Cell-Phone Contract Disputes Heat Up

Court rulings in California could lead to changes in dispute clauses in wireless contracts and fuel class actions against carriers

Read almost any cell-phone contract and you'll discover that the longest passage deals with dispute resolution. While seemingly important matters like billing get only one paragraph, Verizon Wireless devotes six paragraphs to dispute resolution. At AT&T (T), the dispute section takes up 10 fat paragraphs and states: "You agree that, by entering into this Agreement, you and AT&T are each waiving the right to a trial by jury or to participate in a class action."

The small print keeps expanding in response to an influx of court cases—at least 10 of them in California over the past few years—questioning a wireless carrier's right to block consumers from suing or filing class-action claims. In late June a California appeals court reaffirmed a lower court's order that (T-Mobile USA) could not enforce a clause requiring arbitration of disputes with customers. And on Aug. 17, the U.S. Court of Appeals for the Ninth Circuit in California ruled that AT&T's prohibition against subscribers banding together in class actions, "is unconscionable, and, thus, unenforceable."

Many of these lawsuits have managed to expose holes in the contract language, which generally seeks to steer every dispute away from court and into arbitration. Others have leveraged a landmark 2005 ruling in a California court, known as the Discover Bank decision, which allows class actions to proceed under certain conditions even when such suits are prohibited by a contract.

Citing the Discover precedent, Judge Stephen Reinhardt's decision in the AT&T case explained that consumers have little choice but to sign the wireless contracts they are offered. The judge also wrote that the amounts involved in most disputes are often too small to justify an individual action.

Let a Jury Decide

No doubt, few lawyers would be interested in helping to recover a disputed $50 charge. But band a million aggrieved wireless users together, and the damages add up. If you're handcuffed by the arbitration clause, "you have to face [wireless carriers] on your lonesome," says Michael Kelly, a lawyer at Kirtland & Packard who represented a group of Verizon Wireless subscribers who managed to extract a settlement from the company in a class action involving the features on a Motorola (MOT) handset.

Judge Reinhardt's decision opens the way for a group of AT&T subscribers to put their class action in front of a jury. The customers charge they were forced to extend their wireless contracts and pay higher service fees as a result of Cingular's acquisition of AT&T Wireless in 2004. (The combined business is now known as AT&T).

This ruling could prompt an increase in the number of similar legal actions in other states. So far, state courts have varied widely in their views on the arbitration requirement. In 2005, a Florida court upheld the clause in an AT&T Wireless contract.

But, says attorney Kelly: "The Ninth Circuit is a very highly respected branch and a very progressive court. A lot of other courts look to the Ninth Circuit for guidance."

The iPhone Factor

At minimum, the federal court ruling also could mean that more class actions filed in California will make their way to trial rather than be dismissed. One class action involving early-termination charges, a leading gripe among cell users, should get a trial date in the next several months, says Jacqui Mottek, a lawyer at Lerach Coughlin, a lead firm representing the plaintiffs. "You don't see this kind of restrictive contracts except in a few industries," she says. "With [a home] phone company, you can quit any time you want. It [usually] doesn't require you to arbitrate disputes. Wireless companies have brought this upon themselves."

Widespread frustration with onerous contract terms has been highlighted anew by AT&T's recent introduction of Apple's (AAPL) eagerly awaited iPhone. "People may want to buy this, but they can't switch," Mottek says.

The flood of cases is even prompting many wireless companies to beef up their wireless contracts with incentives for customers and their lawyers to choose arbitration. Earlier this year, AT&T added language promising that subscribers who win a dispute in arbitration will be paid $5,000 or possibly more, while their lawyers will receive double their fees. Verizon Wireless offers to pay any arbitration filing fees and all other costs associated with arbitration. "This opinion is based on our old arbitration clause," AT&T said in a statement to BusinessWeek.com about the Aug. 17 decision. "We have significantly improved that clause to make it even more consumer-friendly."

That said, some experts believe the increase in class actions could end up backfiring on consumers by bringing higher service fees. "I think it's bad for consumers," says Ted Frank of the American Enterprise Institute. "It restricts businesses from offering consumers lower prices for waiving certain rights."