Communications Law Bulletin, July/August 2007 - Part Two.

Courts Find Unilateral Changes to Web-Based Terms and Conditions and Prohibitions on Class Action Lawsuits by Consumers Unconscionable

In a number of recent cases brought by consumers against telecommunications carriers and web-based retailers, courts have refused to enforce the mandatory arbitration provisions of the contracts when they include a waiver of a consumer's right to bring a class action claim. While these recent cases are precedential only in 9th Circuit states and rely on the court's interpretation of state law, they will likely impact any contract with consumers in other states that have expressed a policy against class action waivers, regardless of the location of the retailer or carrier or the choice of law provisions in the contract.

The most important of these cases is Douglas v. United States District Court for the Central District of California, where the 9th Circuit granted a consumer's writ of mandamus challenging the lower court's ruling to compel arbitration in a dispute between plaintiff Douglas and long-distance provider Talk America. Douglas addressed the plaintiff's allegation that Talk America had changed the terms and conditions of his service contract by modifying its website without notifying him of the change. One of Talk America's unilateral modifications was the addition of a mandatory arbitration clause and a class action waiver. The lower court had granted Talk America's motion to compel arbitration based on the modified contract and Douglas challenged that decision by filing a writ of mandamus with the 9th Circuit (the writ was required because the Federal Arbitration Act does not permit interlocutory appeals of district court opinions compelling arbitration). The 9th Circuit called the lower court decision enforcing the mandatory arbitration provision a fundamental misapplication of contract law and held that the plaintiff could not be bound by the terms of the revised contract when he was not notified of the changes. The court distinguished this case from others where unilateral changes to terms and conditions posted on a website were found to be enforceable because in those cases the consumers had received separate notice of the modified contract by mail or involved new customers who were required to assent to specific contract terms as a condition of receiving service.

In addition, the Douglas court ruled that even if the added mandatory arbitration provision was enforceable, the lower court had further erred by failing to find that the modified terms, in particular the class action waiver, probably would not have been enforceable in California because it conflicted with California's fundamental policy as to unconscionable contracts. The validity of an arbitration agreement must be determined using state law principles governing the formation of contracts, and contract choice-of-law provision is not determinative for purposes of this analysis. While the Talk America contract stated that New York law governed, under California's choice-of-law rules a court may not enforce the choice-of-law provision if New York law is contrary to a fundamental policy entrenched in California substantive law and if California has a "materially greater interest" than New York in the determination of the issue. Analyzing each state's law, the 9th Circuit found that under California law, a contract can be procedurally unconscionable if a service provider has overwhelming bargaining power and presents a "take-it-or-leave-it" contract to a customer, even if the customer has meaningful choices as to other service providers. Under New York law, the modified contract would have been enforceable because the customer had meaningful alternative choices for telephone service, therefore foreclosing any procedural unconscionability claim. Therefore, finding New York law to be fundamentally at odds with California's on this point and California's interest in protecting its consumers more compelling that New York's interest in the litigation (in part because Talk America is a Pennsylvania corporation), the 9th Circuit determined that California law applied, and under well-settled California law (as set forth in the 2005 California Supreme Court decision in Discover Bank v. Superior Court of Los Angeles), a class action waiver may be substantively unconscionable.

Douglas is an important case because, as the court itself noted, "[t]his the first time any federal court of appeals has considered whether to enforce a modified contract with a customer where the customer claims that the only notice of the changed terms consisted of posting the revised contract on the provider's website." It also highlights a number of significant differences between New York and California law with respect to the enforceability of terms commonly included in contracts for telecommunications services and online retailing.

Douglas has quickly become important precedent even though Talk America has petitioned for en banc rehearing. Within a month of its issuance, the 9th Circuit held, in Shroyer v. New Cingular Wireless Services, Inc., that neither the existence of marketplace alternatives nor the payment of the fees and costs of arbitration will make an otherwise unconscionable class action waiver enforceable. As was the case in Douglas, the Shroyer court found that Cingular's "take-it-or-leave-it" contract was a procedurally unconscionable contract of adhesion even though the consumer had meaningful alternative service choices. In Shroyer, the plaintiffs challenged Cingular's practice of requiring its customers to consent to terms of service that included a required renewal of their contracts for a term period, in order to obtain a remedy for service quality problems allegedly caused by Cingular's merger with AT&T. In another recent case, Oestreicher v. Alienware Corp., the U.S. District Court for the Northern District of California found a mandatory arbitration clause in a web-based click-through agreement to purchase a computer to be unenforceable when it included a class action waiver. Both of these cases turned on California law. Although Alienware was based in Miami, Florida, the Northern District found California's interest to outweigh that of Florida's and found the arbitration provision unconscionable with respect to the class action waiver. Similarly, in Brazil v. Dell, the U.S. District Court for the Northern District of California found a class action waiver caused an arbitration clause to be unconscionable even when the consumer had clear notice of the terms before purchasing the goods.

In addition to California, Washington state law also precludes class action waivers in consumer agreements. In July, the Washington Supreme Court found the class action waiver in Cingular Wireless's contracts to be unenforceable under the state's Consumer Protection Act. As the California Supreme Court had found in Discover Bank, the Washington court found that a class action waiver would protect Cingular from liability for small claims and prevent consumers from pursuing valid claims.

Third Circuit Finally Resolves Core v. Verizon

In recent Bulletins we have reported on the decision of the U.S. Court of Appeals for the 3rd Circuit's in Core Communications, Inc. v Verizon Pennsylvania, Inc., where the court held that disputes regarding interconnection agreements must be taken to the public utility commission that approved the agreement before complainants may resort to the federal courts. On June 15, the 3rd Circuit vacated its opinion due to the recusal of one of the judges on the original panel and announced that it would rehear the case at a future date. On July 18, the court's reconstituted panel issued its revised decision in which it reached the same conclusion as the earlier panel, based on the same reasoning. Again, concluding that Chevron deference to the FCC's decision requiring parties to first exhaust their remedies with the state public utilities commissions was appropriate, the court found that "... the most sensible harmonization of the Act's structure and the FCC's declarations is a solution under which the bodies that are responsible for overseeing the formation of interconnections agreements [the state public utility commissions] are given the first crack at interpreting and enforcing them."

State Regulatory and Legislative Activity

Many state legislatures have wrapped up their 2007 sessions or have recessed for the summer months, and state regulatory commissions typically slow down in July and August. Despite this summertime break, a number of issues have not taken a holiday and continue to be in the headlines. These include VoIP related legislation and consumer protection bills, which continue to advance in a number of jurisdictions.

In New York, Governor Spitzer has signed SB-4611 requiring all interconnected VoIP providers to notify their customers of any material limitations associated with basic or enhanced 911 services. The notifications must be provided before commencement of service and periodically thereafter, and in all marketing materials in television, radio, print media, and online materials. VoIP providers must obtain express acknowledgement of the limitations from their customers and, where service limitations exist, must provide their customers with warning stickers to place on their telephones. Additional notification regarding the need to reinitialize service must be provided to nomadic VoIP consumers. The bill will take effect 120 days after July 18, the day it was signed. On the same day, Governor Spitzer also signed HB-3397 to reduce the costs of collect calls made by inmates from state prisons. The bill codifies an earlier change incorporated into the 2007-08 state budget that eliminated the 57.5% commission paid by MCI, the current inmate pay phone service provider, to the state Department of Correctional Services. The new law prohibits the state from charging a commission on inmate payphone calls in the future and requires that any contract for this service awarded after April 2008 be awarded to the lowest bidder.

In late June, the New York Assembly and Senate each passed and sent to the other similar wireless consumer protection bills. SB-6176 requires the wireless carrier or the authorized retailer to provide a new customer or a customer that has agreed to a change in service that results in an extension of its contract, with written confirmation of the service or service change and other specific information. It also requires all charges for wireless services to be distinguished from taxes, surcharges, and other imposed surcharges, and prohibits carriers from labeling cost recovery fees or charges as taxes. Carriers also must provide the Consumer Protection Board with information for the board to publish an informational guide for the purchase of wireless services, as required by the bill. The comparable Assembly bill, AB-2030, would give the Consumer Protection Board authority to regulate wireless services with respect to consumer protection issues and administer a consumer complaint resolution process. It would also provide consumers with a right to cancel service without termination fees within fifteen days after the first invoice for service is issued, require carriers to disclose detailed service coverage information, and require detailed disclosure of all monthly fees, taxes, surcharges, and other charges for using the service, information about 911 service, estimates of anticipated monthly bills, and a description of the complaint process available at the Consumer Protection Board.

Other year round legislatures are considering VoIP bills. In Pennsylvania, SB-1000 would prohibit any state commission or department from regulating the rates, terms, and conditions of any VoIP or IP-enabled service. The bill will not affect VoIP providers' obligations under state consumer protection laws, the applicability of cable franchise laws, or mandate or prohibit any 911 or other regulatory fees, switched access charges, or intercarrier compensation that may be deemed to apply. The bill was sent to the Senate Communications and Technology Committee on August 9; the Pennsylvania legislature is in recess until September 17. Both houses of the New Jersey legislature have passed and sent to the other VoIP preemption bills. Both bills, HB-4339 and SB-2777, if ultimately passed and sent to the governor, will prohibit the Board of Public Utilities or any other state agency from regulating VoIP or any other IP-enabled telephone service except for 911 fees, telecommunications relay service fees, universal service fees, and intercarrier compensation.

State public utility commissions also continue to relax the regulations they impose on competitive carriers. The Pennsylvania Public Utilities Commission recently eliminated the requirement that long distance carriers file tariffs or price lists, instead requiring them to post their rates at their business offices and online at their websites. Consumer complaints about inadequate notice of price changes will be handled by the state Attorney General, not the PUC. The new rules will take effect upon approval by the Pennsylvania Attorney General and the Independent Regulatory Review Commission. The Texas Public Utility Commission is considering whether to eliminate all review of competitive carriers' mergers and acquisitions, as requested by Level 3. Commission staff has opposed Level 3's request.

The California Public Utilities Commission also continues to reduce its oversight of telecommunications utilities. Its most recent proposal is to eliminate the tariff filing requirements for all incumbent carrier services except basic exchange, resold services, and other limited exceptions. The Commission is authorized by existing state statute to establish rules for detariffing if it finds that a carrier lacks significant market power for the services it seeks to detariff. The draft decision containing the proposal was circulated for comment on July 23 and is scheduled to be considered at the Commission's September 6 public agenda meeting. At its August 23 meeting, the Commission voted to extend for an additional three years its two-year pilot program of streamlined review of uncontroversial small-scale (under $5 million and requiring no environment review) asset transfers by all utilities. Under the pilot program, qualifying mergers, acquisitions, and other transfers may be approved using the less formal advice letter process rather than the more time-consuming formal application. A number of parties sought to make the pilot program permanent, but the Commission determined that two years was not sufficient time to evaluate the program.

Federal Court Rules that Arizona May Not Include Unbundling Requirements in Interconnection Agreements

In late July, the U.S. District Court for Phoenix ruled that the Arizona Corporation Commission may not include Section 271 unbundling requirements in an interconnection agreement between Qwest and Covad. In a February 2006 decision challenged by Qwest, the ACC had concluded that it was authorized by state law and Section 252(e) to require Qwest to meet Section 271 unbundling obligations. Finding in favor of Qwest, the court held that the ACC's authority under Section 252 does not extend to Section 271 unbundling. While the ACC can advise the Federal Communications Commission on Section 271 bundling issues, its ability to mandate unbundling is limited to that which is authorized by Section 251. Also, since the ACC may not mandate the unbundling of Section 271 network elements, it also is precluded from setting rates for those elements.

Private Equity Update

Over the last several months, private equity has demonstrated an increasing appetite for media and telecom transactions. Examples include the acquisition of Clear Channel Communications Inc. by Thomas Lee Partners LP and Bain Capital LLC, the sale of Alltel Corp. to TPG Capital and GS Capital Partners, and the purchase of Intelsat Holdings Ltd. by a consortium of firms led by BC Partners. These deals were reported in the November 2006, May 2007, and June 2007 editions, respectively, of the Communications Law Bulletin. On June 30th, the Canadian telecommunications operator BCE Inc. agreed to be acquired by the investment arm of Ontario Teachers' Pension Plan, Providence Equity Partners Inc., and Madison Dearborn Partners for a total value, including debt, of $48.5 billion, the largest private equity buyout package in Canadian corporate history.

This trend has not gone unnoticed by members of the U.S. Congress. In July, House Commerce Committee Chairman John Dingell (D-MI.) and Telecommunications and the Internet Subcommittee Chairman Edward Markey (D-MA) sent a letter to FCC Chairman Kevin Martin requesting that he investigate the policy implications of the growing trend of private equity ownership of communications-related entities. The letter noted that, as a generalization, the history of private equity ownership suggests (i) a financial management style focused on cutting costs, increasing revenues, and an ultimately reselling the enterprise, (ii) a management structure that is not overly transparent, and (iii) fluid asset management where actual holdings and control may vary. These characteristics may run contrary to the historic role of FCC licensees as trustees of the public's airways, may not be consistent with many of the core public interest and localism values, and may implicitly undermine the FCC's media ownership rules. On the other hand, the letter noted that some supporters of private equity argue that, by taking entities private, the businesses are better insulated from financial market pressures.

Despite Congressional concern, the marketplace might be decelerating, at least for now, the trend of private equity's growing influence in the communications sector. Across all industries, the volatility in the debt markets has slowed private equity investments. Overall, billions of dollars in funding has been pulled since late June 2007 as investment banks balk at providing financing for deals, and the communications industry has not been spared. The auction of Virgin Media Inc., the United Kingdom cable operator listed on Nasdaq, has been delayed and deals involving Insight Communications Co., Nexstar Broadcasting Group Inc., and Clear Channel Communications Inc. have all been impacted by the squeeze on debt financing.

FCC Releases NPRM Promoting Adoption of Two-Way CableCARD Standard and Grants Waivers of Its Set-Top Box Security Integration Ban

On June 29, the FCC released a notice of proposed rulemaking ("NPRM") seeking comments on proposed standards to ensure two-way plug-and-play capability in consumer cable devices. The NPRM is part of a larger effort to promote competition in the market for set-top navigation boxes by requiring multichannel video programming distributors ("MVPDs") to offer security measures in a modular form like the CableCARD that can be used with independently manufactured devices. CableCARD-ready devices sold in retail stores currently are unable to access the two-way features available on many cable systems, such as on-screen programming guides, video-on-demand, and interactive television. The cable and consumer electronics industries, long-time rivals, have submitted different proposals and the Commission seeks comment on both of them. The Commission also is considering applying two-way capability standards to equipment for services other than cable television, such as satellite, IPTV, and pay-TV services offered by Bell Companies.

Meanwhile, in late June, the FCC granted several requests for waiver of its rule prohibiting the sale or lease of new set-top boxes with integrated security features. Waivers were granted for some smaller cable operators facing difficulties in complying by the Commission's deadline, and a blanket waiver was issued to MVPDs planning to switch to all-digital programming by February 17, 2009.

FTC Urges Caution on Net Neutrality as Battle Shifts Focus

At the end of June, the Federal Trade Commission ("FTC") released its report resulting from the two-day workshop it held in February 2007 on broadband access regulation (a/k/a network neutrality or "net neutrality"). In short, the report concluded that the U.S. does not need net neutrality regulation, and that lawmakers and agencies should proceed with great caution because the effect of any such regulation on consumers is unclear. The FTC stated that it was unaware of any market failure or consumer harm, and that it has other tools at its disposal to address broadband access issues and any possible consumer harms. The FTC also announced its intention to hold a series of "town hall" meetings in November to explore net neutrality and related issues.

Following this report, the primary battle over net neutrality shifted focus to the upcoming 700 MHz auction and the "open access" rules being urged by some in that rulemaking. The FCC ultimately did adopt a requirement that the winners of the largest 700 MHz spectrum block permit any and all devices and applications to run on their networks (see "New 700 MHz Band and Automatic Roaming Rules Apply to the Wireless Industry," this issue).

FCC Reminds Licensees of Bankruptcy Requirements

In a letter to Northwest Airlines, the FCC recently reiterated its role in bankruptcy reorganizations. Specifically, the Northwest reorganization plan stated that the bankruptcy court's approval was the only required governmental consent or approval needed. Nonetheless, Northwest in fact did apply for FCC approval for the assignment of the licenses from the debtor-in-possession to the newly reorganized entity. The FCC granted the requested approval, but cautioned licensees that bankruptcy plans must expressly recognize that any proposed transfer or assignment of licenses requires FCC regulatory approval in addition to court approval.

AT&T's IPTV Offering Is a Cable Service; Video Franchising Reform Continues to Make Progress in Several States

In late July, a federal court in Connecticut ruled that AT&T's U-verse Internet Protocol Television ("IPTV") product is a cable service, meaning AT&T will need to seek a state franchise to sell its service in the state. The court reasoned that two-way transmission of data between customers' set-top boxes and the network causes U-Verse to fall within the definition of cable service set forth in 1984 Cable Act. Prior to the court's ruling, the Connecticut Department of Public Utility Control allowed AT&T to offer IPTV services free from franchising requirements. One week later, AT&T filed a petition seeking reconsideration of the federal district court's ruling. AT&T's efforts to find relief in court may be thwarted by pending state legislation; Connecticut's governor recently signed a law shifting video franchising from municipalities to the public utility commission and extending the franchise requirement to IPTV and all other landline delivery technologies effective October 1.

At the federal level, the FCC's March 5, 2007 order streamlining video franchising is being challenged in federal court by various cities and municipalities, who argue the Commission's action usurps local oversight of pay-TV providers. The U.S. Circuit Court of Appeals in Cincinnati announced an expedited schedule for oral arguments, which likely will be held before the end of the year.

Meanwhile, efforts to transfer video franchising authority to the state level continue to make progress in many states. California, Florida, Georgia, Indiana, Iowa, Kansas, Michigan, Missouri, Nevada, New Jersey, North Carolina, South Carolina, Texas, and Virginia all have passed video franchise reform bills. Recently joining this group is Ohio, which in late June passed a bill shifting video franchising from municipalities to the state Commerce Department. In early July, Illinois passed a bill shifting video franchising from municipalities to the state Commerce Commission. A video franchising reform bill recently was introduced in the Pennsylvania House.

Summer Broadcast Developments Heat Up

The summer heat in Washington, D.C. usually dictates a slower pace during July and August, but Congress and the FCC forged ahead on a variety of broadcast issues despite the rising temperatures. Congress tackled DTV transition education funding and media violence. The FCC also addressed DTV issues as well as minority media ownership. Several FCC Commissioners also expressed strong individual views about various media issues.

On the Hill

Although the FCC only requested $1.5 million to finance a DTV transition education program, the Financial Services Subcommittee upped the amount to $2 million before sending the bill (HR 2829) to the House for debate. The Subcommittee's increase reflected concerns that public awareness of the transition is limited. Passed on June 28, the bill is currently on the Senate legislative calendar. Representative Engle (D-NY) is championing a separate transition education bill (HR 2566), calling for $20 million to educate over-the-air viewers and the creation of a federal DTV advisory committee. According to the Association of Public TV Stations ("APTS"), 61% of households are unaware of the transition and additional funding is needed to reach those most affected by the move to digital.

Senator Rockefeller (D-WV) is expected to introduce a bill shortly that would expand the FCC's powers to regulate violence on cable, satellite, and broadcast television. Based on comments made during the June 26 Senate Commerce, Science, and Transportation Committee hearing on media violence and its effects on children; however, majority support is lacking for a crackdown on violence. Proponents of the bill condemn the use of screening tools such as the rating system and TV V-chips, characterizing them as a "gigantic joke" and nothing more than "ineffective Band-Aids." Opponents cited concerns about the constitutionality of restricting programming content. Additionally, they defended the $300 million public service advertising campaign to educate parents about content blocking tools, calling it a roaring success with 77% of TV viewers aware of the ads.

At the Commission

The long-anticipated Digital Television ("DTV") table of channels was released August 7, affecting more than 100 television stations nationwide. The FCC order revealed broadcasters' post-transition slots and the fate of variance requests for previously-awarded channels. Industry response was tentatively favorable upon initial review of the assignment results, although discontent persists with the FCC's freeze on expanding digital signal contours until the transition is complete.

As DTV consumer education initiatives ramp up, the FCC released an NPRM on July 30 to elicit comments regarding the Commission's authority to require different industries to educate consumers about the digital transition. While many of the groups identified are already taking steps mentioned in the NPRM, the FCC contemplates requiring:

television broadcasters to conduct on-air, consumer education efforts, including public service announcements;

broadcasters to periodically report on education efforts;

cable and satellite providers to send periodic transition notices in customer bills;

manufacturers to include notices with television receivers shipped and sold within the U.S.;

retailers participating in the converter box coupon program to submit employee training and consumer information plans; and

digital television partners listed on the Commission's Web site to reveal education and outreach efforts.

The FCC officially joined the Digital Television Transition Coalition ("Coalition") in the beginning of July. More than 120 companies and lobbying groups belong to the Coalition, a large and diverse digital TV education group focused on raising awareness of the pending transition. The FCC's membership bolsters the group's standing and reflects Chairman Martin's public promise to collaborate with the National Telecommunications and Information Administration ("NTIA"), other agencies, and private bodies in alerting consumers about the February 2009 analog-cutoff date.

The FCC issued a broad media-ownership rulemaking on August 1, soliciting comments on 34 media ownership proposals, including 14 that the Minority Media & Telecommunications Council ("MMTC") submitted in an earlier petition. MMTC is pushing for a definition of disadvantaged businesses that is appropriate in the broadcasting context and constitutionally sound, a necessary step, it contends, in tightening up who does and does not qualify as a minority owner. Other MTTC recommendations include letting radio and TV stations sold to socially and economically disadvantaged businesses retain "grandfathered" status, which would allow the licensees to escape ownership rules issued after purchasing a station later determined to be noncompliant.

Commissioners aired their views on pet media issues during a broadcast localism hearing in Portland, Maine on June 28. Comments included the lack of ownership diversity, the glut of junk-food ads, and the trend towards covering celebrity gossip instead of substantive news.

Upcoming Deadlines for Your Calendar

Note: Although we try to ensure that the dates listed below are accurate as of the day this edition goes to press, please be aware that these deadlines are subject to frequent change. If there is a proceeding in which you are particularly interested, we suggest that you confirm the applicable deadline. In addition, although we try to list deadlines and proceedings of general interest, the list below does not contain all proceedings in which you may be interested.

> Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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