Overstock Under Scrutiny: Does This Recent Decision Represent a New Wave of California Litigation for Sellers of Consumer Products and Services?

by Dorsey & Whitney LLP

OverstockIt is not often that a decision from a California trial court receives or deserves as much attention as the recent tentative decision issued by Alameda County Superior Court Judge Wynne Carvill in the State’s case against Overstock.com.  In People of the State of California v. Overstock.com (10-546833), issued January 3, 2014, Judge Carvill determined that online retailer Overstock.com’s method of calculating its advertised discounts on products sold at its website violated California’s consumer protection laws.  Adding some teeth to that conclusion, he ordered Overstock to pay a hefty penalty of $6,819.000 (calcualted as $3,500 per day from March 2006 to September 2008, and $2,000 per day from September 2008 through September 2013) plus reimburse investigative costs and attorney fees which will likely many millions more.  (The case originated in 2010.)

Though not binding precedent such as a reported appellate decision and almost certainly subject to an appeal for the next few years, Judge Carvill’s decision highlights issues which all businesses selling products or services to consumers should be aware.  Before addressing those practical takeaways, I have few thoughts to share on the legal philosophy that underpins the Overstock decision.

The Origins of the Dispute

Overstock’s business model is to sell merchandise to consumers at prices that are significantly lower than one might find elsewhere, either in retail stores or at other online retailer websites.  The key question in this case is how Overstock goes about determining what the competitors’ price should be (the “compare at price”) when calculating the discount that is advertised to the consumers.  Of course, the higher the compare price the greater the discount that is advertised and the more a consumer might be expected to make the purchase.

Given how integral the compare price and percentage discount is to Overstock’s business model, the company implemented a variety of processes and internal controls over the years to arrive at accurate compare prices and discounts.  No one can suggest that Overstock systematically threw random numbers and discount figures on their website.

The issues that are triggered in implementing such a process are legion.  Naturally, one question is whether the compare price is the highest price on the market, the lowest price or an average.  For some of the products that are offered, the compare price was set by a manufacturer who was charged with the task of conducting their own research along guidelines provided by Overstock.  Certainly those manufacturers (as well as Overstock) have an incentive to peg the compare price as high as possible thereby rendering an inflated discount to increase sales.

These challenges are made even more complicated when the products being compared are not identical in terms of a make and model (e.g., the iPhone 5) but are substantially similar with respect to quality and workmanship.  Add to that the sheer volume of product offerings—hundreds of thousands—the challenges of arriving at an accurate comparison price and discount for every product advertised presents remarkable challenges.

The process implemented by Overstock was by no means perfect.  It was certainly not the same as processes that other companies might implement.  But there was a system in place aimed at making a good faith effort to bring integrity to the advertised discount.

As might be expected, some product offerings slipped through the cracks and were advertised at prices that are even higher than what consumers might find elsewhere.

That is the genesis of this lawsuit.  Although claims in California of this nature are brought by plaintiff lawyers as class actions, in this case, a group of California district attorneys filed the action in 2010 seeking substantial penalties.

The Decision

Judge Carvill analyzed the entire process by which Overstock implemented its comparative price determinations and found it lacking.  In an 89-page decision, he concluded that consumers in California were deceived, ordered an implementation of a new process that is more thorough.  Early reports are that the new process will on average decrease the advertised discount from 33 to 26 percent.  This underscores the point made above that the difference between the Overstock’s plan and the “Carvill plan,” though not resulting in a de minimus change, is not all that drastic.  We are talking about a discount spread of 7 percent.  For all of this, he slapped the company with a $6.8 million fine plus additional costs to be determined.

The length of the decision is unusual.  While it represents an enormous amount of work by the Judge Carvill (particularly in light of our ongoing budget crisis), the complexity found in page after page of the decision illustrates one of the problems with these types of cases.  It reads like a legislative analyst’s discussion of new legislation or a bureaucrats’ recommendation for a comprehensive set of new rules to be promulgated by the Department of Consumer Affairs.  It is, in a word, rulemaking. And yet these exacting standards, which result in a seven percent adjustment to the advertised discount, are applied as an ex post facto law going forward for which a multimillion dollar fine is assessed.  For Overstock, a less offensive result would have been if legislators in Sacramento had amended the consumer protections statutes along the lines Judge Carvill outlined, made the new regulations retroactive, and fined the company a multi-million fine.  At least in that scenario, the company would not be additionally burdened with four years of legal fees for both its defense and the state’s prosecution.

The company’s press release expresses more than mild displeasure at the decision and, in my view, the frustration is understandable.

"Overstock Chairman and CEO Dr. Patrick Byrne said, “Where we use comparison prices, we find at least one example of a retailer selling at that price, and across such cases currently Overstock’s discount averages 33 percent. Judge Carvill instructs that we must instead use one of several methods to derive a comparison price, such as using the highest price from among a set of five retailers chosen from a third-party ranking service for some categories, or of three other retailers for other categories, or from three others for some other categories, or the average price among them, and so on and so forth. I freely confess that I had no sense that the word ‘compare’ was replete with so much arcane meaning, nor that our reading of ‘compare’ to mean ‘it is selling somewhere else at this price’ would prove so odd and idiosyncratic in the eyes of California law.  But as best as we can calculate this weekend, following this stipulation will only shift Overstock’s average ‘compare-at’ discount from 33 percent to 26 percent.”

Byrne continued, “Furthermore, Judge Carvill has unwittingly put smaller suppliers at an enormous disadvantage versus the big players. By way of extraordinary example, His Honor’s reasoning disproportionately and greatly harms our Worldstock store, where we are providing much needed market access to global artisans, and our Main Street Revolution store, which provides similar market access to small domestic suppliers. The rules His Honor has created are highly impractical for these categories (unlike, for example, our sales of brand-name televisions, which can easily be made to conform with Judge Carvill’s ruling). In November of this year Worldstock surpassed the $100 million mark in payments made to our artisan suppliers, we have attempted to run that division at 0 percent profit, and where there has been a profit we have used it to build 26 schools educating 6,000 kids (mostly female) across Africa and Central Asia: That is the department that is disproportionately harmed by Judge Carvill’s reasoning. When we go to Nepal and buy some Tibetan singing bowls from an NGO which serves women-at-risk, bring them home, and sell them with the tiniest markup possible, it can be really, really hard to say what the precise compare-at price is (though as an organization we have bent over backwards to be ethical, and have brought such goods to US markets at prices well below anyone else). Under Judge Carvill’s reasoning it becomes highly impractical to market these unique goods in a way that truly reflects the extraordinary values they represent.”

“We are the gold standard in retail price comparisons,” Byrne added, “and we have been for many years. We verify each comparison price we use, and thoroughly disclose the manner in which we do so. Judge Carvill’s decision is a fine example of the principle, ‘No good deed goes unpunished.’”

The net effect the decision is that it serves as the functional equivalent of a regulation applicable to any online retailer based anywhere in the world.  Or, perhaps to be more precise, it applies to any online retailer that does not contemplate excluding the 38 million California consumers from its base of potential customers.  Given the California marketshare and the way online business is done, it is not practical for an online retailer to exclude Californian’s from purchases.  Once again, California flexes its regulatory muscle which is on par with federal regulations.

Apart from the separation of powers problems that are created in this decision, a serious question of the government’s role in alleviating a duty by the consumer to act in a responsible manner in making his or own financial decision.  This is a case that at its core is about information, and more specifically a consumer’s right to accurate information.  But the consumer’s right to information here is, not about the product (as in a breach of warranty case or most false advertising cases), but about the market.

It is thus fair to consider consumers’ access to other information about the market.  Of course access to information about anything today, including the market, is unparalleled in our Information Age.  Anyone with an Internet connection can do what Overstock and its suppliers do—search the web to determine what other retailers are offering for the same or comparable products.  Indeed, search engines and websites like Priceblink.com give consumers the ability to scan the prices advertised by hundreds of online retailers.

This unparalleled access to information about the market calls into question the fundamental assumption on which Judge Carvill’s decision is based—whether consumers reasonably and detrimentally rely on this information.  No doubt some consumers mindlessly accept whatever price and discount is conveyed and never trouble themselves with a few more clicks of the mouse to compare for themselves.  But should the law really help those who are perfectly capable of helping themselves?

This is not a novel concept in our law.  The principle of detrimental and reasonable reliance, originating in the jurisprudence of common law fraud, is even found in most consumer protection statutes.  How does a consumer prove that he or she was defrauded by a discount that was not quite as significant as was advertised by an online retailer like Overstock when they have at their fingertips a world of information before making their purchase?

Related concepts are found not only in tort, but in contract. The common law doctrine of caveat emptor was long recognized by the courts and codified in the Uniform Commercial Code in the context of “puffing.”  Some statements by a seller, even if not entirely true, are not actionable on a breach of warranty case because the seller should expect some degree of puffery.

These are troubling questions that I trust the appellate courts will grapple with in the appeals.

While few would argue that a retailer should be able to simply throw up any discount figure that has no basis in reality and there is surely some affirmative duty to be truthful, the question that was presented here is just how far must Overstock go in finding all relevant comparative prices.  Although he provided his view on the seller’s duty  in great detail, what Judge Carvill does not appear to have dealt with is the ancillary question of the point at which the consumer bears some responsibility to be an informed shopper.

The Take Away For Sellers of Consumer Products and Services

It is interesting to debate these legal and philosophical questions and where these cases will take us in the future.  But businesses selling products to consumers in California must set aside these abstract debates and more immediately focus on the takeaways from this decision. The case is not binding precedent but its concepts will doubtless be a major focus for consumer class actions attorneys in the coming months and years.

Here are my five recommendations for businesses impacted by this case—steps that can reduce, though not eliminate, the risk of future liabilities:

  • First, it is advisable to implement a thoughtful process by which the comparative prices will be advertised.  To the extent a process is in place, now is a good time for an internal or outside review or audit of that process.  How is a determination of what is a comparable product of comparable quality?  The more comparisons certainly the better, but should an extraordinarily high price be thrown out and is it appropriate to use a market average?  Context and the relevant marketplace prevent a one-size-fits-all approach to these and other questions.  But there should be a defensible process.
  • Second, adequate recordkeeping with respect to all comparisons is advisable and those documents should be maintained for four years from the last date the price is offered.
  • Third, consider disclaimers on your website that disclose the process that is implemented.  Define the terms that are used.  As with any disclosure, consider carefully the FTC’s guidelines .com Disclosures:  How to Make Effective Disclosures in a Digital Age (Federal Trade Commission, March 2013)
  • Fourth, consider the safe harbor that might come from giving consumers a remedy if they find a lower price— “price match” offer.  It is not uncommon for companies to offer this as a marketing message (“we’ll be anyone’s price or refund you the difference”).  In addition to the marketing benefits of such a message, price matching may be a way to diffuse a potential consumer class action claim.  If the consumer finds another price that is lower than the advertised price that is purporteedly the lowest and fails to take advantage of the offer by obtaining a refund of the difference, their claim may be barred.  In other words, the exclusive remedy is what is offered and the policy implicitly acknowledges that, on rare occasions, a consumer may find a lower price for which he or she will have a remedy.  It would be a challenge to assert a claim for deception based on consumer protection statutes having failed to take advantage of the full and complete remedy offered.
  • Fifth, in addition to reading and understanding the Overstock decision, consider the FTC’s Guides Against Deceptive Pricing.  The Guides not only address “retail price comparisons” (Overstock’s issue) but other similar matters such as inflating a price in order to offer a discount at a later date (“former price comparisons”).

The Overstock decision is a reminder that concepts of reasonable and detrimental reliance and caveat emptor are fading in a brave new world in which consumers are kings.  Rather than the law telling the buyer to beware, the seller is the party that must take heed as significant liabilities are lurking irrespective of what the consumers know or might be able to learn on their own.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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