking to take advantage of behavioral research suggesting that liquidated damages clauses change individuals’ feelings about breach.” That is, my working theory is that google knows the clause is unenforceable, but assumes that putting it into the contract makes business sense because it changes individuals’ views about contractual damages and enforcement in ways that shift money from consumers to the company.

  15. TJ says:

    Dave,

    I don’t think it matters much that the 1-30 day, 30-120 day, and 120-730 day regime doesn’t make perfect sense. There is a “rational basis” behind the scheme. To the extent that Google could also recover a considerable amount of expectation damages during days 120-730 but chooses not to include them as liquidated damages, that is not “be really good at [evil],” but rather precisely the giving consumers a good deal that well comports to the “don’t be evil” motto.

    Unless there is some reason to think that consumers are paying more in liquidated damages than the expectation damages due under contract law, there is nothing here to challenge. And I would be shocked if Google earns less than $530 on a phone when consumers fulfill the two-year contract with a carrier.

  16. 2L says:

    Okay so this is a working theory, and so I guess you intended the question marks that end the last two sentences of the post to signal rhetorical questions. But in that case I’m still a little confused, as in the longer quotation you don’t take a position on the quality/soundness of the research provided in the hyperlink, and a stance on the same seems necessary in order for the reader to determine that you claim that in including these LDP’s Google has demonstrated that it is “good” at being evil, or just barking up one theoretical tree among many.

  17. Jay says:

    I know there have been cases in the past few years where courts have come down on the wireless carriers for this sort of thing – where I don’t think the facts were as egregious as they are here. Specifically, I believe there was a California class action against Sprint where the court struck down the termination fees. So particularly in light of that trend, doesn’t this just seem kind of un-Googly? I wonder about the business rationale – it seems like a strange fight to pick if over a few bucks, if you’re Google. Then again, maybe the Chinese government is behind this.

  18. Jay says:

    I know there have been cases in the past few years where courts have come down on the wireless carriers for this sort of thing – where I don\’t think the facts were as egregious as they are here. Specifically, I believe there was a California class action against Sprint where the court struck down the termination fees. So particularly in light of that trend, doesn’t this just seem kind of un-Googly? I wonder about the business rationale – it seems like a strange fight to pick if over a few bucks, if you’re Google. Then again, maybe the Chinese government is behind this.

  19. Joshua Bugay says:

    Great post, Dave.