Abstract
Many consumer contracts, such as magazine subscriptions, mobile phone contracts, or fitness club subscriptions, are fixed-term contracts containing an automatic renewal clause. This paper provides the rationale of why such contracts are signed and what are the economic and legislative impacts of such clauses. Article seeks to offer a genesis of behavioural and traditional law and economics’ arguments to regulate inefficient limitations upon the consumer’s authority to terminate. The main findings are as follows: (1) In principle, obscure terms shrouding information on where and how to cancel should be regulated. (2) Formal requirements that impose a heavier burden upon the consumer to terminate (or to switch) than to subscribe with no offsetting economic benefit should be banned. (3) Legislator should intervene in to the formal requirements that increase switching costs imposed upon final consumers. (4) Legislator should intervene in cancellation deadlines that are set very early with no offsetting economic benefit. (5) Regulation mandating sellers to clearly and conspicuously ex ante notify consumers on automatic renewal in writing should be approached with cautiousness. (6) Provisions of Belgium and German law that fix the maximum duration of automatically renewed contracts and convert them into indefinite term contracts should be open to criticism.
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Notes
For employment contracts for an indefinite period of time, legislators have specified minimum notice periods.
We define traditional law and economics as the one which operates in the domain of rational choice theory, where economic agents act as rational, self-interested, wealth maximizing, and risk-averse individuals. Hence, when individuals are confronted with various choices they will choose the option that yields them the most expected welfare. For a synthesis of traditional law and economics see, e.g., Posner 2011, (Korobkin and Ulen 2000), Korobkin 2004; Cooter and Ulen 2011.
“Behavioral” law and economics retains the positive and normative core of law and economics but loosens the behavioural assumptions employed under the “traditional” approach. “Behavioural” law and economics substitute for a strict adherence to rational choice theory a more subtle and context-dependent view of how individuals chose behaviours and actions based largely on empirical studies of behaviour conducted by social scientists. This literature suggests that individuals often make decisions and selected actions based on heuristics, or rules of thumb, rather than on the basis of “rational” calculations of costs and benefits (Korobkin 2004). For a synthesis of “behavioural” law and economics, see Jolls et al. (1998). See also Kahneman and Tversky (1974).
Directive 2011/83/EU OJ L 304/64, 22.11.2011 of the European Parliament and of the Council of 25 October 2011 on consumer rights amending Council Directive 93/13/EEC and Directive 1999/44/EC and repealing Council Directive 85/577/EEC and Directive 97/7/EC. See, however, a proposal for Directive 2008/0196 (COD) according to which all four previously existing EU consumer Directives shall be merged, modernized, and updated.
OJ L 95, 21.4.1993.
On 8 October 2008, the European Commission adopted a proposal for a new Directive on consumer rights (2008/0196 COD) which regulated the automatic renewal clauses in Articles 32 and 35 of the proposed Directive 2008/0196 (COD) and further on in the Annex III to the Directive where the contract terms which are presumed to be unfair were listed. This Annex III listed under its heading (f) as presumably unfair contract terms, which have the object or effect of “automatically renewing a fixed-term contract where the consumer does not indicate otherwise and has to give a long notice to terminate the contract at the end of each renewal period.”
Transposition of the new rules into the national laws shall be done by 13 December 2013, and the rules will be applied in all member states at the latest by 13 June 2014.
Parker v. South Eastern Railway Co Ltd. [1877] 2 CPD 416; Thornton v. Shoe Lane Parking Ltd [1971] 2 QB
163.
Actually, it is designed to control exclusion clauses.
The Directive was initially implemented into English law by the Unfair Terms in Consumer Contracts Regulations 1994 (SI No 1994/3159). The 1994 Regulations came into force on 1 July 1995 but were revoked and replaced by the Unfair Terms in Consumer Contracts Regulations 1999 (SI No 1999/2083).
“Bradley Estate Agents Ltd.”, Unfair Contract Terms, Bulletin No. 3, 1997.
Ibid.
Ibid.
Competition and Consumer Act 2010 - C2011C00003 - Schedule 2 (Australian Consumer Law), Act No. 148 of 2010.
Ibid.
Under section 2 of the Australian Consumer Law states that unfair terms in consumer contracts will be void. And a contract will continue to bind the parties to the contract to the extent that the contract is capable of operating without the undfair term; Ibid.
Ibid.
Gesetz zur Regelung des Rechts der Allgemeinen Geschäftsbedingungen (AGBG).
The new Article 309 § 9 BGB (effective period of long-term obligation relationships), considers as unfair also the automatic renewal clause and provides: “(a) in respect of a contractual relationship which has as its subject matter the regular delivery of goods or the regular effecting of services or work by the user,
(b) a tacit lengthening by, in each case, more than a year of the contractual relationship binding the other contracting party, or
(c) longer period of notice of termination than 3 months before the expiry of the contractual duration provided for initially or extended tacitly and which is to the disadvantage of the other contracting party; this does not apply to contracts for the delivery of things sold as related to each other, for insurance contracts, and for contracts between the proprietors of copyright rights and claims and exploitation companies in the sense of the Act on the exercise of copy rights and related protective rights.”
The rules on automatic renewal clauses have been inserted into the Law on Commercial Practices by the Law of 25 April 2007.
815 ILCS 601/1 (Illinois Automatic Contract Renewal Act).
Ibid.
For example, Arkansas, Connecticut, New Mexico, North Carolina, New York, Pennsylvania, Tennessee, and Utah.
Neither are there involved any negative externalities.
In many contexts, contracting parties have no incentive to increase transaction costs unnecessarily. Conventional economic wisdom even suggests that if people unnecessarily increase the costs incurred by their contracting parties, those parties are likely to find it cheaper to do business with a competitor. Consumer transactions, however, do not always follow this rule, since in some instances business benefits by increasing consumer transaction costs to the detriment of consumers.
Rational consumer will engage in termination until the costs of doing so exceed the transaction’s benefit (where the benefit of the termination consists of the difference between the price and the value of the service during renewal period). For a synthesis on rationality, wealth-maximization self-interest and risk-aversion, see Posner (2011).
Although one should note, that this might not work for all consumers with their valuation lower than the price, some consumers might be effectively deterred from terminating the contract due to this high transaction costs. As a result, they will be bound by the contract for an additional term even when the price is higher than their valuation of the contract.
Since P > MB (where P = price, MB = marginal benefits), the consumer could gain by getting out of this transaction and acquiring something for which the price would be equal or below MB. Even more specifically, it causes an inefficient delay in termination by increasing the time period between the moment that the valuation decreases and the effective termination date.
Under the strong version of the rationality assumption, it is assumed that individuals never make mistakes, only buy products they really want for the lowest price, are fully informed about the clauses they sign, have perfect knowledge about their preferences and needs, have stable preferences (perfect willpower), always do what they plan to do, never regret transactions, etc.
For example, mail-in rebates that increase the costs consumers must incur to obtain the reduced price instead of simply paying less for the item from the beginning. Consumers must fill out a form, gather proofs of purchase, holding a bottle under boiling water to remove the neck label so that it could be submitted to the manufacturer, etc. The obvious result is that only a handful of consumers obtain the rebate. The term inflated consumer transaction costs was coined by Sovern (2006). Another example concerns opt-in and opt-out approaches to personal privacy. Firms might discourage consumers to opt out of the trade in their personal names by increasing the transaction costs in opting out relative to the costs of opting in, for example, by requiring those who opt out to write the firm without providing a form that the consumer could fill out and return to the company. Firms, for example, also increase the transaction costs to effectively use a guarantee. See also Gabaix and Laibson (2006).
Furthermore, one may also argue that cancellation deadlines artificially increase the risk for the consumer to be bound to a contract arrangement that he regrets or that might have become inefficient. Under a fixed-term contract, the consumer assumes the risk (for the duration of contract) that changed circumstances cause him to regret the arrangement. The decision to assume voluntarily the risk of uncertain and unforeseeable events is presumably motivated by the corresponding gains that the fixed term agreement offers in terms of fostering investments in transaction-specific assets (Goetz and Scott 1981, pp. 1089–1140). In other words, cancellation deadlines increases the risk of being bound to the contract when valuation is below the price by increasing the consequences when the decrease in valuation occurs after the cancellation deadline has passed.
In other words, a rival would have to offer (in perpetuity) a discount on the price of its fixed line voice service of 33% of the price paid in order to overcome the average switching costs imposed on households induced by automatically renewable contracts (Crawford et al. 2011).
In addition.
Further justifications for such inefficiencies from the ex ante perspective, such as screening and investment considerations might exist, but do not hold for the sources of discussed inefficiencies. Namely, screening considerations might justify holding the consumer to the contract he signed for the current period, but do not hold with regard to the renewal which is induced by the time limits to terminate. On economics of screening and self-selection in case of book clubs see Coyte and Ryan (1991). See also Glazer and Hassin (1982) and Liebowitz (1983).
More specifically, attention is a scarce resource.
Their study concerns the role of two biases in hypothetical decisions about vaccinations. One bias is the tendency to favour omissions over commissions, especially when either one might cause harm. The other bias is the tendency to withhold action when missing information about probabilities is salient. They show that this bias is found even when the overall probability of each outcome is clearly constant across the conditions compared (Ritov and Baron 2000, pp. 168–170).
Policies in response to errors in decision making include default rules, provision or re-framing of information, cooling-off periods, and limiting consumer choices.
Ogus (2000), for example, argues that one should be careful with paternalistic interventions based on cognitive biases, since there may still be welfare maximization notwithstanding the biases and hence there should not be any need for regulatory intervention.
However, under some circumstances like in cases of herd behaviour, specific vulnerability (e.g., Homer Simpson effect) consumers will make such mistakes several times since learning curves do not work always. See, e.g., Laurance et al. (2011).
Also the decision reached by many sellers to adopt on opt-out rather than an opt-in mechanism is arguably an example of product design in response to consumer misperceptions (Bar-Gill 2007, pp. 27).
In addition, Hanson and Kysar (1999) show that endowment effect results in consumer’s over-valuation of his contract and as a results steers him to keep the good instead of returning it as he thought he would do. Due to this endowment effect, consumers will also tend to stay with the provider of services that they already contracted with, despite the fact that competitors offer better options (Brennan 2007).
“Too many” from an efficiency point of view.
Moreover, service could end without a phone call after the introductory period. A consumer who wishes to continue receiving the service could be required to make the call (Bar-Gill 2007, pp. 27–29).
Epstein argues that many of the design features that Bar-Gill explains as strategic responses to consumer misperception can be explained within a mistake-free, rational choice framework (Bar-Gill and Epstein 2007, pp. 7–17).
Epstein resists this regulatory impulse (Bar-Gill and Epstein 2007).
Directive 93/13/EEC.
Directive 2011/83/EU OJ L 304/64, 22.11.2011 of the European Parliament and of the Council of 25 October 2011.
815 ILCS 601 (Illinois Automatic Contract Renewal Act).
Loi no 2005-67 du 28 janvier 2005 tendant a conforter la confiance et la protection du consommateur: art. L. 136 1. – Le professionnel prestataire de services informe le consommateur par écrit, au plus tôt trois mois a au plus tard un mois avant le terme de la période autorisant le rejet de la reconduction, de la possibilité de ne pas réconduir le contrat qu’il a conclu avec une clause de reconduction tacite.
Lorsque cette information ne lui a pas été adressée conformément aux dispositions du premier alinéa, le consommateur peut mettre gratuitement un terme au contrat, a tout moment a compter de la date de reconduction.
See supra section 2.6.
This is because consumers must spread their attention “thinly across thousands of transactions and the management of hundreds of possessions (Maynes 1997, pp. 163–165).
See, e.g., Ovitz v. Bloomberg L.P., No. 38, N.Y. March 7, 2012.
The costs to society of a warning duty are the following: number of annual contract per family ∗ the number of families ∗ the costs per notification.
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Kovač, M., Vandenberghe, AS. Regulation of Automatic Renewal Clauses: A Behavioural Law and Economics Approach. J Consum Policy 38, 287–313 (2015). https://doi.org/10.1007/s10603-015-9286-4
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DOI: https://doi.org/10.1007/s10603-015-9286-4