Making sure your alarm contracts comply with the law: Part 1

Civil case raises questions about legalities of early termination fees and increasing RMR.

Editor’s note: This is part one in a two-part series from SD&I and SIW legal contributor Eric Pritchard on a California civil suit, Hogan vs. ADT, and what alarm dealers need to know about laws regarding early termination fees. Part two will examine a company’s right to increase RMR during a contract’s term.  

A recent federal court complaint filed against ADT in California calls into question two long-standing contract practices prevalent in the electronic security industry. The case could impact how alarm companies deal with a subscriber’s early termination of a monitoring contract and how alarm companies increase a subscriber’s RMR during the contract’s term. 

The case, Hogan vs. ADT, alleges that ADT’s practice of charging subscribers an early termination fee (an "ETF") is unlawful.  The complaint also alleges that ADT’s approach to increasing a subscriber’s recurring monthly revenue ("RMR") after the initial year of a multi-year contract is likewise unlawful.  The complaint was filed by lawyers who have litigated the legality of early termination fees in the wireless phone industry.  The plaintiffs are asking the federal court to certify the case as a class action on behalf of current and former ADT subscribers.  ADT has yet to file an answer to the complaint. 

The plaintiffs’ claims are instructive for alarm companies for a number of reasons. Larger companies that may be the target of class actions certainly want to avoid the expense and time resulting from class action litigation. Smaller providers want to assure their contracts are enforceable to address issues that may arise with their subscribers, including subscribers who terminate their contract early. 

The bottom line is that you should use this case as a reason to confirm that your contract complies with the law. 

Early Termination Fees

The Hogan plaintiffs attack ADT’s practice of charging an ETF where a subscriber terminates an agreement before the agreement expires.  According to the complaint, ADT charges subscribers two different types of ETFs: In some instances ADT’s ETF is a flat fee; in other instances, the ETF is a percentage of the amount due for the balance of the contract term.  According to the plaintiffs, ADT imposes ETFs even where the subscriber alleges good cause to terminate their agreement with ADT (more on good cause terminations later in this article).  The plaintiffs claim both types of ETF are really a penalty designed to keep subscribers "tethered" to ADT for as long as possible. 

Some background on ETFs is helpful. By terminating a contract without good cause before the end of its term, a party is breaching the contract. (Good cause means there is some uncured, material breach of contract.  Depending on the contract and law, good cause could also require the non-breaching party to provide the breaching party notice and an opportunity to cure any such breach.) 

In our industry the subscriber and alarm company generally agree to a specific term (usually a number of months) and that the subscriber will pay the alarm company periodically some amount of RMR for services during the term. Thus, the alarm company’s profit is premised on receiving payments during each month of the term. A subscriber’s early termination without good cause means the subscriber has not lived up to his or her bargain. Under those circumstances, the law permits the alarm company to recover its lost profits. 

A well-crafted, enforceable ETF is what lawyers call a "liquidated damages" clause. Liquidated damages is an amount one party to a contract agrees to pay the other party if the party breaches the agreement. The law requires the amount of liquidated damages to be determined in good faith and to be an estimate of the actual damages likely to result from a breach.  Liquidated damages are legally recoverable in the event of a breach. If, however, the liquidated damages is not a good faith estimate of the non-breaching party’s damages, but really a penalty designed to prevent a breach, the clause is deemed to be a penalty and is unenforceable.  A key issue is whether the damages are readily ascertainable. 

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