"Negative Option Marketing" Offers Need to be Crafted Carefully to Comply With Existing Federal and State Laws

The Federal Trade Commission ("FTC") announced recently a settlement with a company that used false "free" product offers for weight-loss pills, teeth whiteners, health supplements, a work-at-home scheme, access to government grants, free credit reports and penny auctions, and then charged those consumers monthly recurring fees for products the consumers did agree to purchase.  Federal Trade Commission v. Willms, et al., Case No. 2:11-cv-00828 (W.D. Wash. Feb. 23, 2012).  Unscrupulous and dishonest marketers have given negative option offers a bad name.  The fact remains -- when used appropriately and in compliance with the law, negative option offers can be an effective marketing strategy.  Consumers receive better deals with uninterrupted services (and often a simplified renewal process), while marketers get to reduce costs associated with the renewal of services and continued customers.  However, marketers employing negative option marketing strategies need to comply with the law.

"Negative Option Marketing" refers to transactions where the seller interprets a consumer's failure to take an affirmative action (either to reject an offer or cancel an agreement) as an asset to be charged for goods or services.  Federal Trade Commission Report, A Report by the Staff of the FTC's Division of Enforcement:  Negative Options, January 2009 ("FTC Negative Option Report").  There are four types -- prenotification negative option plans; continuity plans; automatic renewals; and free-to-pay or nominal-fee-to-pay conversion offers.  FTC Negative Option Report, p. 2.  In prenotification negative option plans, the seller sends periodic notices offering goods and, if consumer takes no action, then the seller sends the goods and charges consumers.  In a continuity plan, the consumer agrees in advance to receive periodic shipments of goods or services, which they continue to receive until they cancel the agreement.  In an automatic renewal plan, a seller automatically renews a consumer's purchase of a good or service and charges the consumer for it, unless the consumer cancels the renewal.  In free-to-pay or nominal-fee-to pay conversion plan, a consumer receives goods or services for free or at a nominal fee for a trial period and then, after the trial period, a seller automatically begins charging a fee (or higher fee) unless the consumer affirmatively cancels or returns the good or service.

Federal Trade Commission Act: At the Federal level, negative option offers are governed by, among other things, Section 5 of the Federal Trade Commission Act (the "FTC Act") and regulations promulgated by the FTC.  Section 5 prohibits "[u]nfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce."  15 U.S.C. § 45(a)(1).  "Unfair" practices are those that "cause or are likely to cause substantial injury to consumers which are not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition."  15 U.S.C. § 42(n).  While the FTC Act does not provide for a private cause of action, the FTC has authority under the FTC Act to both propound regulations and to initiate investigations or enforcement actions.  15 U.S.C. § 45.  Under its Section 5 authority, the FTC also issues administrative interpretations intended to provide guidance about compliance with the law.  These guidelines do not have the force of law and are not formal regulations (and there are no direct fines issued for violations of the guidelines); however, violations will likely be viewed as violations of Section 5 and could result in an enforcement action.

On February 9, 2009, the FTC issued a staff report summarizing its Negative Option Workshop (held in 2007).  FTC Negative Option Report, p. 1.  In the Report, the FTC identified five principles to guide marketers of negative option offers.  Each of these principles is discussed in more detail below.

Disclose the Material Terms: Marketers must disclose clearly the material terms in an understandable manner.  At a minimum, disclosure of the following terms must be made:  (1) the existence of the negative option offer; (2) the offer's total cost; (3) the transfer of a consumer's billing information to a third party (if applicable); and (4) how to cancel the offer.  FTC Negative Option Report, p. 26.  The disclosures must be understandable and not made in vague or unnecessary long disclosures.  Id.

Disclosures Must Be Provided in a Clear and Conspicuous Fashion:  Disclosures must be clear and conspicuous.  FTC Negative Option Report, p. 27.  Disclosures should be placed in a location where the consumer is likely to see them, and should not be buried in long paragraphs of dense text or displayed in such a manner so that the consumer is unlikely to read them.  Id.  Disclosures should be labeled in such a way as to indicate the importance and relevance of the information.  Id.  The text should be in a size and color that makes it easy to find and read, and should not be in small in print, contained in long passages that are single-spaced or in all-capital letters or in colors that do not adequately contrast with the disclosure document.  Id.

Disclosures Should Be Made Before the Customer Incurs Any Financial Obligation:  Disclosures must be made before the consumer incurs any financial obligation.  FTC Negative Option Report, p. 27.  The advertiser must disclose the terms to the consumer before the consumer agrees to the purchase.  Id.

Affirmative Consent to the Automatic Renewal Continuity Offer:  Consumers must take an affirmative step to demonstrate their consent to the negative option offer.  FTC Negative Option Report, pp. 27-28.  The advertiser must obtain the consumer's affirmative consent before enrolling the consumer in the negative option program and must memorialize the consumer's consent.

Must Provide (and Not Impede) Cancellation Procedures:  Cancellation procedures must be provided for the offer.  A marketer should not impede the effective operation of promised cancellation procedures and should honor any cancellation request that complies with the procedures.  FTC Negative Option Report, p. 28.  Marketers should not (1) hang up on a consumer seeking to cancel, (2) place a consumer on hold for an unreasonably long time, (3) provide false information to the consumer about how to cancel the offer or (4) misrepresent the reasons for delays in processing consumer's cancellation requests.  Id.

Electronic Funds Transfer Act: If a consumer uses a debit card (instead of a credit card) to pay for the automatic renewal feature of the monthly unlimited plan, then marketers must also comply with the Electronic Funds Transfer Act ("EFT Act") and associated regulations promulgated by the Federal Reserve.  The EFT Act establishes the rights of consumers, as well as the responsibilities of all participants, in electronic funds transfer activities.  15 U.S.C. § 1693, et seq.

Preauthorized transfers from a financial institution are subject to regulations promulgated by the Federal Reserve under Regulation E.  12 C.F.R. 205.10 (Regulation E; Preauthorized Transfers).  In accordance with Regulation E, preauthorized transfers require a writing to be signed or similarly authenticated by the consumer prior to the transfer, and the person who obtains the authorization must provide a copy to the consumer.  12 C.F.R. 205.10(b).  In addition, if the preauthorized transfer varies from the amount of a previous transfer under the same authorization or from the preauthorized amount, then the designated payee (or the financial institution) must send the consumer written notice of the amount and date of the transfer at least 10 days before the scheduled date of transfer.  Id. at § 205.10(d).

A signed agreement (or similar authentication) from the consumer must be obtained prior to the transfer of funds.  If the price changes or the preauthorized transfer varies from the amount of a previous transfer under the same authorization or from the preauthorized amount, then the consumer must be provided written notice of the amount and date of the transfer at least 10 days before the scheduled date of transfer.

State Law Regarding Automatic Renewal Continuity Programs:  State law often applies to negative option offers.  Below is a summary of some of the relevant laws.

Ohio Consumer Sales Practices Act:  Like the FTC Act, the Ohio Consumer Sales Practices Act ("OCSPA") prohibits unfair or deceptive sales practices in consumer transactions.  Ohio Rev. Code § 1345.02.  A consumer transaction "means a sale, lease, assignment, award by chance, or other transfer of an item of goods, a service, a franchise, or an intangible, to an individual for purposes that are primarily personal, family, or household, or solicitation to supply any of these things."  Id. at § 1345.01.   Similar to the FTC Act, the OCSPA allows the Ohio Attorney General to conduct investigations and to prosecute violators to enforce the OCSPA.  Id. at §§ 1345.02 and 1345.05.  Unlike the FTC Act, a consumer has a private cause of action and is entitled to relief including, but not limited to, rescission, actual damages and an injunction.  Id. at § 1345.09.  Under certain circumstances, a consumer may receive treble damages.  Id.

The OCSPA enumerates prohibited sales conduct, including, but not limited to, (1) making representations that the subject of a transaction has sponsorship, approval, or benefits that it does not have, (2) making representations that the subject of a transaction is of a particular standard, quality, grade, or model, if it is not, or (3) making representations that a specific price advantage exists, if it does not.  Id. at § 1345.02.  The OCSPA also lists conduct that may constitute unconscionable sales practices, including, but not limited to, (1) knowingly taking advantage of the inability of the consumer because of his physical or mental infirmities, ignorance, illiteracy, or inability to understand the language of an agreement, (2) entering into an agreement knowing at the time the transaction was entered into of the inability of the consumer to receive a substantial benefit from the subject of the transaction, and (3) entering into an agreement knowing at the time the transaction was entered into that there was no reasonable probability of payment of the obligation in full by the consumer.  Id. at § 1345.03.  The OCSPA also states that "court[s] shall give due consideration and great weight to [F]ederal [T]rade [C]ommission orders, trade regulation rules and guides, and the federal courts' interpretations of [Section 5] of the [FTC Act]."  Thus, the FTC Negative Option Report and related enforcement actions are relevant to determining whether there has been a violation of Ohio law, in addition to Federal law.

The Ohio Attorney General has brought at least two enforcement actions involving negative option offers, one resulting in an "Assurance of Voluntary Compliance" and the other resulting in a "Consent Judgment and Order."  In the Matter of MemberWorks Inc., Attorney General Docket No. 9217947 (assurance of voluntary compliance agreement); State of Ohio ex rel. v. Berkeley Premium Netraceuticals, Inc., Case No. 05CVH-06-6479, Franklin County Common Pleas Court (entry of consent judgment and order).  Both matters provide guidance to advertisers seeking to utilize an automatic renewal continuity program.

In MemberWorks Inc., MemberWorks engaged in the direct marketing of a variety of members' offers to Ohio consumers, including travel, entertainment, credit card registrations, health and dental services and the purchase of other goods and services.  MemberWorks, p. 1.  Consumers were charged membership fees on an annual or monthly basis.  Id.  MemberWorks entered into numerous third-party relationships, which allowed MemberWorks to market its programs.  Id. at 1-2.  As part of the offered programs, MemberWorks employed a "free-trial" negative option program, whereby consumers would sign up for a "free trial" and then were charged monthly renewal fees unless the consumer called a specified toll-free number or wrote to cancel the program within the thirty-day period.  Id. at 2.

As part of a settlement with the Ohio Attorney General, MemberWorks agreed to, among other things, provide clear and conspicuous disclosures of all material terms and conditions for the purchase of the memberships, including (1) the name of each of the sellers offering the program and the entity to which the payment would be made; (2) the amount of the membership change, the frequency of payment (if applicable), the approximate time when the membership charge would be charged to the consumer; (3) the fact, if true, that the consumer's account will be automatically renewed if the consumer does not take affirmative action to cancel the membership; and (4) the fact that the consumer will be automatically charged for the membership at the beginning of each new membership period.  Id. at 7.  MemberWorks was also required to disclose the terms and conditions of any refund and cancellation policies and to obtain verified consent before charging or attempting to collect any payment from the consumer.  Id. at 8.  The verified consent was required to be either in writing or recorded (audio).  Id.  MemberWorks also agreed to provide written notice of the automatic renewal feature to those consumers whose membership program renews after more than a quarterly basis.  Id.

In the Berkeley Premium matter, Berkeley Premium was accused of falsely advertising its dietary supplements.  Berkeley Premium, p. 2.  One component of the Berkeley Premium's sales practices included a negative option automatic renewal feature.  Id.  As part of a consent judgment settlement with the Ohio Attorney General, Berkeley Premium agreed to, among many other things, a restraining order preventing it from failing to obtain a written document clearly and conspicuously disclosing all material terms and conditions of the negative option sale, including, but not limited to:  (1) the fact that the consumer was enrolled in the negative option program and would be charged for successive product shipments; (2) the cancellation terms and conditions for cancelling the program; and (3) the refund policies.  Id. at 14.  MemberWorks also agreed to disclose:  (1) the fact that the consumer will be automatically be charged for absent cancellation; (2) when the amount will be charged; (3) what steps the consumer must take to avoid the charge; (4) when the cancellation request must be received; and (5) a telephone number and address where the consumer's cancellation request should be directed.  Id.

To comply with Ohio law, the advertiser must disclose:  (1) the name of any entity to which the payment would be made; (2) the amount of the charge; (3) the frequency of payment, (4) the approximate time when the charge would be charged to the consumer; (5) the fact that the consumer's account will be automatically renewed if the consumer does not take affirmative action to cancel the membership; and (6) the fact that the consumer will be automatically charged at the beginning of each new period.  The advertiser must also disclose:  (1) the cancellation terms and conditions for cancelling the program; and (2) the refund policies.  The advertiser must also disclose when the cancellation request must be received and a telephone number and address where the consumer's cancellation request should be directed.

Georgia Fair Business Practices Act:  Similar to the OCSPA, Georgia has adopted the Fair Business Practices Act (the "GFBPA").  Ga. Code Ann. § 10-1-390 et seq.  The GFBPA is to be interpreted and construed consistently with interpretations given by the FTC in the Federal courts pursuant to Section 5(a)(1) of the [FTC Act]."  Id. at § 10-1-391.  A consumer has a private cause of action and is entitled to relief including, but not limited to, actual damages, and an injunction.  Id. at § 10-1-399.  Under certain circumstances, a consumer may receive treble damages.  Id.

While there are no reported decisions involving Georgia law and negative option plans, the Georgia Office of Consumer Protection does provide guidance to consumers about warnings of negative option programs.  See Negative Option Plans, Georgia Office of Consumer Protection.  The Georgia Office of Consumer Protection refers to the Negative Option Rule promulgated by the FTC, and directs consumers to file complaints with the FTC or with the Georgia Office of Consumer Protection "[i]f you were enrolled in a negative option plan without your knowledge, and the terms and conditions of the plan were not described in a clear and conspicuous manner."  Id.  As a result, the advertiser should follow the FTC Negative Option Report when conducting negative option marketing offers.

Illinois Automatic Contract Renewal Act:  Illinois has adopted the Automatic Contract Renewal Act.  815 Ill. Comp. Stat. 601/1 et seq.  Violations of the Automatic Contract Renewal Act are considered violations of the Illinois Consumer Fraud and Deceptive Business Practices Act (815 ILCS 505/1 et seq.).  815 Ill. Comp. Stat. 601/15.  The Automatic Contract Renewal Act provides that businesses that "sell any products or services to a consumer pursuant to a contract, where such contract automatically renews unless the consumer cancels the contract, shall disclose the automatic renewal clause clearly and conspicuously in the contract, including the cancellation procedure."  815 Ill. Comp. Stat. 601/10(a).

The Automatic Renewal Contract Act has additional requirements if the renewal term is more than one month.  Id.  ("Any person, firm, partnership, association, or corporation that sells or offers to sell any products or services to a consumer pursuant to a contract, where such contract term is a specified term of 12 months or more, and where such contract automatically renews for a specified term of more than one month unless the consumer cancels the contract, shall notify the consumer in writing of the automatic renewal.  Written notice shall be provided to the consumer no less than 30 days and no more than 60 days before the cancellation deadline pursuant to the automatic renewal clause.  Such written notice shall disclose clearly and conspicuously:  (i) that unless the consumer cancels the contract it will automatically renew; and (ii) where the consumer can obtain details of the automatic renewal provision and cancellation procedure (for example, by contacting the business at a specified telephone number or address or by referring to the contract)").

There is a safe harbor provision in the Automatic Renewal Contract Act that provides that a person (or corporation "will not be liable for a violation of this Act or the Consumer Fraud and Deceptive Business Practices Act, if such person . . .  demonstrates that, as part of its routine business practice:  (i) it has established and implemented written procedures to comply with this Act and enforces compliance with the procedures; (ii) any failure to comply with this Act is the result of error; and (iii) where an error has caused a failure to comply with this Act, it provides a full refund or credit for all amounts billed to or paid by the consumer from the date of the renewal until the date of the termination of the account, or the date of the subsequent notice of renewal, whichever occurs first."  Id. at § 601/10(c).

To comply with Illinois law, the advertiser should disclose the automatic renewal clause clearly and conspicuously and should include detailed information about the cancellation procedure in that agreement.  In addition, the advertiser should establish and implement written procedures to comply with this Automatic Renewal Contract Act to ensure that it can take advantage of the safe harbor provision, if necessary.

Other States:  California's Automatic Purchase Renewal Act:  California has enacted the Automatic Purchase Renewal Act that took effect on December 1, 2010.  Cal. Bus. & Prof. Code § 17601 et seq.  The statute regulates "automatic renewal" and "continuous service" offers.  Id. at §17601.  The new California law prohibits "any business making an automatic renewal or continuous service offer to a consumer in this state" to do any of the following:

"Fail to present the automatic renewal offer terms or continuous service offer terms in a clear and conspicuous manner before the subscription or purchasing agreement is fulfilled and in visual proximity, or in the case of an offer conveyed by voice, in temporal proximity, to the request for consent to the offer; Charge the consumer's credit or debit card or the consumer's account with a third party for an automatic renewal or continuous service without first obtaining the consumer's affirmative consent to the agreement containing the automatic renewal offer terms or continuous service offer terms; and Fail to provide an acknowledgment that includes the automatic renewal or continuous service offer terms, cancellation policy, and information regarding how to cancel in a manner that is capable of being retained by the consumer.  If the offer includes a free trial, the business shall also disclose in the acknowledgment how to cancel and allow the consumer to cancel before the consumer pays for the goods or services."

Id. at § 17602(a).  To be considered "clear and conspicuous" under the law, the disclosure must be "larger type than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same size, or set off from the surrounding text of the same size by symbols or other marks, in a manner that clearly calls attention to the language."  Id. at § 17601(a).

The law also requires that "businesses making automatic renewal or continuous service offers" must "provide a toll-free telephone number, electronic mail address, a postal address only when the seller directly bills the consumer, or another cost-effective, timely and easy-to-use mechanism for cancellation.  Id. at § 17601(b).  If there is any "material change in the terms of the automatic renewal or continuous service offer that has been accepted by a consumer in this state," the business "must provide the consumer with a clear and conspicuous notice of the material change and provide information regarding how to cancel in a manner that is capable of being retained by the consumer."  Id. at § 17601(c).

Products provided without complying with the new California statute are considered gifts.  Id. at 17603 ("In any case in which a business sends any goods, wares, merchandise, or products to a consumer, under a continuous service agreement or automatic renewal of a purchase, without first obtaining the consumer's affirmative consent as described in Section 17602, the goods, wares, merchandise, or products shall for all purposes be deemed unconditional gifts to the consumer, who may use or dispose of the same in any manner he or she sees fit without any obligation whatsoever on the consumer's part to the business, including, but not limited to, bearing the cost of, or responsibility for, shipping any goods, wares, merchandise, or products to the business.")

Negative option offers can be effective marketing strategies that benefit both consumers and marketers.  However, marketers employing negative option marketing strategies need to be careful so that they are complying with the law.

About The Author

Brian Wright | Faruki Partner