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

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

From the alarm company’s perspective, an enforceable liquidated damages clause means the alarm company does not need to go to court to establish its damages. That saves time and legal expense and it provides a sum certain to charge a subscriber who terminates their contract early without good cause. Keep in mind, however, that the law only permits a non-breaching party to recover its lost profits following a breach. 

Many alarm companies use liquidated damages clauses to protect their interests. The approach is pretty straightforward. Almost all subscriber contracts have an initial term for an agreed-upon number of months. Each month the subscriber pays a stipulated amount. Generally speaking, the total amount due under the contract can be computed when the parties enter into the contract (There will be more on this issue in my next article). A complicating factor is that many subscribers don’t pay the entire installation cost up front. Instead, they pay a portion of these costs monthly over the term of the agreement.  That should be factored into the determination of liquidated damages. If you can calculate the non-breaching alarm company’s lost profits resulting from the breaching subscriber’s early termination of the monitoring agreement, you can calculate the damages an alarm company is legally entitled to recover following a subscriber breach and you should have a legally enforceable liquidated damages provision.    

Here’s a simple example - a subscriber who terminates an alarm contract in month 12 of a 36 month term has 24 months left to pay under the contract. Assuming $50 month in RMR, the gross amount due for the balance of the contract term (24 months times $50 per month) is $1,200. The non-breaching alarm company is legally entitled to recover its lost profits, not the gross amount due under the contract. (This example assumes the alarm company has recovered its installation related costs in the first 12 months.) If it costs the alarm company $10 a month to provide monitoring services to the breaching subscriber, and the alarm company recovered the subscriber’s unpaid installation costs prior to breach, $40 of the RMR due is profit. Under this formulation, the alarm company is legally entitled to recover liquidated damages of $960 (24 months times $40 per month). 

Simple example aside, there’s plenty for lawyers and accountant expert witnesses to argue about when calculating the correct measure of contract damages and I suspect this case may be no different. In their complaint, the Hogan plaintiffs seem to be focused on the flat fee ETFs. (It appears that plaintiffs’ counsel has had some success challenging flat fee ETFs in wireless phone industry.) Given the principles outlined above, and assuming the allegations in plaintiffs’ complaint are true, I can understand counsels’ concerns about flat fee ETFs. A flat fee ETF that doesn’t decline over the term of the agreement doesn’t really seem to adequately address an alarm service provider’s lost profits. The liquidated damages formula in my form of agreement uses a formula based on a good faith estimate of the alarm company’s profit. I think that’s likely to be enforceable under the law of most states. Having said that, the litigation process in Hogan will provide the parties ample opportunity to prove their claims and defenses, including the enforceability of the flat fee ETFs. I strongly suspect ADT’s lawyers will have a reply on this issue if they file an answer to plaintiffs’ complaint. 

From the perspective of others in the industry, I recommend you use this news as an impetus to make sure your subscriber agreement, including any ETF or liquidated damages clause, complies with the law. An efficient, cost effective step in the direction of compliance is to purchase a form of agreement prepared by industry experienced legal counsel and then work with counsel to tailor these terms to your business. After all, an ounce of prevention is worth a pound of cure. 

About the AuthorEric Pritchard, the legal columnist for SD&I magazine and's LegalWatch blog, is a partner in Kleinbard Bell & Brecker LLP, Philadelphia, a commercial law firm with a national practice in the electronic security and life safety industries. He co-chairs the Electronic Security Group at Kleinbard and has 20-plus years of experience representing U.S. electronic security and life safety providers.