A California restaurant can offer a $5 sandwich for $4.90 to customers who pay with cash but until recently state law prohibited it from offering a $4.90 sandwich and adding a 10-cent surcharge for customers who paid with credit card. Either results in a $4.90 sandwich for cash payers or a $5 sandwich credit card payers, so it may surprise retailers to learn that so-called surcharge bans are common across several states and were once federal law.
There are several reasons why retailers care about whether they may add surcharges. Those reasons have caused retailers to challenge California’s and New York’s surcharge bans. And now state and federal courts—including the U.S. Supreme Court—are chiming in on the debate.
In January 2018, the Ninth Circuit issued an opinion in one of these cases. It held that California’s surcharge ban was unconstitutional as it applied to the pricing schemes in that case. That decision highlighted this often overlooked but evolving issue that retailers would be wise to review.
California’s Surcharge Ban
Retailers impose a surcharges because credit card companies charge them fees of around 2-3 percent of the transaction cost when a customer pays by credit card. Retailers can recoup the cost of that fee by adding a surcharge unless a statute or contractual agreement prohibits them from doing so.
In 1985, California enacted Civil Code section 1748.1. That section provides that “[n]o retailer … may impose a surcharge on a cardholder who elects to use a credit card in lieu of payment by cash, check or similar means.” But the law permits retailers to “offer discounts for the purpose of inducing payment by cash, check, or other means not involving the use of a credit card, provided that the discount is offered to all prospective buyers.” Simply put, retailers cannot add a surcharge when customers pay by credit card, but they may offer discounts to customers who pay with cash. Willful violators are liable for three times actual damages, as well as attorney fees and costs in an action enforcing the ban.
In Italian Colors Restaurant v. Becerra, Case No. 15-15873 (9th Cir. Jan. 3, 2018), a group of California retailers filed an action against the state challenging its surcharge ban. The retailers alleged in part that the ban restricted commercial speech in violation of the First Amendment. A federal district court agreed and declared the ban unconstitutional. The district court issued an injunction permanently enjoining enforcement, and the state appealed.
The Ninth Circuit affirmed summary judgment but modified the relief. The court agreed that the surcharge ban was unconstitutional as applied to the retailers. Because the retailers presented an as-applied challenge, the court declared the ban unenforceable only as to the specific pricing practice that the retailers sought to employ. Nearly all wanted to charge lower prices overall and a higher price for credit card payers, expressing the difference as a surcharge or “percentage fee.” One retailer already charged a regular price and a discount price for cash customers but wanted to describe the difference as a surcharge.
The opinion in Italian Colors Restaurant offers compelling reasons for why retailers prefer to impose surcharges rather than offer cash discounts. First, surcharges more effectively convey to customers the high cost of credit card fees. Second, raising prices overall and then offering cash discounts makes goods and services appear more expensive. Third, research shows that a substantial number of individuals are more likely to change their spending behavior if presented with a potential loss than with a potential gain. One study suggested that 74 percent of consumers base purchase decisions on that perception.
The Court’s Ruling
The Ninth Circuit found that the surcharge ban regulated commercial speech because it applied to the communication of prices. Restrictions on commercial speech must survive intermediate scrutiny under the test from Central Hudson Gas & Electric Corp. v. Public Service Commission of New York, 447 U.S. 557 (1980). That test first asks whether the speech is misleading or related to unlawful activity. If it is neither, then the state must assert a substantial interest that the regulation aims to achieve. Finally, the regulation must directly advance that interest and cannot be more extensive than necessary to achieve that interest.
As applied to the retailers, the surcharge ban did not pass the Central Hudson test. The court found that the retailers’ desired pricing scheme was “no more misleading than calling the weather warmer in New Orleans rather than colder in San Francisco.” Moreover, the retailers wanted to communicate rather than conceal surcharges. Next, the court considered the state’s purported interest to “promote the effective operation of the free market” but found that there was “no evidence that surcharges posed economic dangers that were in fact real before enactment of Section 1748.1.”
Nor did the ban directly advance the state’s purported interest in protecting consumers from deception. Indeed, the ban undermined “truthful price information” because it kept retailers from conveying that higher prices were the result of credit card fees. Because there were more narrowly-tailored means available—e.g., banning only deceptive or non-disclosed surcharges—the ban was also more extensive than necessary.
In sum, the court held that the surcharge ban restricted the retailers’ non-misleading commercial speech in violation of the First Amendment.
Surcharge Bans in Other States
California’s surcharge ban is not unique. In 1976, the federal Truth in Lending Act included a similar clause that prohibited retailers from imposing surcharges on credit card payers. The federal surcharge ban expired in 1984 at which point several states adopted similar bans including California, Colorado, Connecticut, Florida, Kansas, Massachusetts, New York, Oklahoma and Texas.
Retailers recently challenged New York’s surcharge ban as well. That case reached the U.S. Supreme Court which held only that New York’s statute regulated speech rather than conduct and was not unconstitutionally vague. See Expression Hair Design v. Schneiderman (Expressions III), 137 S.Ct. 1144 (2017). The court remanded to the Second Circuit to decide whether New York’s statute violated the First Amendment. The circuit court, in turn, issued a certified question to the state court of appeal as to whether a retailer complies with the ban as long as the merchant posts the “total-dollars-and-cents price” charged to credit card payers. Expressions Hair Design v. Schneiderman (Expressions IV), 877 F.3d 99 (2017). That question is still pending.
What Retailers Can Take Away
For one, California retailers should make express all surcharges that apply to credit card paying customers prior to the point of sale. Recall that California’s statute is unconstitutional only as applied to the pricing practices in Italian Colors Restaurant. Notably, all of the practices there involved communicating the surcharge—or “percentage fee”—to customers. Indeed, the court noted that “[t]o be sure, credit card surcharges can be deceptive, especially if they are imposed surreptitiously at the point of sale.”
Second, state laws largely determine whether and how retailers may impose surcharges. Multi-state chains and franchisors should review any surcharge policies and price-disclosure guidelines according to each state’s laws. For example, in Minnesota, a retailer may impose a surcharge “provided (1) the seller informs the purchaser of the surcharge both orally at the time of sale and by a sign conspicuously posted on the seller’s premises, and (2) the surcharge does not exceed five percent of the purchase price.”
Third, retailers must also be careful to review their contracts with credit card companies. There is a separate wave of litigation between retailers and credit card companies. These disputes arise in part over contractual prohibitions on surcharge fees. Accordingly, retailers must also pay attention to their contractual obligations with credit card companies regarding surcharges.
Italian Colors Restaurant highlights California’s limit to regulating surcharges. The case also illustrates why retailers prefer adding surcharges instead of offering cash discounts. These recent challenges to surcharge bans also ensure that consumers, regulators and credit card companies will be increasingly mindful of whether and how retailers apply surcharges. Retailers should likewise be mindful.
Justin McGuirk is a complex litigation attorney in the San Francisco office of Reed Smith, focused on the food and beverage industries.