Payment service providers should take note of an expansive new rule proposed by the Federal Trade Commission (FTC) intended to protect consumer shoppers of goods and services sold on a subscription basis. For merchants engaged in sales of subscription-based products or services, the FTC's objective is to set forth "clear, enforceable performance-based requirements for all negative option features in all media," and the proposed rule would greatly expand the scope of FTC regulations applicable to their offers.

There is, however, a nuance to the FTC's proposed rule that, if enacted, would allow the agency to regulate commercial contracts between businesses that contain automatic renewal clauses, including merchant services agreements. It is important to bring this subtle purpose of the proposed rule to light.

Background: About the Proposed Rule

The FTC published the proposed rule on March 23, 2023 as an amendment to its existing "Prenotification Negative Option Rule," which currently only regulates prenotification plans (such as book-of-the-month) clubs where the seller provides periodic notices offering goods to consumers and treats the consumer's failure to decline the offer as acceptance of the offer.

While the Prenotification Negative Option Rule may have limited applicability in today's marketplace, numerous other laws enforced by the FTC require certain disclosure, consent, and cancellation requirements in sales of subscription-based goods or services, membership clubs, automatic renewal programs, free-trial offers, continuity plans, and other categories the FTC now includes in the "negative option" category.

These laws include, among others, the Restore Online Shoppers' Confidence Act (ROSCA), for online sales; the Telemarketing Sales Rule (TSR), for telephone-based sales; Section 5 of the Federal Trade Commission Act ("FTC Act"), which generally prohibits unfair or deceptive practices; and the Electronic Fund Transfers Act, which governs recurring debits from consumer accounts. There are also myriad state laws that regulate subscription programs and other negative option features, including laws in California, New York, and more than a dozen other states that are actively enforced by state attorneys and class actions.

According to the FTC, the "patchwork of laws and regulations does not provide industry and consumers with a consistent legal framework across media and offers." Moreover, dozens of law enforcement actions brought by state attorneys in recent years and over 100 class action lawsuits filed against businesses for alleged non-compliance with state automatic renewal laws, combined with the FTC's own enforcement efforts and enforcement guidance, have not eliminated "ongoing, widespread deceptive practices" in the negative option marketplace.

Thus, the FTC has invoked its general rulemaking authority under Section 18 of the FTC Act to promulgate a sweeping replacement of the Prenotification Negative Option Rule—to be renamed the Rule Concerning Recurring Subscriptions and Negative Options—to broadly regulate all negative option offers in all media, including by imposing specific disclosure, consent, and cancellation requirements that extend beyond any current law or rule enforced by the FTC.

Why the Proposed Rule Would Impact Payment Processors in Their Business-to-Business Contracts

It has long been the FTC's position that small and medium-sized businesses, including merchant-customers of payment processors, are covered by consumer protection laws and regulations enforced by the agency. Thus, payment processors engaged in the sale of products and services to merchants are subject to FTC scrutiny with respect to their own sales practices.

The hidden pitfall for payment processors is rooted in complaints that merchants file about their payment processors, regardless of whether such complaints have merit. Reasons for customers to complain are many: to effect early termination of an agreement without paying an agreed-to early termination fee; to receive refunds of fees they dispute because they do not want to pay; and to otherwise gain more favorable treatment despite the contractual obligations they signed.

A few complaints about rates and fees or other terms relative to a portfolio of tens of thousands or hundreds of thousands of merchants may invoke unintended scrutiny under consumer protection laws and regulations, notwithstanding best efforts to reasonably accommodate merchants while maintaining a viable payment processing business.

Any merchant services agreement containing an automatic renewal clause could be subject to the FTC's new proposed rule if it were enacted. The FTC has recently tested the waters on applying ROSCA to merchant processing agreements containing automatic renewal clauses and signed through an online application.

That case settled without any admission of liability or findings by a court that the processor violated any law or that ROSCA—a law specifically enacted by Congress to protect online consumer shoppers—applied to the matter. However, the FTC referenced that case in its recent announcement concerning its rule proposal to support one particularly broad provision of the new rule that would encompass not just representations about the automatic renewal component of an offer, but any representation about the underlying product or service. Thus, if merchants complain about rates and fees or any other aspect of the relationship, and the merchant agreement has an automatic renewal clause, the FTC would have a potential law enforcement claim against the processor.

One issue open for comment is whether the FTC should exempt certain industries from the rule. Given the FTC's history of enforcement against payment processors in various contexts, it seems highly unlikely there is a carve-out for payment processors here. Rather, exemptions are more likely to be considered for telecommunications providers and other regulated utilities and entities generally exempted from state law coverage. However, worthwhile exemption arguments for payment processors may be made.

Key Provisions of the Proposed Order to Consider

For an additional summary of the proposed rule's new requirements, read our All About Advertising Law blog post. Among other things, the proposed rule would have the following impacts and pose certain compliance obligations on payment companies in their dealings with merchants (considered as "consumers"), if the merchant processing agreement includes an automatic renewal clause. Automatic renewal clauses have been a mainstay of merchant processing agreements, enabling the merchant to receive the benefit of uninterrupted merchant processing services accepting payments for their sales.

• The rule would directly regulate any contract with an automatic renewal provision as a negative option. The FTC has not proposed to define "automatic renewal" or limit the term in any way.
• The rule would make it unlawful for any negative option seller to misrepresent any material fact related to the transaction, including not only information about the negative option program, but also any material fact related to the underlying good or service. This is a broad requirement that could encompass any contractual terms about rates, fees, term and termination, early termination fees, authorization to debit and credit, personal guarantees, obligations of the merchant to cover losses, and any other term in a merchant agreement, if it includes an automatic renewal clause.
• The rule would require disclosures about any material term related to the underlying good or service, regardless of whether that term directly related to the negative option feature, to be disclosed prior to obtaining billing information from the consumer. The proposed rule further clarifies that such information must appear clearly and conspicuously "before consumers make a decision to buy (e.g., before they 'add to shopping cart')."
• The rule would require the seller (i.e., the payment processor) to obtain unambiguous affirmative consent to the negative option feature separately from any other portion of the transaction. The FTC has suggested that a separate signature or other method of consent solely for the automatic renewal component would be necessary, and one signature to agree to various other, comprehensive terms may not be sufficient.
• If the consumer enrolls online in an automatic renewal contract through a website or web-based app, the seller must provide a cancellation mechanism over the same website or web-based app. This may be an operational challenge for payment processors that have built online apps for collecting merchant application information and agreement signatures but use a different application for merchants to access account information, reports, and merchant services, where an link to effect contract termination may exist.
• If a consumer makes a request to cancel the automatic renewal contract, the seller must immediately cancel the contract, unless the seller asks the consumer for consent to receive a "save" offer (i.e., lower pricing, different term length) and receives the consumer's unambiguous consent to receive such save offer. Sellers must maintain verification of the consumer's consent to receive a save for at least 3 years, or 1 year after the contract is terminated, whichever is longer. This requirement would add technical compliance and recordkeeping obligations that would need to be implemented and worked into operational controls.

Increased compliance burdens always come with reduced flexibility and increased compliance costs. By the FTC's estimate, there are currently 106,000 entities offering negative option features to consumers. For all of those entities, estimated annual labor costs of these entities to comply with the new requirement total about $5.7 million (including about $1 million in recordkeeping costs and $4.7 million in disclosure costs).

The FTC used census data for firms and establishments in industry categories where some sellers offer free trials, automatic renewal, prenotification plans, and continuity plans. It is unclear whether these figures cover payment processors or any other industries serving business customers where automatic renewal or evergreen contractual provisions are used. Given the scope of the rule and the FTC's nuanced interest in applying it not just to true consumer-facing retailers but also business-to-business entities, it is unclear whether these numbers are as comprehensive as they would need to be.

Net Impact of the Proposed Rule

As noted, one of the FTC's primary goals is to synthetize the patchwork of various laws and regulations into a consolidated regulatory framework. Often, this is a helpful goal. However, the proposed rule here would not preempt state laws that are inconsistent or more restrictive or impact the ability of class action plaintiffs to continue to file lawsuits to enforce state laws, often on a seemingly nuisance basis.

Another benefit the FTC has touted is that the proposed rule would "level the playing field" for legitimate businesses, "freeing them from having to compete against those employing deception." This rationale may be difficult to buy, however, as we have seen numerous instances where the FTC has pursued "legitimate businesses" and served as judge, jury, and executioner of its desired outcome, often making settlement the more appealing outcome to defendants than years of costly and distracting litigation.

Notably, various courts have upheld the enforceability of merchant processing agreements in contractual disputes between merchants and payment processors. In our view, the FTC has been pushing the envelope with business-to-business commercial agreements, especially in the payment processing space. The new proposed rule gives the FTC more leeway to push further as it squarely encompasses any contract with an automatic renewal clause, regardless of whether it is signed online, in person, or over the telephone.

The FTC is accepting comments on the proposed rule for a period of 60-days from the date the proposed rule will be published in the Federal Register.