Hanging Up on Early-Exit Fees

Regulators and courts are taking aim at early-cancellation penalties charged by carriers such as AT&T, Verizon, and DirecTV

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by Olga Kharif

There may be 50 ways to leave your wireless carrier. Just don't do it before your contract is up—or you'll be forced to pay a fat early-termination fee. That's the lot facing most U.S. consumers of communications services, from mobile calling to cable TV to high-speed Internet access.

Consider the subscriber who wants to end a DirecTV (DTV) service contract and has to pay $20 a month for the remainder of the term. Breaking a wireless services contract can cost as much as $175. It's a big reason why few people switch communications providers. At satellite TV company DirecTV, only 1.42% of customers close their accounts each month. Even Sprint Nextel (S), with one of the highest customer defection rates in the wireless industry, loses a mere 2.45% of its customer base in a month.

A prorated approach?

But in a move that could make it easier for customers to drop phone or satellite providers, early termination penalties are coming under new fire from federal regulators, legislators, and courts. The Federal Communications Commission (FCC) has scheduled a hearing for June 12 to consider potential restrictions on the penalties. And even if the FCC doesn't act to rein them in, Congress is mulling legislation that would.

Cable and phone companies, which spend hundreds of dollars on advertising and promotions to sign up each new subscriber, fear they'll have a harder time recouping that investment if the penalties are diminished too far. And exit penalties exist worldwide: European telco Vodafone (VOD) requires subscribers to pay their monthly fees for the duration of wireless contracts, even if they don't use the phone.

FCC Chairman Kevin Martin has suggested that the commission may require service providers to prorate penalties through the life of a contract, so that the longer a customer stays, the lower the fee. The agency may also require that buyers be allowed to drop a service such as a new cell phone contract without penalty within 30 days of purchase. "Certainly carriers may be able to recover legitimate out-of-pocket expenses and costs," says FCC spokesman Robert Kenny. "On the other hand, we want to make sure this isn't being used as an artificial means of locking consumers into a particular service provider." A ruling to alter the allowed penalty structure could come as early as this fall, says Carol Mattey, a former FCC official who is now a managing director for consultancy Deloitte & Touche.

"Enormous Pressure"

Congress, meanwhile, is considering several bills backed by powerful supporters, including Edward Markey (D-Mass.), chairman of the House Subcommittee on Telecommunications & the Internet, and Senator Jay Rockefeller (D-Va.). The measures, proposing conditions for wireless contracts similar to those being considered by the FCC, are already going through revisions in Congressional committees and could be passed in early 2009.

But while the FCC and Congress may impose restrictions, it's the legal system that threatens to scratch early termination fees altogether. Courthouses from California to New York are flooded with class actions claiming that early termination fees, especially those on wireless contracts, are unfair to consumers. In a landmark ruling on May 27, the Supreme Court refused T-Mobile USA's request to dismiss one class action based on the cellular company's contract stipulations that all customer disputes be settled through arbitration. The decision means that all similar suits can proceed—some state courts are expected to decide cases within days—and may open the floodgates to new class actions. "I just see an explosion of lawsuits," says Mattey. "Every week, every carrier is getting sued. It's going to create enormous pressure."