Several years ago, I had a friendly lunchtime discussion with a colleague about the legality of early termination fees in cell phone contracts. I argued that early termination fees, which at the time were regularly $350.00 or more regardless of when one cancelled (even one day can result in a full penalty), were contractual penalties for the “breach” of the cell phone contract.[1] While liquidated damages, (e.g., an advance settlement of the anticipated actual damages arising from a future breach) have been around for generations, contractual penalties that are effectively “security for performance” are not valid in Kansas.[2] Kansas, along with most states, has adopted this quasi-common law view.[3] Although this law is settled,[4] termination fees are now common place in cell phone contracts, cable contracts, various household service contracts (home security), etc. These and other fees often dwarf the actual loss suffered by the supplier and result in “bill shock” to consumers when they get the bill.[5]
My colleague, every bit a laissez fair/invisible hand capitalist as Adam Smith, claimed the early termination fee was a fair mechanism to make sure customers did not break contracts before the end of the term, thus guaranteeing a profit for the supplier (closer to a liquidated damages clause, but not quite).[6] My initial response to the economic argument was “why not just offer the best service at the best price, keep the customer, and make a profit at the same time?” My colleague was initially silent, but then stood up for termination fees as an industry practice adopted to stay competitive, and otherwise, the cost would be passed down to consumers, resulting in higher prices.
One question that was not asked is, why did all cell phone companies adopt termination fees? While it is not exactly clear which provider imposed these fees first, in March of 2013, T-Mobile’s new chief executive, John Legere, readily admitted that T-Mobile spent over a decade misleading and overcharging consumers.[7] “Do you have any idea what you’re paying?” Mr. Legere said. “I’m going to explain how stupid we all are because once it becomes flat and transparent, there’s nowhere to hide. You pay so much for your phones, it’s incredible.”[8]
This article is about the way that a group of oligopolies can force consumers into something potentially far more financially damaging than cancellation fees: Arbitration.
The Oligopoly – What is it?
An oligopoly is a market structure in which a few firms or companies dominate an industry.[9] Economists identify an oligopoly by using so-called “concentration ratios” which measure the total market share by a given number of companies. When there is a high concentration ratio in an industry, it will be identified as an oligopoly.[10] Cell phone providers are a good example of an oligopoly in the United States. By 2011, AT&T, Verizon, Sprint and T-Mobile controlled 93% of the cell phone service market.[11] In Q4 2015, the same four cell phone companies dominated 99% of the market with AT&T and Verizon accounting for 67%.[12]
The media often confuses an oligopoly with a monopoly. The Atlantic Monthly referenced various industries, declaring “it seems as though we are growing accustomed to monopoly. . . [s]hould we be worried?”[13] The article does not mention a single monopoly, and instead references several oligopolies. For example, just four airlines control the vast majority of all air travel. Five record companies control 89% of all commercially released music. Two beer companies make up 65% of all beer sales.[14] More than 80% of all toothpaste sales are attributed to just two companies, Proctor & Gamble and Colgate-Palmolive.
Who or what is to blame for the rise of oligopolies? It is perhaps not a stretch to blame the failed Supreme Court nominee, Robert Bork. In Bork’s view, two companies acting in parallel in a reactive state that cause prices to increase in a harmful way (such as was the case with cell phone termination fees), does not violate antitrust law. In the 1960’s Bork published a series of articles attacking the state of antitrust policy in the United States.[15] In 1978, Bork published “The Antitrust Paradox” which argues that the original intent of antitrust laws and economic efficiency make consumer welfare and the protection of competition, rather than competitors, the only purpose of antitrust law calling this a “consumer welfare prescription.”[16] In 1982, the Reagan Administration Department of Justice rewrote its enforcement guidelines to match Bork’s views. As a result, new antitrust investigations reached historic lows in the 1980’s as industry consolidation reached historic highs.[17] The United States Supreme Court adopted many of Bork’s views over a 30-year period beginning in the late-1970’s.[18]
It wasn’t always this way. From mid-century to the 1970’s, the Justice Department pursued oligopolies with vigorous thrust. In 1969, a later supporter of the antitrust backlash, then Professor Richard Posner, argued that when firms maintain the same prices, even without an overt agreement between them, this could be considered a price-fixing conspiracy – an antitrust violation.[19] As observed by Tim Wu in the New Yorker:
“Like many things from the nineteen-seventies, the treatment of oligopoly was subject to an enormous backlash in the nineteen-eighties and nineteen-nineties. (Posner actually helped lead the backlash.) And with some justification: some of the cases were quite bad, like a long-forgotten federal war on the breakfast-cereal industry. Firms shouldn’t be penalized for practices that are parallel but not actually harmful, nor for mere “parallel pricing.” An interpretation of law that makes nearly every gas-station owner into a felon is questionable.
But just as the nineteen-seventies went too far, the reaction to the nineteen-seventies has also gone too far. As part of a general retreat from prosecution of all but the most extreme antitrust violations, the United States has nowadays nearly abandoned scrutiny of oligopoly behavior, leaving consumers undefended. That’s a problem, because oligopolies do an awful lot that’s troubling.”[20]
One troubling trend is the increased use of forced arbitration to prevent the airing and resolution of disputes. As noted below, this trend is more pronounced with the rise of oligopolies.
Forcing Arbitration
Simple observation shows that nearly every oligopoly uses the same forced arbitration clauses and concepts in consumer transactions. Take, for example, consumer finance. In 1999, the U.S. Congress passed the Graham-Leach-Bliley Act, or “Glibba,” (the Financial Services Modernization Act of 1999), in which key provisions of the Glass-Steagall Act of 1933, the prior banking regulatory law, was eroded. Glibba effectively allowed banks to merge and invest consumer deposits in riskier business ventures, with less regulation. During the congressional debate on the law in 1999, Representative John Dingell (D-Mich.), went on record arguing the bill would result in banks that are “too big to fail” which would result in the Federal Government having to “bail out” these banks.[21] As we know, Dingell was correct. In the 1950’s, one could open an account in one of nearly 13,000 banks.[22] If you want to open an account today, you have only 800 to chose from, most of which are not in your town.[23] In 2013, only one new bank was formed, Bank of Bird-in-Hand in Lancaster County, Pa. (serving the Amish community), down from over 100 ten years prior.[24] The finance industry is now an oligopoly, with just four banks holding roughly 45% of all consumer deposits, 80% of the consumer loans and unsecured debt, and 90% of consumers with an income above $30,000.00 having another form of a fee generating credit line – credit cards issued by Visa or Mastercard- by 2007, worth trillions of dollars.[25]
In 1984, the U.S. Supreme Court decided Southland Corp. v. Keating which interpreted the Federal Arbitration Act to apply anytime a transaction involves interstate commerce.[26] Seeing an opportunity to limit litigation for issues such as confusing fees, finance institutions started including arbitration clauses in banking agreements, credit card agreements and other finance products.[27] Soon after the consolidation of powerful finance institutions, consumers started seeing more aggressive use of forced arbitration to “resolve” consumer lawsuits. It is perhaps no surprise that arbitration clauses, according to the Office of the Comptroller of the Currency, are “associated with abusive lending practices.”[28]
Other industries began to follow the consumer finance industry’s lead. A bird’s eye view of the most common industries reveals that oligopolies are likely to use arbitration clauses as a rule. Oligopolies like Student loans (two major private loan companies and the federal government control 75% of all student loans), car manufacturers (7 manufacturers control 80% of all sales), prepaid cards (dominated by two companies), cell phones (four major companies, as discussed above), and cable and satellite providers (three companies control nearly half the market), incorporate forced arbitration into their transaction agreements.[29]
It is evident that oligopolies use arbitration clauses in the same manner cell providers use termination fees, to deter rather than encourage. The mass use of arbitration clauses has not resulted in the mass use of arbitration.[30] A 2015 report released by the Consumer Financial Protection Bureau (“CFPB”) which found few consumers actually file claims in arbitration, with almost no consumers filing claims when less than $1000 was in dispute.[31] The CFPB’s recently completed study on forced arbitration also found that less than 7% of credit card consumers whose contracts included arbitration clauses understood that they could not sue their provider in court.[32]
In addition, forced arbitration is inherently unfair. A recent study of cases filed with the American Arbitration Association finds that “defendants have become increasingly familiar with the AAA process” but that consumers won only 35% of cases filed, and their recoveries were limited.[33] “Of the full sample of cases, consumers recovered, on average, between $6000 and $7000, 19% of the average monetary demand . . ..”[34] Also noted by the National Consumer Law Center, “[t]o begin with, private arbitration companies compete to be selected by corporations in their standard form contracts with consumers and employees, and in doing so they often overtly suggest that they will rule for the company. Arbitration work is often very lucrative, and arbitrators know that if they rule against a corporate defendant too frequently or too generously in the corporation’s view, they will lose the work. . .. [t]here is some empirical evidence and a good deal of commentary suggesting that arbitrators do, in fact, have a tendency to favor “repeat player” clients.”[35] Thus, forced arbitration acts as a deterrent to raising a dispute, rather than a resolution mechanism that saves the parties time and money. The oligopolies know this truth.
When there is a dispute between two or more corporations, however, corporations will often do everything in their power to avoid arbitrating the dispute. When AT&T attempted to merge with T-Mobile, AT&T asked no less than eight Federal Courts to block consumer arbitrations because they would interfere with the merger.[36] This is exactly the double standard corporations seek to hold themselves to. Most litigation concerning arbitration clauses, including Southland Corp. v. Keating, involved corporate parties. According to a Cornell Legal Studies Research Paper, only 11% of corporate contracts included arbitration clauses, while the same companies included them in consumer contracts in much greater numbers.[37] As one commentator noted, “[i]f arbitration—in particular, the arbitration system you have—is so great, why are you imposing it on your customers/employees while reserving to yourself the option of avoiding that arbitration system and pursuing litigation?”[38]
Conclusion
The rise of industrial oligopolies has lead to the erosion of consumer rights to have a case heard in court. Each new consolidation of power amongst suppliers of consumer goods and services has employed arbitration not to quickly and cheaply resolve disputes, but instead to prevent disputes from being heard altogether. Consumers need to be vigilant in their awareness of oligopolies, and how they are eroding consumer rights.
Tai J. Vokins is an attorney licensed to practice in state and federal courts in Kansas. Mr. Vokins concentrates his practice in the areas of civil litigation and consumer protection issues. If you have questions about this article, call Tai at 785-842-6311.
The information and materials on this blog are provided for general informational purposes only and are not intended to be legal advice. The law changes frequently and varies from jurisdiction to jurisdiction. Being general in nature, the information and materials provided may not apply to any specific factual and/or legal set of circumstances. No attorney-client relationship is formed nor should any such relationship be implied. Nothing on this blog is intended to substitute for the advice of an attorney, especially an attorney licensed in your jurisdiction. If you require legal advice, please consult with a competent attorney licensed to practice in your jurisdiction.
[1] Carrothers Const. Co., L.L.C. v. City of South Hutchinson, 288 Kan. 743, 754-55, 207 P.3d 231 (2009).
[2] See St. Louis & S.F. Railroad Co. v. Gaba, 78 Kan. 432, 435–436, 97 Pac. 435 (1908) (discussing a liquidated damages clause).
[3] See Erickson v. O’Leary, 127 Kan. 12, 14, 273 P. 414 (1929).
[4] In 2000, the Federal Communications Commission held that awards of damages for breach of contract or fraud claims do not constitute “rate regulation” and thus federal preemption does not apply. See In re Wireless Consumers Alliance, Inc., 15 F.C.C.R. 17021, at ¶¶ 38–39 (Aug. 14, 2000). However, in 2005 (during the George W. Bush administration), the Federal Communications Commission held that state court and legislative action to curb early termination fees was an impermissible state regulation of “rates” preempted by 47 U.S.C. § 332(c)(3)(A). Ultimately the FCC’s action was overturned by Nat’l Ass’n Of State Util. Consumer Advocates v. F.C.C., 457 F.3d 1238 (11th Cir. 2006). The FCC has recognized lack of preemption since that time.
[5] See Thomas v. Sprint Solutions, 2010 WL 1263189, at *7 (N.D. Cal. Mar. 30, 2010) (challenge to wireless company charges of late and reconnect fees without disclosure in the terms and conditions).
[6] Adam Smith never used the term “laissez fair” instead opting for the metaphor of an “invisible hand” in his book “The Theory of Moral Sentiments” which is widely the bane of the existence of most college students during the required Western Civilization course. See Invisible Hand: The Wealth of Adam Smith, p. 123 (2002) (The Minerva Group, Inc.) (numerous authors).
[7] Here is how the New York Times described Legere: “At a news conference in New York on Tuesday, Mr. Legere, wearing a blazer, T-shirt, jeans and sneakers with hot-pink shoelaces, casually dropped curse words while mocking his competitors, saying they were deliberately confusing customers with unclear two-year contracts and punishing them with fees for surpassing data limits or ending contracts early.” March 26, 2013, “T-Mobile Shakes Up Its Service,” http://www.nytimes.com/2013/03/27/technology/t-mobile-unveils-aggressive-phone-pricing-with-no-contracts.html?pagewanted=all&_r=1 (retrieved on January 22, 2016).
[8] Id.
[9] Definition from Economics Online (United Kingdom Site has the best definition): http://www.economicsonline.co.uk/Business_economics/Oligopoly.html (retrieved on January 22, 2016).
[10] Economists also use the “Herfindahl – Hirschman Index” or “H-H Index” to measure the concentration of industry by adding together the squared values of the market place percentage. A value of above 2,000 considered an oligopoly.
[11] Data from 2011 to 2015 in graph format: http://www.statista.com/statistics/199359/market-share-of-wireless-carriers-in-the-us-by-subscriptions/ (retrieved on January 29, 2016).
[12] Id.
[13] April 2013 Issue: The Atlantic Monthly, “The Return of the Monopoly: An Infographic.” Weissmmann, Jordan.
[14] All examples from the The Atlantic Monthly, “The Return of the Monopoly: An Infographic.” Id.
[15] Robert H. Bork & Ward S. Bowman, Jr., The Crisis in Antitrust, FORTUNE 138 (Dec. 1963); Robert H. Bork, The Rule of Reason and the Per Se Concept: Price Fixing and Market Division, Part I, 74 YALE L. J. 775 (1965); Robert H. Bork, The Rule of Reason and the Per Se Concept: Price Fixing and Market Division, Part II, 75 YALE L. J. 373 (1966); Robert H. Bork, Legislative Intent and the Policy of the Sherman Act, 9 J. L. & ECON. 7 (1966); Robert H. Bork, The Goals of Antitrust Policy, 57 AM. ECON. REV. 242 (1967); Robert H. Bork, The Supreme Court Versus Corporate Efficiency, FORTUNE (Aug. 1967); Robert H. Bork, Resale Price Maintenance and Consumer Welfare, 77 YALE L. J. 950 (1968); Robert H. Bork, Antitrust in Dubious Battle, FORTUNE 103 (Sep. 1969).
[16] Bork, Robert H. (1978). The Antitrust Paradox. New York: Free Press (1978).
[17] See The Return of the Monopoly: An Infographic, supra.
[18] See e.g., Leegin Creative Leather Products, Inc. v. PSKS, Inc., 551 U.S. 877 (2007).
[19] Richard A. Posner, Oligopoly and the Antitrust Laws: A Suggested Approach, 21 STANFORD L. J. 1562 (1969).
[20] Tim Wu, The Oligopoly Problem, The New Yorker (April 15, 2013).
[21] United States House of Representatives Session Record, November 4, 1999, comments by Rep. John Dingell, Michigan. For a video of his 3-minute speech, visit http://www.c-span.org/video/?153391-1/house-session&start=10927 (retrieved January 27, 2016).
[22] Roisin McCord, Edward Prescott and Tim Sablik, “Explaining the Decline in the Number of Banks Since the Great Recession,” P. 1-3, Economic Brief, Federal Reserve Bank of Richmond, EB15-03 (March 2015).
[23] Id.
[24] Id.
[25] Zhu Wang, “Market Structure and Credit Card Pricing, What Drives the Interchange?” Economic Journal, JEL Classification D40; L10; L40.
[26] Southland Corp. v. Keating, 465 U.S. 1 (1984).
[27] See, e.g., Jean R. Sternlight, Consumer Arbitration, in Edward Brunet et al., Arbitration Law in America: A Critical Assessment 127, 129 (2006) (“Throughout the 1990s, companies in a wide array of areas followed the lead of the securities industry and began to use form agreements to require their customers to agree to resolve all future disputes through arbitration rather than litigation.”); Theodore Eisenberg, Geoffrey P. Miller & Emily Sherwin, Arbitration’s Summer Soldiers: An Empirical Study of Arbitration Clauses in Consumer and Nonconsumer Contracts, 41 U. Mich. J.L. Reform 871, 883 (2008) (over 75% of consumer contracts with large telecommunications, financial services, and credit card companies include arbitration clauses); Karl E. Neudorfer, Defining Due Process Down: Punitive Awards and Mandatory Arbitration of Securities Disputes, 15 Ohio St. J. on Disp. Resol. 207 (1999) (“Customer agreements that do not contain boilerplate language requiring that all disputes be submitted to arbitration are now the exception to the rule. As a result, in the new era, arbitration is suddenly everywhere.”); Arbitration: Happy Endings Not Guaranteed, Bus. Wk., Nov. 20, 2000 (“Since 1995, cases filed with the American Arbitration Association, one of several arbitrators available, have increased dramatically. . . .”); David Hechler, ADR Finds True Believers, The Nat’l L. J., July 2, 2001 (“[M]ost of the organizations that collect ADR data report substantial increases in recent years. For example, of the cases filed between 1996 and 2000 with the American Arbitration Association, mediations and arbitrations combined almost tripled.”); Robert W. Snarr, Jr., No Cash ‘til Payday: The Payday Lending Industry, Federal Reserve Bank of Philadelphia Compliance Corner (First Quarter 2002), available at www.philadelphiafed.org (noting that use of mandatory arbitration clauses appears to be “standard operating procedure among payday lenders and banks that partner with payday lenders to originate payday loans”). See also Mercedes Homes v. Colon, 966 So. 2d 10, 20 (Fla. Dist. Ct. App. 2007) (Griffith, J., dissenting) (“What we have begun to see is that virtually all consumer transactions, no matter the size or type, now contain an arbitration clause.”); Jean R. Sternlight & Elizabeth Jensen, Using Arbitration to Eliminate Consumer Class Actions: Efficient Business Practice or Unconscionable Abuse?, 67 Law & Contemp. Probs. 75 (2004) (“If one looks at the form contracts she receives regarding her credit card, cellular phone, land phone, insurance policies, mortgage, and so forth, most likely, the majority of those contracts include arbitration clauses, and many of those include prohibitions on class actions.”); Eric Berkowitz, Is Justice Served?, L.A. Times Magazine, Oct. 22, 2006, at 22 (noting that recent study found that 55.1% of all consumer contracts have arbitration clauses).
[28] Office of the Comptroller of the Currency, Administrator of National Banks, Guidelines for National Banks to Guard Against Predatory and Abusive Lending Practices, OCC Advisory Letter 2003-2, at 2, 3 (Feb. 21, 2003).
[29] Ft. Nt. 27, ibid.
[30] Judith Resnik, Diffusing Disputes: The Public in the Private of Arbitration, the Private in Courts, and the Erasure of Rights, 124 Yale L.J. 2804 (2015)
[31] Consumer Fin. Prot. Bureau, CFPB Finds Few Consumers File Arbitration Cases (Dec. 12, 2013), available at www.consumerfinance.gov.
[32] Id.
[33] David Horton & Andrea Cann Chandrasekher, After the Revolution: An Empirical Study of Consumer Arbitration, 104 Geo. L.J. 57 (2015), available at http://ssrn.com.
[34] Consumer Arbitration Agreements, Sec. 1.3.3, National Consumer Law Center (2015).
[35] Id.
[36] Martha Neil, After Supreme Court Win Forcing Customers to Arbitrate, AT&T Now Sues to Stop the Arbitration, A.B.A. J. (Aug. 17, 2011).
[37] Theodore Eisenberg & Geoffrey P. Miller, Cornell Legal Studies Research Paper Series, The Flight from Arbitration: An Empirical Study of Ex Ante Arbitration Clauses in Publicly-Held Companies’ Contracts (Aug. 30, 2006), available at http://ssrn.com
[38] Jeffrey W. Stempel, Mandating Minimum Quality in Mass Arbitration, 76 U. Cin. L. Rev. 383, 421 (2008).
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