When Talk America changed the terms of its long-distance telephone service agreement, it posted the new contract on its Web site. Among the changes was an arbitration clause and a choice-of-law provision that subjected customers to New York state law. But Joe Douglas, a California customer Talk America acquired from AOL in 2001, didn’t learn about those changes until 2006, when he brought a breach-of-contract class action against Talk America.

The Pennsylvania-based phone company, which recently merged with Cavalier Telephone, moved to compel arbitration, per its service agreement. A California district court agreed with the defendant and ordered the parties into arbitration in October 2006. But Douglas brought a mandamus petition to the 9th Circuit, and in July 2007 the appeals court vacated the district court order, allowing the class action to proceed. The court said Talk America could not expect its customers to visit the company’s Web site to check for changes in terms.

“Click-wrap contracts are enforceable, but you have to follow the basic principles of contract law,” says David Stoll, a senior associate with Farella, Braun & Martel in San Francisco. “As we’ve moved into the online world, some people have stretched those principles and forgotten they need to get informed consent from customers.”

Informed Consent
State and federal laws both regulate customer agreements, such as Talk America’s long-distance service contract. The FCC, for example, enforces anti-slamming laws, which forbid switching a customer’s telephone company without consent. And the Federal Arbitration Act requires companies to adhere to state laws regarding enforceability of arbitration clauses.

In California, contract laws are more favorable to consumers than they are in many other states. In Discover Bank v. Superior Court of Los Angeles, for example, the California Supreme Court in June 2005 ruled, “Class-action waivers in consumer contracts of adhesion are unenforceable, whether the consumer is being asked to waive the right to class-action litigation or the right to class-wide arbitration.”

Talk America sidestepped California’s consumer-friendly policies with a choice-of-law clause invoking the laws of New York, which generally would permit the company’s arbitration clause. But the 9th Circuit rejected Talk America’s contract for several reasons.

Most important, the court said a party cannot unilaterally change the terms of a contract without first getting the other party’s consent, citing its 1976 ruling in Union Pacific Rail Road v. Chicago, Milwaukee, St. Paul & Pacific Rail Road.

For its part Talk America argued Douglas’ consent was implied, because he should have seen the terms when he paid his bills electronically. “It was absolutely absurd,” says J. Paul Gignac, a partner with Arias, Ozello & Gignac, which represents Douglas and the other plaintiffs in the class action. “The defendant argued our client was bound by a contract change posted on the defendant’s Web site.”

The appeals court sided with Douglas, who claimed he had no reason to visit Talk America’s Web site. Douglas had authorized AOL to bill monthly charges to his credit card before Talk America took over his account and subsequently changed the terms of service.

“Just because a contract is online doesn’t mean you don’t need to follow regular contract principles,” Stoll says. “You still need to have an offer and acceptance to have a binding contract.”

Choice of Law
While Talk America’s contract fell short of the court’s expectations, the 9th Circuit in Douglas said implied consent might be sufficient in other situations. For example if a credit card company notified cardholders of revised terms of service, customers could agree to the new terms just by continuing to use their credit cards.

But the court also said California law sets a higher consent standard for contract revisions affecting consumers’ access to the courts. The court cited Badie v. Bank of America, in which the California Court of Appeals in 1998 refused to enforce an arbitration clause in Bank of America’s revised contract even though the bank notified customers of the revision.

“It’s well and good to have inferred consent with general contract terms,” Stoll says. “But if you are making changes to a very important provision in an existing contract, the court may find you must give the customer an opportunity to say yes or no.” And given California’s consumer-protection policies, even that opportunity might be insufficient.

In addition to the consent issues that derailed Talk America’s arbitration motion, the 9th Circuit said Talk America’s choice-of-law provision would have rendered the contract unenforceable even if Douglas had consented to the changes. The reason was Talk America’s choice of New York law.

California’s choice-of-law rules prohibit parties from invoking the laws of other states if those laws are contrary to California law and if California has a “materially greater interest in determining the issue.” Because neither Douglas (a California resident) nor Talk America resided in New York, the court said California’s interest in the Douglas dispute was greater than New York’s.

“When you put a choice-of-law provision in a consumer contract, you should make sure the law you are seeking to apply bears some relationship to the consumer or the company’s business,” Gignac says.

The same principle applies in many other states whose choice-of-law provisions largely follow the Restatement of Laws treatise upon which California’s provisions are based. This uniformity offers a degree of comfort for companies doing business in multiple states–but only as long as they can justify their choice of law and exercise due care in following standard contract-law practices.

“The more you push the envelope trying to be tricky with enforceability, the more you will run up against state rules,” Stoll says.